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I

THE 1979 ECONOMIC REPORT OF
THE PRESIDENT

HEARINGS
BEFORE THE

JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
NINETY-SIXTH CONGRESS
FIRST SESSION

PART 1
JANUARY 23, 25, 29, AND 30, 1979

Printed for the use of the Joint Economic Committee

0GB
U.S. GOVERNMENT PRINTING OFFICE
46-126 0

WASHINGTON:

1979

For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington, D.C. 20402

JOINT ECONOMIC COMMITTEE
(Created pursuant to sec. 5(a) of Public Law 304, 79th Cong.)
LLOYD BENTSEN, Texas, Chairman
RICHARD BOLLING, Missouri, Vice Chairman
SENATE
HOUSE OF REPRESENTATIVES
WILLIAM PROXMIRE, Wisconsin
HENRY S. REUSS, Wisconsin
ABRAHAM RIBICOFF, Connecticut
WILLIAM S. MOORHEAD, Pennsylvania
EDWARD M. KENNEDY, Massachusetts
LEE H. HAMILTON, Indiana
GEORGE McGOVERN, South Dakota
GILLIS W. LONG, Louisiana
PARREN J. MITCHELL, Maryland
JACOB K. JAVITS, New York
CLARENCE J. BROWN, Ohio
WILLIAM V. ROTH, JR., Delaware
MARGARET M. HECKLER, Massachusetts
JAMES A. McCLURE, Idaho
JOHN H. ROUSSELOT, California'
ROGER W. JEPSEN, Iowa
JOHN R. STARK, Executive Director
Louis C. KRAUTHOFF II, Assistant Director-Director,
SHEC
RICHARD F. KAUFMAN, Assistant Director-GeneralCounsel
CHARLES H. BRADFORD, Minority Counsel
*

~~~~~~~~(HI)

CONTENTS
WITNESSES AND STATEMENTS
TUESDAY,

JANUARY

23, 1979
Page

Bentsen, Hon. Lloyd, chairman of the Joint Economic Committee: Opening statementSchlesinger, Hon. James R., Secretary of Energy

1
2

THURSDAY, JANUARY 25, 1979

Bentsen, Hon. Lloyd, chairman of the Joint Economic Committee: Open-ing statement
Strauss, Hon. Robert S., Ambassador, Special Representative for Trade
-Negotiations
Eberle, William D., former Special Representative for Tradle NegotiationsTrezise, Philip H., acting program director, the Brookings InstitutionBaliwin, Robert E., professor of economics, University of Wisconsin,

51
52

68
78
81

Madison ---MONDAY, JANUARY 29, 1979

Bentsen, Hon. Lloyd, chairman of the Joint Economic Committee: Open-------------ing statement
Schultze, Hon. Charles L., Chairman, Council of Economic Advisers, accompanied by David Munro, Senior Staff Economist

--

--

--

103
104

TUESDAY, JANUARY 30, 1979

Bentsen, Hon. Lloyd, chairman of the Joint Economic Committee: Opening statement -187
Miller, Hon. G. William, Chairman, Board of Governors, Federal Reserve
System -188
SUBMISSIONS FOR THE RECORD
TUESDAY, JANUARY 23, 1979

Schlesinger, Hon. James R.:
-Prepared statement, together with attached charts
Response to additional written questions posed by Senator Kennedy

6
35

THURSDAY, JANUARY 25, 1979

Eberle, William D.:
Prepared statement -73
Response to Representative Rousselot's query regarding specific U.S.
tax laws that might be changed which would enable U.S. companies
to compete more effectively in the Japanese market without relocating outside the United States Strauss, Hon. Robert S.: Response to additional written questions posed
by Senator Bentsen ------------------------Trezise, Philip H.: Response to additional written questions posed by
Senator Bentsen (III)

88
94
97

IV
MONDAY, JANUARY

29, 1979

Javits, Hon. Jacob K.: Study entitled "Reaching a Higher Standard of
Living," prepared by the Office of Economic Research of the New York
Stock Exchange -----------------------Schultze, Hon. Charles L., et al.:
Prepared statement _--------111
Response to Senator Javits' request to supply an analysis of the
sections of the New York Stock Exchange's study "Reaching a
Higher Standard of Living" dealing with productivity and inflation
TUESDAY, JANUARY

Page

138

184

30, 1979

Miller, Hon. G. William:
Prepared statement- _
_192
Paper entitled "Programs To Reduce Structural Unemployment" Response to Senator Javits' request to supply for the iecord the
Fed's opinion regarding Congress making some provision in law to
deal with the ability of homeowners to keep up with their mortgage
payments Response to an additional written question posed by Representative
Brown-_

204

214
233

I

THE 1979 ECONOMIC REPORT OF THE PRESIDENT
TUESDAY, JANUARY 23, 1979
CONGRESS OF THE UNITED STATES,
JOINT ECONOMIC COMMITTEE,

Washington, D.C.

The committee met, pursuant to notice, at 10 a.m., in room 1202,
Dirksen Senate Office Building, Hon. Lloyd Bentsen (chairman of the
committee) presiding.
Present: Senators Bentsen, Proxmire, Kennedy, McGovern, and
Javits; and Representatives Brown and Heckler.
Also present: John R. Stark, executive director; Richard F. Kaufman, assistant director-general counsel; John M. Albertine, Paul B.
Manchester, Kent H. Hughes, Thomas F. Dernburg, George R. Tyler,
Deborah Norelli Matz, and William D. Morgan, professional staff
members; Mark Borchelt, administrative assistant; Charles H.
Bradford, minority counsel; and Stephen J. Entin, Mark R. Policinski, and Robert H. Aten, minority professional staff members.
OPENING STATEMENT OF SENATOR BENTSEN, CHAIRMAN

Senator BENTSEN. Mr. Secretary, our economy is expanding rapidly.
In the last quarter of 1978; we had a real growth rate of some 6.1
percent. We created 3 million new jobs last year. Yet, inflation remained as a very critical and emotional issue for our country, and
refused to yield to any of the traditional answers.
We have almost rampant interest rates, voluntary wage and price

guidelines, a relatively tight monetary policy, and yet the cost of
living continues to rise at an unprecedented rate and despite a per-

sonal tax cut of almost $13 billion by the Congress last year, inflation

has outpaced the tax cut the people received in the tax bill.
Our dependency on oil imports since 1973 has continued to increase,
and it has now reached almost 50 percent of total domestic oil use.
We have come to depend far too much on oil from the Persian Gulf,
and too little on some of the vast reservoirs that are much closer at
hand, in Mexico, for example.
I don't want to belabor the point. We have made substantial
progress in bringing commendable progress to the problem of solving
our energy shortfall. But we still have a long way to go down a very
dangerous road.
Mr. Secretary, this committee has had an unprecedented number
of requests for membership on it this year, from both the House and
the Senate. I think it reflects the feeling of the Congress that the
economy is by far the No. 1 issue facing this Nation.
(1)

2

We have chosen you as our first witness to start these hearings on
the economy so that we might explore with you the question of energy
and its impact on inflation, and the security of this Nation.
Mr. Secretary, you may proceed.
STATEMENT OF HON. JAMES R. SCHLESINGER, SECRETARY OF
ENERGY
Secretary SCHLESINGER. Thank you, Mr. Chairman.
Mr. Chairman, I do have a prepared statement which, with your
permission, I shall insert into the record, and I will attempt briefly
to summarize some of the major issues that confront us in the interactions between the economy and/or energy sector.
As you know, quite recently OPEC increased prices by 14.5 percent
year-end over year-end. The effect of that will be to impact on the
performance of the economy, and notably, to increase energy prices
and through energy prices the cost of living.
When we trace through the effects of those crude oil increases,
plus the increases on domestic crude oil, the result on gasoline pricesto take a dramatic example-will rise because of crude oil increases
alone, by approximately 4 cents per gallon.
We face, also, a very tight international market in which spot
prices are well above the nominal market prices of the OPEC nations.
This will spill back into even higher prices for imported crude.
Presently in the short run, our conditions are dominated by what is
occurring in Iran, and the effect of the shutdown of Iranian production
on world oil markets. Since the end of December there have been
essentially no exports of crude oil from Iran. Prior to the time Iran
provided something on the order of 20 percent of the oil that flowed in
international commerce, which represented approximately 10 percent
of the free world's crude oil production.
So in the short term we have a problem that affects not only the
United States but other countries as well.
I have not Cone through the impacts of the curtailment of Iranian
production and unless there is a desire on the part of the committee,
Mr. Chairman, I will leave that to the question period.
Senator BENTSEN. Mr. Secretary, that will be covered I am sure
during the period of questioning to follow. You don't have to have that
in your presentation.
Secretary SCHLESINGER. Suffice it to say, Mr. Chairman, that we
are drawing down inventories worldwide at the rate of approximately
2 million barrels a day in excess of what we normally do during this
winter season.
Since world inventories are at a high level, we can afford to do
that for a certain period of time.
We believe that we can get through the first quarter reasonably well;
possibly through the second quarter, although our difficulties will
increase. But unless Iran comes back onstream sometime in the second
quarter, we face increasing difficulties through the rest of the year,
and notably in next winter's season. Normally, after this initial
period of drawdown at the start of a calendar year, there is a period
starting in the spring in which there is restocking, a rebuilding of
inventories. Unless Iran comes back onstream, that rebuilding of
inventories will be less than it should be and as a consequence, next

3

\

winter we would be in trouble, given inventory levels and the expected
demand which should be higher than it is this year.
Senator BENTSEN. Well, I would just interrupt at that point.
Secretary SCHLESINGER. Yes, sir.
Senator BENTSEN. This question concerns all of us. If you have
that kind of a drawdown in inventories coupled with no current
production, are we faced with the possibility of oil and gas rationing
by this summer due to the Iranian shutdown?
Secretary SCHLESINGER. I think not, Mr. Chairman, though I would
prefer not to be categorical on that at this time.
Senator BENTSEN. You do not rule that out as a possibility,
however?
Secretary SCHLESINGER. We do not rule it out, but we think it is
very unlikely, and it should be regarded as a last resort.
We have published recently in the Federal Register, our standby
allocation regulations. To the extent that the voluntary response-in
terms of enforcement of the 55-mile limit, the turnback of thermostats
to 65 degrees during the winter, the elimination of unnecessary
driving-does not work, we may have to have recourse to allocations
later in the spring but I think that we can, under the worst of circumstances, avoid gasoline rationing.
Senator BENTSEN. Fine, Mr. Secretary, proceed.
Secretary SCHLESINGER. I think that that covers the short term
problem.
As you know, Mr. Chairman, other OPEC countries have increased
their production somewhat to offset the effects of the decline in
Iranian production. How long those higher levels of production will
last is also a question that we may have to face.
Without Iran, the world will continue in a supply squeeze and we
face spot market prices well above the nominal prices of the OPEC
nations.
Mr. Chairman, that brings us to the longer term conditions which
reflect the elimination of Iran. Iran affects the longer term as well as
the short term because we do not expect Iran to come back to the same
level of production that was experienced prior to these recent difficulties in that country.
In the longer term, we have recognized, Mr. Chairman, that we face
difficulties in increasing the world's oil output to match the growth of
demand on a historical basis. Each time we review the availability of
oil worldwide for 1985, we come to conclusions which are somewhat
more grim that in the prior review.
For example, in the CIA study of early 1977 it was estimated that
OPEC would produce something in the neighborhood of 44 million or
45 million barrels a day, if needed, in 1985.
Last year, our estimate was 37 million to 39 million barrels a day.
Today, as a result of what has happened in Iran, and because of the
projected investment in capacity by other countries, we anticipate that
OPEC will be on the low side, 36 million to 37 million barrels a day.
As a consequence, in the 1980's we continue to face an inability of

the world's oil suppliers to provide for the growth of demand at roughly

the present price level in real terms. And unless we constrain demand,
we will face either rapidly rising prices for oil, or a reduction worldwide
in income, output and employment, as markets are cleared at those
higher prices.

4
Those are the difficulties that we face in the longer term, Mr.
Chairman.
The underlying question which this committee is interested in, and
what all Americans are interested in, is: "What do we do about it?"
In the first place, we have resources other than oil in the United
States that we have not completely tapped. The current supply of
natural gas illustrates this point. The elimination of the dual market,
Mr. Chairman, has resulted in the beginnings of a flow of gas that
was surplus in Texas, in Oklahoma and, to some extent, in some of
the other States, reflected in an article in this morning's business
section of the New York Times.
It says, "Texas Surplus Gas Begins To Flow."
We have identified up to 1 trillion cubic feet of gas, a domestic
bubble that can back out in the short term, approximately 500,000
barrels of oil a day of imports.
We want to make use of that gas so that we can reduce our oil
requirements and the impact of our oil import bill on the balance of
payments.
Further, we are interested in moving the Alaska natural gas pipeline. There is the possibility of 1 trillion cubic feet of deliverability
from the North Slope.
The investment in that pipeline is desirable from the standpoint of
the long-term energy economy of the United States.
Even if there is no more gas on the North Slope than is present in
Prudhoe Bay, that pipeline turns out to be a bargain in the long term
even though, for the first 5 or 6 years, the prices, given utility rate
setting, will be somewhat higher than some of the alternatives.
In the long run, there is a net national benefit of about $5 billion
without the discovery of additional gas on the North Slope which,
however, we expect to see.
Indeed, we would expect that pipeline to move gas for 50 years
rather than for the 20-year amortization period.
That is a desirable thing.
Further, we are interested in pipeline gas from our neighbors, from
Canada, from Mexico. As you know, Mr. Chairman, we are presently
importing almost 1 trillion cubic feet a year from Canada and we hope
that that flow continues, and we welcome Mexican gas.
We feel that that gas should be competitively priced so that we
can back out residual fuel oil which represents five-sixths of the
potential market for Mexican gas.
By making better use of natural gas, we can alleviate our own
pressures on the international oil economy.
In the oil area, we are not moving as well as we might. Partly this
is due to the surplus on the west coast which is a reflection of our own
energy policies.
We have precluded the export of oil or the swapping of oil with
those who can effectively use it in the Pacific at the same time that
our procedures are blocking the construction of pipelines that can
carry that oil from the west coast into the interior of the country.
Most notable is the case cf the Sohio pipeline from Long Beach,
Calif., to Midland, Tex., that has been held up by these kinds of
procedures for 2 years.

5

California heavy oil can be better employed, can be better exploited
than it is at the present time once we have resolved that surplus
condition on the west coast.
In this connection, Mr. Chairman, I should have mentioned at the
outset that these tight market conditions and the OPEC price increase
have led to a deferral of the decision on the adjustment of the controlled prices for our domestic crude until we see better where the
world's market is going.
We have on the street two rulemakings, one with regard to the socalled new oil, new reservoirs, that would provide incentiveforadditional discovery; and, at the same time, a rulemaking with regard to
so-called marginal wells, particularly those in the lower-tier category,
in order to maintain production at whatever level we can achieve.
Oil is, of course, another problem. We must remember that whatever
we do, right now we are 75 percent dependent in this country on foreign
oil and natural gas and whatever we do in terms of moving to alternative supplies, by the end of the century we will be 50 percent dependent on foreign oil and natural gas.
So, it is necessary to provide the necessary stimulus to production,
particularly in the areas of coal and nuclear.
Mr. Chairman, we recognize, and I think all of us would desire,
that we become less dependent upon foreign sources, particularly
insecure foreign sources, but we have been unwilling to take those
steps that would reduce our dependency on those foreign sources.
In the area of coal, we need to have a stabilization of the regulatory
regime so that industry, as it decides whether or not to invest in coalfired boilers, knows what the future will bear, and that it will not be
faced periodically with changes in the regulatory requirements regarding coal, notably regulations in the environmental area.
Above all else, we need stability in regard to the regulatory regime.
The tendency for industrial capital is to flee uncertainty; to the extent
that we can provide greater stability, we can move coal more effectively.
Similarly in the nuclear area, we have in this country a great deal
of ambivalence about nuclear power, but it will be a necessary part of
our energy mix.
Right now it takes some 12 years to construct a nuder plant, given
the length of the regulatory requirements, given the planning process,
given the length of the construction period.
Each year, Mr. Chairman, of delay in the construction period adds
$120 million to the cost of a nuclear plant or about 3 mils per kilowatthour.
By shortening that process, that is one way that we can help solve
our energy problem, and also reduce the inflationary impact on the
economy.
Inefficiency in the regulatory process has become one of the major
elements in terms of permitting inefficiencies in production, and higher
rates of inflation associated with declining rates of productivity, as
you mentioned in your introductory remarks.
Finally, Mr. Chairman, I should mention conservation. I am happy
to say that since the President's original presentation of the national
energy plan that the arguments over conservation have tended to
disappear.

6
The President asserted conservation was the cornerstone of our
energy policy. There was a great deal of questioning on how much we
could conserve.
In recent years we have brought down the rate of increase of energy
requirements for growth of the GNP from 1.0 to 1 to 0.7 to 1, reflecting
much higher efficiency in our energy use.
Industry has done a notably good job in that regard by reducing
energy requirements per unit of output and their relative share in the
use of energy nationwide.
Conservation has worked, and I think that there is a nationwide
recognition of how effectively, indeed, it can work.
I should underscore that conservation is not a substitute for the
provision of adequate supplies of energy to permit the growth of the
economy, an increase in number of jobs, the growth of production and
of productivity.
Whatever else we do, we must see that there are adequate energy
supplies in the long term to permit the necessary economic growth.
Mr. Chairman, that is a brief summary of the position that we have
taken.
We have short-run problems that, reflecting longer ones, demonstrate the inability of the world's producers to increase dramatically
the supplies of oil, forcing us to turn elsewhere to meet our energy
needs.
Thank you, Mr. Chairman.
Senator BENTSEN. Thank you very much, Mr. Secretary.
[The prepared statement of Secretary Schlesinger, together with
attached charts, follows:]
PREPARED STATEMENT

OF HON. JAMES R.

SCHLESINGER

Mr. Chairman, I appreciate the opportunity to appear before you today to discuss a broad range of energy and economic issues.
In developing national energy policy, careful and continuing attention must be
paid to the close interrelationship between energy and the economy. The burden
placed on the economy by the continually large payments for imported oil has
contributed to record trade deficits and inflation. The ties between energy supplies
and the economy would be all too evident if the United States were to encounter
another major supply interruption of the magnitude of the 1973-1974 embargo,
which could lead to a large and precipitous drop in out put and national income.
Even the Iranian crisis has stretched taut the world's productive capacity, led to
sharp increases in spot prices and provided a basis for higher than anticipated
OPEC price increases.
The immediate concerns raised by the difficulties in Iran and recent OPEC
price increases are only a small part of the energy problems that lie ahead. We
would be lucky indeed to avoid other short-term threats to the security of our oil
supply in the years ahead. Even if we are fortunate, the fundamental reality that
oil supplies are eventually limited must be faced. By the mid to late 1980's, the
Nation will face a condition in which ex-ante demand overtakes supply. Prices
will then be driven up and/or markets balanced by a sudden reduction in income,
output, and employment. We must plan now for the transition from oil to other
fuels in anticipation of that day. Our action, and those of others, can alter this
timing. Slower economic growth, a prescription offered by some, tends to delay
the inevitable. Events such as those in Iran tend to bring it closer.
Let me address for a moment your particular concerns regarding U.S. oil supplies and requirements in light of the crisis in Iran. The recent events in Iran
dramatically underscore our continuing vulnerability resulting from a growing
dependence on increasingly expensive and insecure oil supplies. Overnight we have
seen a 5 percent excess of productive capacity turn into a shortage.
The removal of Iranian production from world markets, coupled with increased
production from other OPEC nations, is resulting in a worldwide drawdown of
inventories of about 2 million barrels per day in excess of the normal drawdown
at this time of year. This translates into an increase in stock drawdowns of approxi-

7
mately 500 thousands barrels per day in the United States. Current stock levels
both worldwide and in the United States make such drawdowns manageable for
the near-term. Increases in production from other OPEC nations have also helped.
But until a major portion of Iranian production is restored-and it is unlikely to
be restored to the full level of 6 million barrels per day-the consuming nations of
the world are borrowing against the future.
Petroleum stocks are normally high approaching the winter to meet increased
winter demand. Higher than normal drawdowns this winter will result in the need
for a faster than normal stock buildup in the spring in order to be prepared to meet
next summer's gasoline demand. If Iranian curtailments continue much beyond
this spring, summer supplies will be particularly tight, and there will be little
chance for rebuilding stocks during the fall in time to meet next winter's peak
demand. Should stocks be insufficient to meet demand during next winter's heating season, prices could increase substantially.
The Administration has, therefore, asked every American to observe the 55
mile-per-hour speed limit, eliminate discretionary driving, turn thermostats down
to 65 degrees, and take a number of other steps. Observance of these conservation
measures could result in oil savings equal to the entire 500 thousand barrel per
day shortfall caused by the shutoff of Iranian exports. This would take the pressure off current stock drawdowns, whatever the duration of the Iranian shutdown
and put the United States in a far better position to meet normal increases in
demand this summer and next winter. Last week I wrote to Governors, Mayors,
associations and companies urging support for additional voluntary conservation
actions now in order to avoid mandatory measures later.
The Administration is also stepping up its efforts to maximize the use of the
current natural gas surplus by urging that existing dual-fired facilities be switched
from oil to gas. With a gas surplus of approximately I trillion cubic feet, the
potential exists for displacing another 500 thousand barrels per day of imported
oil.

\

If the Iranian curtailments continue beyond the spring of this year, and the
response of the American public to voluntary conservation and fuel-switching is
not satisfactory, other Governmental actions to reduce oil demand will have to
be implemented. The list of potential actions. currently under review includes
displacement of oil used in electric utilities by power from nuclear or coal-fired
power plants, further switching from oil to natural gas and coal, possible temporary suspension of selected environmental requirements and deferral of Strategic Petroleum Reserve shipments.
Combined with stringent implementation of the oil to gas fuel switching program, these measures could save up to three-quarters of a million barrels per day.
Unless a new supply interruption in addition to the Iranian crisis should occur,
some combination of these measures, together with the voluntary program,
should be sufficient to compensate for supply shortages and inventory drawdowns
that would occur from a continuation of the Iranian curtailment for the rest of
this year.
As a precaution, the Department will also submit gasoline rationing and mandatory conservation plans to the Congress. It should be emphasized that these
measures are designed to deal with more substantial supply interruptions than
those expected to arise from the Iranian situation.
The current tightening of the oil market due to the Iranian situation demonstrates the type of future events the United States must prepare for today. As
the Members of this Committee are keenly aware, the OPEC nations recently
announced a 14.5 percent increase in the price of crude oil. This increase will also
be reflected in the price of the 2.5 million barrels per day of uncontrolled domestic
production. Taking account of domestic inflation as well, gasoline prices will
rise almost 4.0 cents per gallon in 1979 as a result of these foreign and domestic
crude oil price increases. As a result of the Iranian curtailments, spot market
prices are already running substantially above the announced OPEC price increase. Continuation of this situation could lead to even higher price increases
over the course of the year.
In light of the significant economic effects of both price increases and supply
shortfalls, the United States must take steps to reduce its consumption of oil.
Many avenues are available to accomplish this goal.
One avenue is increased production and use of natural gas. The steady real
increase in the price of new gas provided by the Natural Gas Policy Act, the
protection against inflation, the more stable and predictable regulatory and financial environment, the deregulation of high cost gas (notably that below 15 thousand feet) and "the light at the end of the tunnel" for producers should-after a
transition period-ensure a high rate of drilling activity in the lower-48 States.

8
We, consequently, expect that by 1985 annual lower-48 production will be at
least 2 trillion cubic feet above that which would have pertained if the Natural
Gas Policy Act had not been enacted. Thus, it is essential that producers have
ready markets for this lower-48 production that will be the base of our future
natural gas supply. For this reason, it is essential that the current surplus of up
to a trillion cubic feet, made available to the interstate market upon enactment
of the Natural Gas Policy Act, be absorbed to increase incentives for natural gas
production as well as to decrease oil imports.
As a matter of national policy, when an industry or utility has a choice between
burning oil or gas in existing facilities, that choice should be gas. Proposed regulations recently published under the Fuel Use Act and the Standby Petroleum
Allocation Regulations incorporate this critical priority. This priority does not
affect the Administration's commitment as outlined in the Fuel Use Act to the
longer-range use of coal and renewable resources, as opposed to oil or gas, in new
facilities or existing facilities which are coal capable.
If gas production from the lower-48 States can maintain or increase current
gas use, then reasonably priced supplemental sources of gas should be used to
further displace oil imports. These supplements should come on line according to
a reasonable hierarchy based on their relative marginal attractiveness.
One highly appealing source of supplemental gas supplies is the Alaska Gas
Pipeline. The pipeline represents an important investment in the Nation's energy
future not only because it provides long-term supplies at reasonable prices, but
also because it provides access to anticipated natural gas finds beyond Prudhoe
Bay.
Other high priority sources of supplemental gas supplies are Canada and Mexico.
We welcome such additional supplies-to the extent that they are reasonably
reliable and are priced sufficiently attractively to maintain a market in the United
States. We already receive a trillion cubic feet of imports from Canada, and with
completion of the Alaska gas pipeline, this may increase substantially. Additionally, growing oil production in Mexico is making available substantial quantities
of natural gas. A unique opportunity exists, given the mutual interests of our two
countries, to negotiate gas sales that appropriately reflect the marginal value of
the gas in both nations.
Domestically produced synthetic gas would be next in the hierarchy, although
some uncertainties remain with regard to technical problems and costs. It is
important to demonstrate the economic feasibility of high-Btu coal gasification,
which could substantially increase the quantity of gas available to the U.S.
Finally, at the bottom of the hierarchy falls long haul, high cost, possibly
insecure sources of LNG. We should not shut the door completely to LNG, but
we should turn to it only if other, more attractive, lower cost sources of supply
do not materialize.
Domestic oil production can also be enhanced. In this effort, it is essential that
the logistical and institutional barriers to increased oil production be minimized.
The greatest single opportunity for potential short-term increases in oil production
involves the North Slope of Alaska. Increasing production above the current level
of 1.2 million barrels per day, however, is difficult in view of the crude oil surplus
on the West Coast. Refiners on the West Coast are unable to absorb some 400 to
500 thousand barrels per day in Alaska production, requiring expensive shipment
of this oil to the Gulf of Mexico and the East Coast. If new markets could be
opened for increased Alaska production, the United States could make better
use of this valuable domestic resource, displace substantial additional quantities
of foreign oil, and save billions of dollars in balance of payments outflows. The
Administration is carefully reviewing the possibilities for action in this area.
The Department is also pursuing other methods for increasing oil production
through proposed rulemakings on marginal wells and newly discovered oil. These
regulatory changes could help increase discoveries and production from new
reservoirs and maximize production from existing reservoirs.
A major issue that was not resolved during the last Congress is the development
of a pricing formula for crude oil. The Administration remains committed, as a
matter of energy policy, to moving toward replacement cost pricing for crude oil
with equity for the Nation's consumers. Our current inflation problems, along
with the OPEC price increase and the uncertainties resulting from the Iranian
curtailments have required that we carefully review and weigh the schedule for
meeting this goal. We look forward to further consultation and discussion with you
and other Members of the Congress on this issue.
To meet the challenge of dwindling oil supplies, it is essential that the Nation
make maximum use of its most abundant resource-coal. Increased coal use over
the next decade will require prompt resolution of the uncertainties over environ-

9
mental standards. Technologies are available which allow the clean burning of
coal. Scrubbers are immediately available and atmospheric fluidized bed combustors are the object of a major DOE commercialization effort. But even with
effective technologies, the United States must assure a stable, dependable regulatory climate to provide the certainty needed to expand coal production and use.
To this point, concern over the newly enacted Fuel Use Act has also contributed
to the uncertainties surrounding coal use. Recently proposed regulations now
make clear the Department of Energy's intent to see coal used in major new
industrial and utility facilities wherever possible. Where the choice for new facilities is oil, gas, or coal, coal will be the preferred fuel. Recent orders issued under
existing authorities also make it clear that where gas, oil and coal can be burned in
existing facilities, the Department of Energy (DOE) will press for the use of coal
notwithstanding the preference for gas over oil.
I would like to take this opportunity to make a few remarks about conservation,
a key energy policy area that is directly tied to the development of the Nation's
economy. Conservation is a crucially important means for reducing the adverse
effects of higher oil prices on the economy. Whether we face a potentially serious
short-term problem like Iran, or the inevitable long-term transition so a less
petroleum-dependent energy base, conservation remains the cornerstone of the
National Energy Plan. Historically, growth in the national economy has closely
tracked growth in energy demand. Until recently, this had led many people to
believe that economic growth could not occur without a similar percentage rise in
energy consumption. Conservation provides the key to breaking this historical
relationship between economic growth and energy demand.
One of the most striking developments in recent years is the effect of conservation on the energy-economic growth equation. The National Energy Plan was
premised on reducing the relationship of energy demand to GNP from an historic one-to-one ratio to an energy demand requirement of less than 70 percent of
GNP growth. From 1975 to the present, the relationship between growth in energy
demand and GNP has dropped from approximately 1.1 to .7, and we may all hope
that this relationship can be reduced even more in the future. This significant
development means that the Nation has put conservation into practice. In doing
so, the United States has shown that we no longer must assume that our economic
vitality is inevitably tied to lock-step increases in energy use. With that myth
behind us, we can more clearly see the central role of conservation in our struggle
to minimize oil consumption and shift to the use of more abundant energy
resources.
Finally, I would like to comment on the actions the Department is currently
undertaking to reduce inflation. All of the major actions to reduce oil imports
will have an important positive effect on the Nation's effort to reduce the trade
deficit, strengthen the dollar and control inflation. The Department is also
intervening before the Interstate Commerce Commission to contest railroad rate
increases for coal which DOE feels will inevitably result in higher utility bills and
frustrate the Nation's efforts to reduce our dependence on foreign oil.
The Department is also vitally interested in steps to reduce the time needed to
site and construct major energy facilities. It now takes from 12 to 14 years to
site and construct a nuclear power plant. Each year of delay results in cost increases of up to $120 million. The Department's nuclear siting legislation is
designed to reduce the time required to no more than 6 or 7 years. Also, a group
has been established under the Energy Coordinating Committee to help coordinate regulatory actions of various agencies in the construction of major energy
facilities.
In conclusion, I would just observe that there are few subjects which affect
every special interest and every aspect of a powerful Nation's activities like
energy. Based on the experience of the last several years, building a consensus
concerning our problems, not to mention agreeing upon solutions, is not an easy
task. Enactment of the National Energy Act was an important beginning in
building a national consensus that recognizes the limits of world oil supplies.
The many issues raised by the national effort to meet this challenge are too
numerous to mention in an overview statement. I trust many of those issues not
yet touched upon will be discussed in the course of the questions that follow.
As these discussions progress today and in the future, I would hope we can
build in the spirit of understanding and cooperation that finally helped enact
last year's legislation. The tasks that lie ahead are monumental. Our sense of
national purpose and urgency must be heightened. Honest disagreements as well
as good faith compromises lie ahead. But with that approach, perhaps we can
break the paralysis of inaction experienced in recent years.
The truth is that there is much to do and not much time left in which to do it.
Thank you for this opportunity to appear before you today Mr. Chairman.

Free World Petroleum Demand/Supply
FIrst Qunrtor, 1979

Million Barrels Per Day
60 -

Stock Drawdown

50

401-

Japan

301-

Stock Drawdown

0th er

Western
Europe

Other
OPEC

Other .
OPEC

Iran

201-

1EA Countries

1EA Countrles

II..-.-

:

R

Demand

l

U.S.

Other'
al

U.S.

North
Amerlea

101

Other'

-

Supply-Normal

________

Supply-Without

Iran
'Includes BovIet Block F Chine Not Exports

Free World Stockc Situation
Billion Barrels
hr

Oil In
4

Transit

31Other Free
World
Petroleum
I Stocks

21-

11F
U.S.

Petroleum
Stocks

bays10
4i

n
I
v.

Estimated
Stocks
December 1, 1970

Global Impact from
Net Loss of
Iranian Exports
12 mmbld)

Millions of
Barrels/Daily

Free World Projected Petroleum
Production and Demand

1978
41h Quarter

1979
lot Quarter

1980

2nd Quarter

3rd Quarter

41h Quarter

1st Quarter

M

U.S. Petroleum Supply

0

IAD

Imports From
Iran IM%)
.1

Third Quarter 1978

Projection, Assuming
No Iranian Exports

U.S. Stock Situation
Million of Barrels
1200

December 1978

Natural ons
Liquids

900 i-

-Jit Fuel
Gasoline

600 i
Distillate

Crsidual Oil

3001Crude Oil
180 Days
. 90 Days

0

Gross U.S. Petroleu It'
Stocks

Impact of 600mbld
Shortfall of Imports

Free World Oil Demand and Supply 1966 - 1985
70

r

'6G

601-

so5
2
43.7

0

- 401'a

C
0

OPEC Supply

C."

301-28.5'22 3

201

is 6

24

on - OPE

17.2

UppIV

12.7

10
I

I

I

I

I

I

I

I

I

I

I

I

I

I

i

I

I

I

I

1968 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85

Comparative Natural Gas Prices
$ Per MMBtu

(1 979 Dollars)

or

Hiah World Oil Prices

71Imported Gas - Border Price
Equivalent to Distillate Oil

6

51-

I

4
3121-

II1904
0

0 1

1985

I

1990

i

1995

a

2000IUI
2090

l
._

7UU5

Comparative Natural Gas Prices
$ Per MMB Itu
8r

(1979 Dollars)
High World Oil Prices

716-

Imported Gas - Border Price
Equivalent to Residual Oil

5
41_
3

2F
1
1984
itI

.

.

1985

I

I

1990

1995

2000

2005

Real Gasoline and Crude Oil Prices
(Constant 1972 Dollars)
Cents
Per Gallon

50 r
Gasoline
40

24.3

27.8

22.0

30

Crude Oil

20

10

0 _
1973

1974

1975

1976

1977

1978
(10 Mo. Period)

Real Gasoline and Crude Oil Prices
(Constant 1972 Dollars)

Gasoline
Cents Per Gallon
50 1-

Crude Oll
Dollars Per Barrel
- 9.00

8.00

7.00
co

-

6.00

_ 5.00

4.00
1978
(10 Mo. PerIod)

20
Senator BENTSEN. Mr. Secretary, Congress has been very concerned about possible disruptions in the supply of oil from abroad.
We therefore mandated that standby petroleum reserves and standby
gas rationing systems be established.
We are far behind schedule on both systems.
Last year you said that we would have 250 million barrels of oil in
our strategic petroleum reserve by the end of 1978. To my understanding, however, we only have approximately 70 million barrels now.
In addition, we have no standby gas rationing system yet in place,
nor has one been submitted by the administration.
Tell me what happened?
Secretary SCHLESINGER. Mr. Chairman, let me take the less complex question first with regard to standby gasoline rationing.
As you know, we published a plan in the Federal Register last fall
for public comments. I think that given the haste at the close of the
session last fall, there was no eagerness to receive that on the Hill.
We will deliver that plan, as modified by public comments, to the
Congress early in February, and the Congress will examine that plan
for some 60 days.
With regard to the strategic petroleum reserve, when the administration examined that issue early in 1977, we desired to move that
reserve ahead as quickly as possible.
We inquired of the FEA what level of reserve they had a 50-50
chance of making and we funded at that level. The response was, I
think, about 220 million barrels.
We have just passed, as you indicated, the 70-million-barrel level.
We are about 1 year behind in terms of reaching the target of 250
million barrels.
Quite recently we have been making our schedules; we have been
moving 400,000 barrels a day approximately into the reserve, or
approximately 10 million barrels a month.
However, we have been thrown somewhat off our stride of late, first,
by force majeure resulting from the Iranian shutdown.
Second, there is a consideration whether we should divert some of
our acquisitions to those refiners in the United States heavily dependent on foreign crude in order to avert a shutdown.
By this summer, aside from that issue, we will have 150 million
barrels in reserve.
By next spring we will have the 250 million barrels, as I recall it.
Now, I should point out, as I did, Mr. Chairman, the question of
our ambivalence on the west coast, about which we refused to have
swap arrangements, yet we have procedures too complex to permit
pipelines to go to the interior of the country.
We have had difficulties with regard to permitting for the strategic
petroleum reserve. Despite the fact that we have had excellent cooperation from the permitting authorities, be it the Corps of Engineers
or EPA or the Mine Safety Administration, each of these permits has
taken time. Even at the Federal level, it took us 18 months, I believe,
to get a permit to move brine from Brine Mound, Tex., into the Gulf
of Mexico.
In Weets Island, we are engaged in negotiations with the Mine
Safety Administration and as a result the Weets Island facility has
slipped considerably.
It will come in about a year late.

21
We have had some difficulty with the authorities in the State of
Louisiana with regard to the permitting process.
So, if we want to move these national projects rapidly, and we
ought to be able to do that on the first' 250 million barrels, we need
to have a more dedicated effort with regard to permitting as well
as to other issues.
The last 750 million barrels, Mr. Chairman, will require leeching
operations in those salt domes and that is a complex technical
operation.
We should have the 250 million barrels approximately a year after
our desired date.
Senator BENTSEN. Is it true that we don't have equipment installed
yet to pump that oil out of our reserves at the present time if we
needed it?
Secretary SCHLESINGER. That is true. The removal system was
scheduled to come in in late summer of 1979. We had a desire to move
that oil into storage because we felt quite rightly that we could acquire
it early at lower prices than later on.
The removal system is scheduled to come in in the summer of 1979.
It should be available for next winter should we continue to have
problems on inventory resulting from the Iranian situation.
We can develop a quick removal system of 200,000 to 300,000 barrels
a day at an additional cost of about $5 to $10 million.
We do not believe that that is a necessary expenditure, however.
Senator BENTSEN. Mr. Secretary, mainland China is very much up
front now, a hot topic included on the itineraries of Cabinet-level
officials such as yourself.
Is China now energy self-sufficient? Can we look to exports of oil
from China in the near future?
Secretary SCHLESINGER. Mr. Chairman, China is indeed energy selfsufficient. There are small exports of oil from China to Japan at the
present moment.
I do not believe that the exportable surplus of China will increase
in the near future.
In the more distant future, say 1985, it may increase depending on
luck in the exploration and development process, and the speed with
which foreign oil companies are able to negotiate with the Chinese
Government.
The question is, in large part, uncertain because we do not know
precisely where those resources lie.
Senator BENTSEN. Mr. Secretary, I am deeply concerned about our
situation with Mexican gas
You mentioned the Alaska Pipeline and I agree with you that the
highest priority should be given to domestic production.
But we must not ignore Mexican gas. We should negotiate with them
aggressively for their natural gas. As you well know, we have a surplus
of gas today and, therefore, now is the time to talk, Mr. Secretary, I
strongly feel that the time to negotiate with Mexico is when we have a
surplus of gas; we will be in a much more difficult negotiating position
when we are short of gas in this country. You can make a better deal
at a time like this.
I also feel, having been born and reared on that border and having
some understanding of the Mexican people, that they will retain full
control over what they do with their natural resources. We must stand

22
in line with the rest of the nations of the world in a competitive position
and offer them a competitive price for those resources. If we do not,
you are going to find the Mexican Government committing that gas
elsewhere, perhaps doing some of the wasteful things in Mexico that
we did in years past in Texas when gas was plentiful and cheap. We
can make good use of their excess gas. And they are not going to
produce all the oil we would like to see them producing unless they have
a sale for that excess but associated gas.
Can you tell me the status of the negotiations?
Secretary SCHLESINGER. Yes, sir. The negotiations were suspended
pending the completion of the congressional debate on natural gas,
and since the conclusion of that congressional debate there has been
an effort on the part of both countries, I believe, to renew those
negotiations.
The President will, of course, be visiting Mexico next month and
this is a subject that will come up.
With regard to the Alaska natural gas, I think that we have a chart
attached to my prepared statement that will demonstrate, and you
have raised questions about this, that it is desirable to use domestic
resources.
There is not a conflict, I should emphasize, between domestic
resources and pipeline gas fromSenator BENTSEN. I agree. I don't think it is an "either/or situation." I think we ought to proceed on all fronts to diversifying our
energy supply and try to assure a long-term supply of energy for our
country.
Secretary SCHLESINGER. Yes, and I think that that investment in
the Alaska pipeline is a necessary ingredient that should not affect
what we do on the Mexican border.
I think there has been some misunderstanding of that question.
The question of Mexican gas, I think, is driven by two considerations
which we have discussed at some length with Mexican officials, and,
of course, with Members of Congress and elsewhere.
First, as you know, we are importing approximately a trillion cubic
feet of gas from Canada. The price on the Canadian border has followed

closely the negotiations between the United States and the Canadian
Government.
That price is the highest price for pipeline gas in the world. It is
presently $2.16. The price the Mexicans would have expressed a
preference for is the price of distillate, which now comes through at
approximately $3 per million cubic feet.
The Canadians have indicated to us quietly but firmly that if the
price on the southern border would go to $3, that even though they
recognize that it is not in their economic interest, because it would
result in the shrinkage of sales, that they would be forced to follow
suit.
The consequence of raising that price to obtain that price in Mexico
would be to increase the price that we pay along the Canadian border
by approximately $800 million a year if we were to go all the way.
It would include aSenator BENTSEN. But don't you think those prices are going to go
up on the Canadian border when that contract expires?
Secretary SCHLESINGER. As you know, Mr. Chairman, the Cana-

23
dians have indicated that they would follow the Btu equivalent of
crude oil in their pricing.
They have not done so completely because they have discovered
that their share of the American market has tended to shrink at that
price, given the surpluses in the States, because they cannot effectively
compete at that price.
The second point, Mr. Chairman, follows from that and that is
five-sixths of the potential Mexican market in the United States is
represented by backing out residual fuel oil.
The debate over the natural gas bill indicated that industry would
not pay a higher price to back out residual fuel oil if that price were at
the distillate level.
That came up in the incremental pricing section.
If, indeed, we are unable to obtain a competitive price for Mexican
gas, they will not be able to make as large a market in the United
States as would otherwise be the case.
At a residual fuel oil price, the market is essentially limitless. At a
distillate fuel oil price, the market is exceedingly limited.
In my judgment-and I believe also the judgment of all who have
looked at the energy conditions and the economics-it is no favor to the
Mexicans to press for a price of distillate when the effect of that would
be to constrain dramatically the market available to them in the United
States.
In the long run, we should be eager to have Mexican gas when it is
competitively priced and when it is available as a reliable source of
supply.
Senator BENTSEN. I have one or two more questions.
But first I want to recognize the Senators as they have arrived to
question you. We will do that because I think we ought to reward

patience.

Senator Proxmire.
Senator PROXMIRE. Thank you very much, Mr. Chairman.
Secretary Schlesinger, we are delighted to have you. I very much
appreciate your most thoughtful statement, and your responses to the
chairman's questions indicated how very much on top of this whole
situation you are.
Now, we have talked about the oil supply situation, first the shortrun problem with Iran, and you say that oil inventories are now at a
high level, and we are drawing down 2 million barrels a day.
Can you give us a little more on the arithmetic of that? You told us
2 million barrels a day, but you didn't tell us how big the inventories
are and what level would be a danger point.
Secretary SCHLESINGER. Yes, Senator Proxmire.
About 2 weeks ago-I should be more precise-there were 3.8
billion barrels of oil in the inventory.
There were some 700 million barrles of oil in transit. It takes 30 or
40 days to transitSenator BENTSEN. Mr. Secretary, will you speak into the mike. We
all want to hear what you have to say.
Secretary SCHLESINGER. It takes 30 or 40 days to transit from the
Persian Gulf so oil has continued to flow in even though the shutoff
occurred in December.

24
We still have about 3.8 billion barrels in storage in inventory, but
the amount of oil in transit has diminished.
We are drawing down about 2 million barrels of oil per day. If one
takes the impact of a 90-day cutoff, one can see in relation to the inventories that that is relatively limited. Even a 180-day cutoff, should full
production be restored, is relatively limited in its impact in relation
to the available inventories.
We are drawing down on stocks. We cannot do that endlessly.
To the extent that we do so, it reflects, I think, the anticipation of a
restoration of production in Iran.
Senator

PROXMIRE.

Now, you said that on the assumption that the

Iranian situation does not improve, and on the further assumption
that we don't get the kind of response that we hope to get with

voluntary programs you described, that we perhaps would not have to
go to gas rationing-you say that is unlikely-but you say we might
go to allocations.
What does that mean?
Isn't that kind of a private rationing?
Isn't that the nightmare experience we went through in 1973 when
we stood in line at the gas stations all over the country and there was
sort of a situation where we didn't have official rationing; we had
something that was maybe even worse?
Secretary SCHLESINGER. Of course, that depends on one's judgment
as to the efficacy of rationing, Senator Proxmire.
Generally speaking, we have been reluctant to institute rationing
because we fear that unless there is a high patriotic fervor, the rationing
systems tend to break down very quickly.
Allocation systems are more effective.
The base period that we would draw on is much higher than was the
base period in 1973 and as a consequence, I do not believe that you
would have a repetition of what you described.
Senator PROXMIRE. Well, would you have gasoline stations closing,
for example, on Sundays?
Secretary SCHLESINGER. That is a possibility, Senator. Yes, indeed.
Senator PROXMIRE. Now, you made what I thought was a tremendously impressive presentation with that chart you had on Alaska,
and gave an indication that by moving ahead with that pipeline we
will be assuring ourselves in the long term, in the long run, by 6 or 8
years from now, of a much lower price than if we failed to move ahead
promptly with it.
Would you describe what you mean by putting thi pipeline in place?
Where is the policy decision now?
Is it a congressional decision or is it an administrative decision?
Secretary SCHLESINGER. It is both, Senator Proxinire.
In the first place, due to the congestion last fall, we were unable
to send to the Hill, or the Hill was unwilling to receive-to be more
precise-the reorganization plans that would place the responsibility
of all of these agencies of the Federal Government in one Federal
inspector by which means we would avoid some of the catastrophes

that we experienced on the Alaska oil pipeline.

That reorganization plan will be presented to Senator Ribicoff
and to the House shortly.

That is the congressional side of the action that will have to be
taken, though it need not be taken immediately.

25
The immediate pressure point is certain regulatory decisions by
the
FERC regarding the gas price, regarding the adjustment of processing
costs, and two or three similar items.
The FERC should complete this within 60 days and at that point
we will test the market to see whether this pipeline is privately
financeable.
Senator PROXMIRE. What action, if any, can we take
Congress to encourage proceeding rapidly with that? It up here in the
seems to me,
in my part of the country-Wisconsin-and also in Senator Kennedy's
and Senator Javits' part of he country, this is particularly significant
to us. Is it not or am I misunderstanding?
Secretary SCHLESINGER. I think that it is particularly significant
to you but also, of course, is significant to the entire Nation in
terms
of our secure energy supply.
I think that the expression of interest on the part of Members
of
the Senate and House to the FERC that these matters be resolved
expeditiously, the indication to the financial market and
producers that indeed the expectation is that they will get to the
on with
this pipeline, would be beneficial.
Senator PROXMIRE. Now, supposing we get a negative reaction
from the market.
Is there any action that the Federal Government can consider
any option that we have, any sort of guarantee or any sort of
appropriation, even, that might make it feasible?
Secretary SCHLESINGER. I think that there are two aspects to
that,
Senator.
Of course, the Congress, in approving the President's recommendation, insisted, wrote in, that it should be privately financeable.
That is a decision that is, of course, reversible by the Congress.
But the expectation has been for private financing.
I don't think it is necessary to provide an appropriation but certainly
the Congress will not wish to reject out of hand the possibility
of
loan guarantees for the pipeline.
That would make it more readily financeable on a private
basis.
It would permit certain adjustments of the ratesetting mechanism
that would equalize the rates over a 20-year period or possibly
a
longer period and thus permit the early year cost of that
pipeline
gas to be lower than it would otherwise be.
Senator PROXMIRE. How large would that kind of guarantee
have
to be, roughly; what is the ballpark figure?
Secretary SCHLESINGER. I think that if it is guaranteed for
first period of pipeline operations, that that is the difficult period. the
It should be a percentage guarantee of the cost of the pipeline.
Senator PROXMIRE. I am thinking of the potential liability
to the
Federal Government. How big would it be?
Would it be a $2 billion, $3 billion, $4 billion guarantee? Would
it
be in that area? Bigger than that? Smaller?
Secretary SCHLESINGER. I think that one must look at the pipleine
as several pipelines.
There would be no need, for example, for an American guarantee
of a Canadian portion of that pipeline. The southern portion
of
pipeline below the Canadian border that goes into Dwight, the
Ill.,
would not need to be guaranteed because that is easily financable.
So, one is dealing only with the component from the North
Slope
down to the Alaska-Canadian border.

26
indeed
That is the sum you mentioned of $2 or $3 billion, which
right ballpark.
might be in the
Senator PROXMIRE. Thank you.
Thank you very much, Mr. Chairman.
the second
Chairman BENTSEN. Senator Kennedy, I think you were
to arrive.
Senator KENNEDY. Thank you, Mr. Chairman. to the committee
I, too, want to join in welcoming the Secretary
with his fine presentation.
that is
Mr. Secretary, even though we are a region of the country percent
only heat about 12
a relatively low user of natural gas-we
in different
of our homes in Massachusetts with gas, but it varies important
is an extremely
parts of New England-nonetheless, it
source of home heating energy.
about the
The people in my part of the country are quite puzzled
policy.
administration's energy
about
When they watched the debate in the Congress last year
then saw in recent years the continued
scarce natural gas resources,
dry on the
escalation of energy costs, and then before the ink was
they read in the Washington Post and the
National Energy Act,
and in other
national magazines of the natural gas sources in Texas and product
a problem of overdeliverability
producing States causing
where
bubble. And now they read reports of your New York speech,
premium on the protection of the domestic
you place a very high
industry at the expense of the consumer.
that Canada now
In your New York speech you say, for example, we would welcome
that
provides almost 1 trillion cubic feet per year;
reliable;
additional supplies to the extent that they are reasonably United
that the price is attractive to maintain a market in the
and
You
States and do not force the shutting in of domestic production. the
ignored aspect of
say this last point is a vital but frequently
problem:

even from our neighbors on a
We should be reluctant to contract for supplies
of the American producers,
take-or-pay basis if that should be at the expense
diminishing domestic incentives
resulting in the shutting in of domestic capacity,
for drilling.

what
Now, the consumers in my part of the country want to know
is.
the administration's policy
part of the
Is high price a part of the problem, or is high price aprice is part
in your statements that high
solution? It seems to me
interested in
of the solution and not the problem. I would just be
your repsonse to that.
Secretary SCHLESINGER. Yes, Senator Kennedy.you have raised are
I think that the answers to the questions that
all straightforward.
long time, indeed,
In the first place, we know, we have known for a structure that we
emphasized that because of the dual market
we
could flow
were trapping gas in surplus in the intrastate market that
we created a single national market.
once
there are
Senator KENNEDY. I know that is your position, but
pressures on the
those that felt that with the various competitive
for gas pipeintrastate market and the other kind of debt financing
that would have come onstream.
lines,
that
Secretary SCHLESINGER. I think that there is clear evidence
in
Senator, is beginning to flow as indicated in the article
that gas,

27
the New York Times this morning. Now, with regard to the more
fundamental question that you raise about protection of American
producersSenator KENNEDY. At what price, that is right.
Secretary SCHLESINGER. In the first place, we are not protecting
American producers. We are preventing American. producers from
discrimination.
American producers are producing at lower prices than prospective
foreign imports. The reason for our concern over a take-or-pay contract is that we would contract with foreign sources at higher prices
and shut in lower priced American products.
Senator KENNEDY. But, Mr. SecretarySecretary SCHLESINGER. There is no protection of American industry. We are
Senator KENNEDY. Mr. Secretary, everyone knows there is a rolling
in process. You have just commented that with the pressures on
Canadian gas that they are not-at least at this time-going for Btu
equivalent because of the market pressures.
You are not giving market pressures an opportunity even for our
neighboring countries. You are basing the price of natural gas on
your chart here in order to bring in a natural gas pipeline that is going
to cost approximately $16 billion of American capital, as compared
to the transportation of gas some 14 miles into the gas system in the
southwest part of the country.
You show, by your own charts, that these lines are going to cross
some time in 1992-93.
I say that natural gas policy, with the surplus that we have now,
is based upon what the natural gas projection price is going to be in
Alaska in 1992 or 1993. What that policy is, I think, is an unwarranted
and unjustified burden on the American consumer. It is in my part
of the country. I daresay that the pricing policy of the administration, based on what you anticipate is going to be the cost of gas coming in, will result in what the Congressional Research Service estimates at $6.16 per mcf.
But, nonetheless, those who are developing natural gas policies do
so in order, I believe, to justify the capital market for the Alaska
pipeline.
Secretary SCHLESINGER. That happens to be erroneous, Senator.
Senator KENNEDY. Well, you straighten me out.
Secretary SCHLESINGER. In the first place, the issue of the Alaska
natural gas pipeline is detachable from the general issue of American
supply. That. happens to be an important investment for the United
States in the long run which, over the long run, will provide us, on
average, with lower gas prices over the life of the pipeline even though
the initial cost., you point out, would be higher.
That is a detachable issue.
The other part that you refer to implies, I think, that we should
accept the price on the Mexican border of distillate. This surprises
me, Senator, because in the past you have not been enthusiastic about
pricing gas at distillate prices.
Senator KENNEDY. I wasn't enthusiastic about a lot of your policies
on the regulations, either.
Secretary SCHLESINGER. That is correct, Senator.
So, this is a reversal of your prior position in that you are urging
a price on the Mexican border 35-percent higher than is the price on

28
the Canadian border; almost 50-percent higher than the new gas price
that you have objected to in the natural gas pricing bill; more than
double the average price of gas in the United States; 4 times the
price of gas flowing in interstate commerce; 10 to 12 times the price
of gas that is charged in Mexico; and infinitely greater than the price
of the 400 to 500 million cubic feet of gas that is being flared each day
down in Mexico.
Senator

KENNEDY.

I am delighted to hear you state my position and

then differ with it. That is not an accurate portrayal of my position.
I basically reject it. I think that now we are setting the course of this
country on gas policy which basically has spurned the opportunity for
negotiations with the Mexicans on price; it has been really quite
unimaginative in terms of contracting with the Canadians.
We all understand the distinction of the current price, but we also
understand the importance of rolling in the price. You and I know,
even though you talk about detachability, that unless the investors
gas,
are going to be able to be assured of a very high return on Alaskanplain
to put the investment in. That ought to be
they are not going
to anyone in the investment market.
I daresay that the administration's policy is committing ourselves
to unwarranted and unjustified cost increases.
Let me ask you on one
Secretary

SCHLESINGER.

Let me, if I may-

Senator KENNEDY. Well-I would like to, if I could-we are running
out of time.
Secretary SCHLESINGER. Well, I am coming back to that issue,
Senator.
Senator KENNEDY. In the area of exclusions from the wage-andprice guidelines, you have excluded company price calculations under
the wage-price guidelines. You say that sales by producers of goods
and services included in the following categories are excluded. You
have mineral products in exception of 138.
It says major group 13 and subgroup 138. The major group is oil
and gas extraction; 138 deals with oil and gas field services.
In effect, what we are doing, as I understand it, is putting the limitations of the wage-price guidelines on the various cost activities in the
oil and gasfields but we are not doing it on the pricing or the selling
of the gas.
in
We ask every major corporation to show restraint in these areasthe
am interested in what activities
the battle on inflation, and I
Department of Energy are taking with the oil and gas companies to'
try and bring about the same kinds of restraint that we are asking of
General Motors or A.T. & T.
Secretary SCHLESINGER. Of course, the oil industry is quite complex, Senator.
For the extraction of oil and natural gas, the regulatons, as issued
by the Council on Wage and Price Stability, are as you have indicated.
On natural gas, we are following the legislative practices laid down
last year by the Congress.
For oil, we are continuing to follow the escalation of prices at the rate
of inflation as indicated under the EPCA, but when we get to the refinery gate, the same kinds of constraints will apply to refinery gate
marketing as are applied to other industries.

29
Senator KENNEDY. My time is up, Mr. Chairman.
Secretary SCHLESINGER. Mr. Chairman, could I respond to the prior
comments of Senator Kennedy?
Senator BENTSEN. Yes; if you would keep your answer very short,
Mr. Secretary, as Senator Javits is patiently waiting.
Secretary SCHLESINGER. In the first place, Senator Kennedy, I
should underscore that we have not spurned Mexican gas. We have
repeatedly indicated that we are prepared to take whatever volume
is surplus to Mexican needs at a price that is competitive.
In the second place, the asking price of $3 is, as I have indicated,
is 50-percent higher than the new gas price in the United States,
35 percent above the Canadian price.
The consequence of accepting that, if the Canadians do as they have
suggested, would be to raise the prices to people in northwestern New
England and all across the Canadian border to Washington State, by
approximately 80 to 85 cents per million cubic feet and at a cost to
the economy of approximately $800 million.
Indeed, if you stretch that additional cost to the economy over the
1 billion cubic feet per day that the companies now say that they
expect to get out of Mexico, then the net cost of that additional gas
from Mexico would be approximately $5.25 per million cubic feet
because of the higher prices on the Canadian border.
That is no way to protect the American consumer in general; it
certainly is no way to protect the consumer along the Canadian
border.
Senator BENTSEN. Thank you very much, Mr. Secretary.
Senator Javits.
Senator JAVITS. Thank you, Mr. Chairman.
I join my colleagues in welcoming you, Mr. Secretary.
Secretary SCHLESINGER. Thank you, Senator.
Senator JAVITS. I enjoy your mettlesome answers to the questions.
Perhaps you will (1o the same for me.
Mr. Secretary, what do you think about the OPEC price increase
of 1432 percent? How does it affect the people of the United States
and our business?
Secretary SCHLESINGER. Senator Javits, the size of that price
increase is unwelcome.
It will add about-just in crude oil costs with the increases in
domestic prices-4 cents per gallon to the cost of gasoline.
It will increase the rate of inflation this year by about four-tenths
of 1 percent, and next year about two-tenths of 1 percent.
Senator JAVITS. Now, as to this year, how much money in the
aggregate is it. going to cost the American consumer?
Secretary SCHLESINGER. At the anticipated level of import for this
year, it will add $4 billilon to our balance-of-payments requirements.
Senator JAVITS. Now, Mr. Secretary, don't you think it is fair to
compare that $4 billion to the $800 million you just talked about?
Secretary SCHLESINGER. No, sir.
Senator JAVITS. How do the two relate to each other?
Secretary SCHLESINGER. No, sir, I don't thinkSenator JAVITS. Why not?
Secretary SCHLESINGER. I don't think that is relevant because right
now we have a gas surplus in the United States that we are attemting
to persuade industry to absorb.
46-126 0 - 79 - 3

30

In the second place, if that gas began to flow, it would flow in late
1980 or early 1981. It does not bear on the present circumstance.
Senator JAVITS. Mr. Secretary, hasn't it been your feeling about

our energy policy that we were caught flatfooted in 1974 by OPEC
because we had not prepared some years ahead, and aren't we therefore making precisely the same mistake today if we follow your philosophy that it is today's price that determines our policy?
Secretary SCHESLINGER. No, sir. We are not suggesting that as an
appropriate policy.

We are saying that in the competitive market whatever international
oil prices may be, be they high or low, that external sources of gas
in the American market should be priced at the British thermal unit
equivalent of resid, not of distillate.
If prices go up, so be it.
Senator JAVITS. Mr. Secretary, is it a fact that if Mexico can export
gas, it can produce 20 to 25 percent more oil?
Secretary SCHLESINGER. Indeed, if gas is not sold by Mexico and if
it is not flared by Mexico, then the failure to find a market would
impose a limit on oil production.

But, the production plans of the Mexicans have been drawn up on a
somewhat different basis.
Senator JAVITS. Do your studies indicate the validity or invalidity

of the Mexican claim that their reserves are twice as big as what they
were contemplated to be, say, before this year?
Secretary SCHLESINGER. Through our sources, we have recognized,
since the inception of this administration-and I think earlier than
that-that the Mexican oil reserves prospectively were as great as
those of Saudi Arabia.
Senator JAVITS. Isn't it a fact that we are only importing 400,000
barrels of oil a day from Mexico today?
Secretary SCHLESINGER. That is approximately correct. We are
importing about 90 percent of Mexico's exports. We have repeatedly
indicated that we are eager to be responsive to any Mexican initiative
with regard to financing or technical assistance.
As the chairman indicated earlier, there is sensitivity over the
national patrimony in Mexico, and that as a consequence, we did not
want to seem to be in a position of pushing the Mexicans but we are
prepared to be of whatever assistance we can in raising that level of
production.

Senator JAVITS. Mr. Secretary, we have a way of saying among
lawyers that it isn't what the facts are, it is what the judge thinks
they are that really counts.
Isn't it a fact that we have very materially been poisoning the
atmosphere between ourselves and the Mexicans by the adamant
position that you have taken on Mexican gas?
Whatever you may say about the technicalities, "We will do it
later; we offered them technical help," and so on.
In the meantime, the atmosphere is poisoned and the Mexicans
give up on us because of this seeming position which we take that
we cannot find some way of banking them. Even though their demands
may be what we consider unreasonable, considering the greater issues
that are at stake, especially, Mr. Secretary, breaking OPEC, if
Mexico's reserves are as big as that of the Saudi Arabians, they are
the greatest asset we have.

31

Second, there are millions of illegal aliens pouring across the border
into this country because half of the Mexican people are not even in
the money economy.
There is great disturbance and complaint in this country about
that. Our relations with Mexico are very critical on that subject and
materially are affected by what seems to them to be our arbitrary
policy on their oil and gas reserves.
Those are my conclusions and you are perfectly at liberty to challenge them.
I would like to ask you this: As far as I know, this subject is not
even on the President's agenda for Lopez Portilla in February.
As I understand it, the President is not even going to discuss oil
and gas prices. Do you understand any differently?
Secretary SCHLESINGER. I believe that the subject of energy, indeed,

is going to come up at those meetings. I think the President has indicated that he is not going to negotiate a contract as indeed he
cannot under the law, and probably should not.
With regard to your more general comments, Senator Javits, I do
not agree with your adjectives such as "adamant." We have taken
a very flexible position with regard to this issue. It is not arbitrary.
It has been carefully expressed to Mexican officials since January
1977. It should have been no surprise to them. Indeed, under the
Natural Gas Act we are obligated to hold public hearings on these
prices.

The FERC, in approving such sale, has to be assured that it is just
and reasonable, that the prices and volume are justified, and those
decisions by the FERC, or by the hearing board, cannot be based upon
such concepts as the flow of illegal aliens.
It must be based on the requirements for energy. Now, it is no favor
to Mexico to insist that they be given a price that is so high that they
cannot effectively compete in the American market.
They will be excluded from a substantial share of the American
market if indeed they price at distillate.
The reason for that is that distillate represents only one-sixth of the
potential market.
We are eager to have not only Mexican gas, but Mexican oil, and
irrespective of your questioning of our policies with regard to the
pricing of gas, we have certainly been nothing but encouraging with
regard to oil.
Whatever we say on that subject, we must recognize that the Mexicans have stated that they are concerned about the domestic impact of
too rapid development in terms of its social implications. Those concerns have been reinforced by developments in Iran; they have indicated that they are prepared to go to something on the order of 2.2
million barrels a day by 1982.
The pace of development of these resources is not going to be-and
perhaps we must all agree with regret-sufficient to break the OPEC
cartel.

The only thing that will break the OPEC cartel is very substantial
restraint in our use of oil internationally.
Senator JAVITS. Mr. Secretary, of course, these are things which I
have heard you on before. Will you agree, however, that the matter of
dealing with Mexico on oil and gas is a mix of foreign policy and the
energy question.?

32
Secretary SCHLESINGER. Absolutely, sir.

Senator JAVITS. And therefore that it is not entirely within your
department or within your attributions?
Secretary SCHLESINGER. That is correct. Indeed, in our discussions

with the Mexicans that started in January of 1977, we worked very
closely with the Department of State; our missions to Mexico included
State Department officials as well as energy officials.
Senator JAVITS. May I through you express the hope and the expectation that the President will recognize the importance of this question
and to affirm my own testimony as a witness that this situation, as I
said when I began, is not what the facts are-it is what the judge thinks
they are; and it is very materially prejudicing the relations between
ourselves and Mexico, which are more critical than ever.
May I just ask one or two other questions, if I still have time?
One: We in the Northeast are very deeply concerned about the local
aspect, the regional aspect, of the strategic reserve; and there seems
to be even no provision for that at all, let alone any beginning of it.
Can you enlighten me on that?
Secretary SCHLESINGER. Yes, sir.

The intention reflected in the budget is that no consideration be
given to a regional reserve, as opposed to the general national reserve
located primarily in the Gulf States, until such time as there has been
a chance for the Congress to review a use plan for that general regional
reserve.
Senator JAVITS. So that we cannot-my time is up-expect any
action on that unless Congress changes that?
Secretary SCHLESINGER. That's true.
Senator BENTSEN. I think Senator McGovern is next.
Senator McGOVERN. Thank you, Mr. Chairman.

Mr. Secretary, I want to join with my colleagues in welcoming you
as the first witness before the committee this year.
As you know, Mr. Secretary, the President's budget is being submitted for fiscal 1980, and has been described by him as an "austere"
budget, and has been geared very heavily to the President's concern
about inflation. I would like to ask some questions on the energy
portion of that budget as it impacts on the problem of inflation.
First of all, as one looks at the energy budget of $8.4 billion, I
notice that in excess of $3 billion of that is for defense activities,
weapons of various kinds, naval reactors.
That represents a 12-percent increase in the defense portion of the
energy budget, which, if my information is correct, goes beyond the
increases in other parts of the budget.
It is true that the defense budget itself represents an add-on of
some 3 percent above and beyond the inflationary increase, and this
would be a 5-percent increase above the inflation rate.
How do you justify that kind of an increase in view of the guidelines that have been laid down by the President?
Secretary SCHLESINGER. There are two aspects. For research and
development and weapons labs and testing, there is no increase of the
sort that you have indicated.
In the production area, weapons production area, we have major
new programs on the line: Poseidon retrofit, the production of the
new warhead for the Minuteman III, the start of the development,

. 33
the completion of development on the warhead for the cruise missile,
and the Trident warhead.
We have a very substantial increase as a result of a change in our
strategic posture.
The largest element of the increase in the defense programs relates
to the handling of radioactive wastes that have been in this country
since 1945.
There is a $400 million increase in that program for waste management. Senator McGovern, I think that you and many of your colleagues share the view that we must get on with the management,
indeed, the final disposal of those radioactive wastes left over from
the defense program.
We have delayed long enough. This is a good year to start.
Senator McGovERN. Since you brought that up, Mr. Secretary,
I am working on an amendment to the energy authorization bill that
would require a State to concur with the Energy Department before
it was designated as a nuclear waste site.
It is my understanding that interim studies in the Department
have indicated that there ought to be some kind of State approval
before they are so designated.
Mr. Secretary, would you support giving the States the veto power
with regard to the use of their State as a nuclear waste material
disposal area?
Secretary SCHLESINGER. I think that that is unnecessary, Senator.
We have already indicated to the States; and as a practical matter
unless a State concurs, we would not be in a position to go ahead with
such disposal projects.
There is a very tangled relationship. Under the Atomic Energy Act
the Federal Government preempted some of these decisions, so before
I could agree with the proposal-and I think the proposal is unnecessary-I will have to consult our lawyers.
Senator McGOVERN. Do you support the general principle that
there would have to be some sort of State concurrence before a State
is designated as a site?
Secretary SCHLESINGER. Yes, sir, and we have informally indicated
that to the various States, and I think, as a practical matter, the
States can block such a facility.
Senator McGOVERN. Returning to our earlier line of questioning,
in 1973, when the first oil embargo hit, President Nixon said that we
were going to have to move to greater energy independence.
His position made sense at the time. Since then, we have seen repeatecl price increases over which we have had no control; the OPEC's
most recent one being close to 15 percent for the coming year.
Yet, as you know, we have not become more independent. Whereas
5 or 6 years ago we were importing a fourth of our oil, now it is up to
about half of our oil consumption.
Doesn't that dictate in your mind an alternative energy strategy,
where we move with much greater urgency in developing other sources
of energy rather than relying as heavily as we have on oil?
How are we going to bring the inflationary impact of energy costs
under control if we continue to be at the mercy of oil prices that are
set by an agency over which we have no control?
Secretary SCHLESINGER. Senator, we agree with the objective as
outlined. Indeed, conservation has been immensely successful if we
look at the trends in energy use per unit of output in this country.

34
We have major investments in the technology of solar energy, and
a substantial increase in this year's budget.
We trust that solar energy becomes cost effective, but until such
time that it does, we are looking at potential costs in this area, for
example, solar energy and other alternatives, of $70,000 to $80,000
investment per barrel equivalent.
That is not a way of bringing down energy costs, but your underlying strategy that we should go to whatever alternative energy source
permits us to reduce the rate of inflation is one which we heartily
embrace.
Senator McGOVERN. Well, I agree that there is some increase in
the solar portion of the budget. I think it is roughly comparable to the
increase in the defense part of the energy budget.
The problem is that you begin with such a small figure that when
you increase it, you really haven't done very much in absolute terms.
Haven't you earmarked around $650 million of the entire budget
for solar energy purposes?
Secretary SCHLESINGER. I believe that if we include the tax expenditure, the expenditures are $800 million, and that is a very significant
figure, I think, for solar energy.
Senator McGovERN. That tax expenditure figure is included in the
overall estimates of the energy budget?
Secretary SCHLESINGER. Yes, sir. We do it both ways.
Senator McGovERN. It strikes me, Mr. Secretary, that what you
are proposing will, in the short run, be a very expensive strategy.
Looking down the road apiece, if we are going to continue to be so
heavily dependent on the foreign oil, I don't see much hope for us
getting out of this inflationary bind.
We can cut the Federal budget by a few billion dollars, but that is
quickly neutralized by these very substantial and escalating energy
prices; whereas, if we could begin to make some substantial progress
on alternative sources of energy, not only solar power but biomass,
windpower, hydroelectric, and other things, it seems to me that that
not only holds out the hope for Project Independence at long last
getting off the ground, but it also releases, over the long pull, us from
some of these uncontrollable inflationary factors that we are confronted
with now in OPEC.
Secretary SCHLESINGER. Once again, we share that objective. To the
extent that we can move to alternative energy sources, well and good,
but we must recognize, I think, that we will continue to be dependent
upon foreign sources of supply for our oil and that even by the year
2000 that the amount of oil and gas we use in this country will be 50
percent of our energy budget.
Senator McGovERN. Let me ask a related question, Mr. Secretary.
I think second only to inflationary problems on the economic front,
we have to be concerned about developing programs that are going
to hold out the maximum prospects for jobs for our people.
We still have several million people looking for work. What do your
studies indicate in the Department are the most labor-intensive types
of energy development?
What would generate the largest number of jobs in the various forms
of energy that are open to us?

35
Secretary SCHLESINGER. Conservation generates a very high proportion of jobs, notably in the building trades and in certain unskilled
areas. Solar energy would also generate additional jobs.
The reason that oil and natural gas prices are relatively low is because it requires little labor to produce them.
Senator McGoVERN. Mr. Secretary, my time is up.
Senator Kennedy asked me to submit to you a number of questions
which you may answer for the record.
There are some 14 questions about the Alaska Pipeline which have
been made available to the press and the Senator would appreciate
very much the committee receiving the answers to these questions on
the pipeline within a week from today.
The remainder of the questions on other matters may fall within
the same time frame. I would make those available to you.
Secretary SCHLESINGER. Thank you, sir.
[The following questions and answers were subsequently supplied
for the record:]
RESPONSE OF HON. JAMES R. SCHLESINGER TO ADDITIONAL WRITTEN QUESTIONS
POSED BY SENATOR KENNEDY

Question 1. Has Northwest Pipeline filed a detailed project costs statement
with FERC? If not, on what basis has DOE made its estimate of the costs involved?
Answer. The Department has based its cost estimates for the Alaska pipeline
upon the record in the proceeding before the Federal Power Commission and upon
detailed information filed by the applicants during the President's consideration
of the project pursuant to the Alaska Natural Gas Transportation System Act.
The FPC record contains several thousand pages of detailed exhibits and testimony concerning the costs of pipeline construction. Consideration of that record
and other filed data formed the basis for the cost overrun projections for the Alcan
and El Paso systems that are contained in the President's Decision and Report
to Congress on the Alaska Natural Gas Transportation System, September 1977.
The overall cost overrun projection for the Alaska Highway project (then Alcan)
was approximately 30 percent above the applicant's filed costs. That projection
was based upon a. separate analysis of each major segment of project.
The January 1979, Department of Energy Analysis also presented two additional
cost overrun cases for illustrative purposes. Those cases represent projected costs
approximately 60 percent and 90 percent above the applicant's original filed costs.
Question 2. Do the costs included in your calculations include all costs of gathering facilities? All new developmental wells?
Answer. The consumer costs section of the paper contains an illustrative field
price for the gas of $2.25 in 1979 dollars. That amount is more than sufficient to
cover all incremental costs of natural gas sales from the Prudhoe Bay field. In fact,
the FERC on February 2, 1979 issued a tentative order that would require the
producers to absorb all costs of producing and processing the gas to pipeline

quality within the base price of $1.69 (1979 dollars) plus severance taxes, a total
of approximately $1.86.
The national economic benefit calculations also takes account of the incremental
costs of gas sales compared with continued oil production. Large quantities of
natural gas currently are being produced in association with the oil production.
That gas is being partially processed, compressed to several thousand pounds per
square inch, and reinjected into the formation. The gas-oil ratio will increase over
time and additional gas handling and reinjection facilities will be needed even if
gas is not sold. When sales of gas are commenced, the reinjection process will be
reversed.
The incremental cost of gas production is very small in relation to the value of
the gas. The January 1979, Department of Energy analysis uses the incremental
cost estimates contained in the Van Poolen study of production options for the
Prudhoe Bay field.
Question S. Does it include the complete cost of that portion of the line necessary
to deliver the gas to Dwight, Illinois, or only the price to the border? What is the
estimated cost of this U.S. pipeline?

36
Answer. The cost estimates include the complete cost of the Northern Border
pipeline system which will deliver the gas to Dwight, Illinois, and the cost of the
Western leg portion of the line which will deliver gas into California. In the cost
overrun case from the President's Decision and Report to Congress, the projected
cost (including AFUDC) of the Northern Border system was approximately $1.2
billion (1979 dollars). The projected cost of the Western le-, which consists of
looping existing pipeline systems, was approximately $750 million (1979 dollars).
Question 4. It is not clear in the transportation costs allocation for 2003 how the
costs you estimate affect financing. Are these the costs now being presented to
investors and how does the market view these returns?
Answer. The transportation costs for each year of the project reflect constant
assumptions regarding the cost of equity and debt for the project. The equity
returns are based upon the variable rate of return proposals currently before the
FERC and the Canadian National Energy Board. The proposed allowed returns
for the construction period range between 10 percent and 19.7 percent in the U.S.
and 14.5 percent and 23.8 percent in Canada. depending upon the geographical
location of the construction, and extent of cost overruns. The current proposed
rates of returns for the operational phase are 13 percent for the U.S. and 14.5
percent for Canada.
In the United States, the actual rates of return for the equity investors will be
much higher than the stated regulatory return. The Internal Revenue Code
prohibits the FERC from taking account of the investment tax credit in setting
the rates for the pipeline. The regulatory rate of return, therefore, does not take
account of the value of the investment tax credit.
The FERC and the NEB have not made final determinations regarding the
operation of the variable rate of return or the tariff. Also, no gas sales contracts
have yet been signed. Therefore, it is not clear at this time how the market will
view the equity returns.
The debt financing of the pipeline will be at the market rates prevailing at the
time of financing. The cost estimates are based upon a debt cost of 10 percent;
whether this is too high or too low cannot be determined at this time.
Question 5. Are these returns on investment consistent with the historic cost of
operating pipelines? Are they consistent with rates of return and the rate base
which pipelines have enjoyed in the United States?
Answer. The rates of return comDare very favorably with the historic cost of
operating pipelines. The pre-operational rates of return are considerably higher
than the average allowed rates of return on equity for U.S. pipelines to reflect the
additional risks associated with the pre-completion phase of the project. The
proposed rate of return for the operational phase is near the average for U.S.
pipelines because the risks of the project once construction is completed are not
appreciably higher than for other pipeline projects.
The concept of a rate base determined by original cost less depreciation is
consistent with U.S. Federal practice that has prevailed since the 1930's. It also
is consistent with long-standing Canadian regulatory practice.
Question 6. You cite a transportation cost in the year 2003 ranging from $.68
to $.84. What value are you assuming for the pipeline at that point: salvage
value, zero value, replacement value, current value, etc.?
Answer. The projected transportation costs for the year 2003 are based upon
the depreciated rate base for that year. In the 30 percent cost overrun case, the
2003 rate base for all segments of the project is $0.9 billion (1979 dollars). For the
90 percent cost overrun case, it is $1.4 billion (1979 dollars).
Question 7. Do these figures assume inflation in operating costs of the pipeline
and, if -so, at what rate?
Answer. The estimated operating and maintenance expenses for the pipeline
are assumed to remain constant in real terms, i.e., increase with inflation. The
long run inflation rate assumed in the cost of service model is 5 percent.
Question 8. Footnote No. 1 indicates that project field costs of $2.25 are "used
for illustrative purposes only." While recognizing that a final determination cannot be made at this time, the Committee would appreciate the details of what is
included in this price. Precisely what severance taxes and what allowances for
conditioning? Are these all the costs that should be included in "field costs?"
Answer. The mid-1979 wellhead ceiling price for the Alaska gas under the
Natural Gas Policy Act of 1978 would be approximately $1.69. The Alaska
severance tax varies with the rate of production, but averages approximately 10
percent. The total wellhead price would be $1.86.
The allowance for conditioning costs within the $2.25 thus would be $.39. That
amount alone would be sufficient to cover more than 50 percent of the current

37
estimates of all incremental gas production costs in the field. The FERC, of course,
on February 2, 1979 issued a proposed order that would provide no separate
allowance to the producers for conditioning costs.
Question 9. Please provide the Committee with the calculations by which you
arrived at the price of distillate oil. Figures provided to the Committee from other
sources are lower than your figures; thus, we would like to know how you arrived
at the product price from the crude price used in your calculations.
Answer. The DOE integrated energy model projects that by 1985, the wholesale
distillate prices in the New York area, including cargoes delivered to New York
Harbor, will increase to more than $3.50 per million btu in 1979 dollars, assuming
no real world oil price increases beyond the currently scheduled 1979 OPEC
increases.
Current prices in New York Harbor for domestic distillate oil are more than
$3.00 per million btu ($.41 to $.42 per gallon). These prices do not reflect subsequent OPEC increases but do reflect the substantial domestic subsidy of crude oil
of approximately $1.50 per barrel, or $.25 per mmbtu. Spot distillate cargo prices
have recently been reported as high as $3.25 to $3.30 per mmbtu ($.44-.46 per
gallon).
The 1977 Memorandum of Intentions between PEMEX and the U.S. pipeline
companies regarding the purchase of Mexican gas refers to the "average of high"
prices in New York Harbor. Therefore, in representing New York Harbor prices,
at approximately $3.50 in 1979 dollars in the low world oil price, the DOE analysis
is conservative on the low side.
As the DOE analysis paper notes, the 1984 distillate equivalent price includes
also an allowance for differential transportation costs. The Alaska pipeline cost
includes delivery to major markets in California and the Midwest. Imported
natural gas at border points, particularly on the Southern U.S. border is much
more remote from the marginal natural gas markets. Therefore, to equate the
two gas sources, a transportation cost of approximately $.20 per mmbtu is assumed for the distillate equivalent prices. The $.20 would cover incremental and
operating expenses and additional capital costs for facilities to transport incremental gas supplies to the existing U.S. pipeline systems.
Question 10. Please give the Committee the assumptions made about costs to
be borne by Canada in arriving at the United States cost. Include where appropriate the allocation of procurement exprenses by both Canada and the United
States.
Answer. The consumer cost in the U.S. for costs incurred on Canada will be
determined by whether, and the extent to which, Canadian gas flows through
the pipeline. If Canadian gas flows, the Agreement on Principles between the
United States and Canada contains a complex cost allocation formula that allocates to the United States a portion of the costs of a Canadian lateral pipeline
between Dawson and Whitehorse in the Yukon Territory. The amount of the
U.S. share of costs of that lateral pipeline will be determined in relation to the
extent of cost overruns on the main pipeline. Once in the main pipeline, Canadian
gas would participate in the costs on a zoned, mcf-per-mile basis. The costs estimates in the DOE analysis are based upon an assumption that 1.2 befd of Canadian
gas from the McKenzie Delta will flow in the main pipeline system. Further
details regarding. the cost allocation system and its relationship to U.S. costs
are set forth in the President's Decision and Report to Congress on the Alaska
Natural Gas Pipeline System, September 1977, pp. 163-174.
If the Canadian gas never flows in the mainline system, there would be no
sharing of mainline costs by Canada, but the tariff for U.S. consumers would be
slightly lower than that set forth in the January 1979 DOE analysis due to lower
capital costs and higher fuel efficiency.
From a national economic prespective, the Canadian tariff payments by U.S.
consumers are treated as a real resource cost to the U.S. in their full amount in the
year when incurred.
Question 11. Please indicate whether reinjection costs for natural gas in the
North Slope were offset against project costs.
Answer. Reinjection costs were not offset against project costs, However, as
noted in the anwere to Question No. 2, many of the existing reinjection facilities
will be used to produce, gather, treat, and compress the gas that is sold. These
existing facilities of course are not treated as incremental real resource costs in
the national economic benefit analysis.
Question 12. If a contract with Mexico were executed for $2.60 and escalated
at 7 percent, and if Mexico exported the maximum projected as available according to the Congressional Research Service study (e.g., 1.5 tcf in 1988), is it the

38
judgment of the Department that the Alaskan Gas Pipeline would still be necessary and economically feasible on the basis as in your paper?
Answer. If the Mexican gas were priced at $2.60 (1979 dollars), and the price
escalated at 7 percent per annum (assumed to be equal to the rate of inflation).
it would be a very attractive supplemental source of gas supply. Imported pipeline
gas at that price would be less costly than incremental LNG supplies and the
overall cost would be slightly less than the Alaska North Slope gas for comparable
volumes.
If an assured supply of 1.5 tcf per year of Mexican gas was available for 10-15
years at a fixed price and excalation factor and if currently projected U.S. supply
and demand for gas are accurate, it is probable that construction of the Alaska
pipeline could be deferred for a few years. However, the future of energy prices
and availability, and the vaildity of projection models is sufficiently uncertain
that the U.S. should, at this time, proceed with the project that will develop
the certain energy resource on the Alaska North Slope. The potential for additional
imports of reasonably priced natural gas from Canada or Mexico or the potential
of future domestic supplies are not adequate substitutes for development of a
long-term existing domestic energy supply such as the Alaska North Slope natura I
gas.
Question 13. Has the United States government made any attempt to insure
through understandings with the Canadian government that any excess Canadian
gas is sold through the lower portion of the Alaskan gas pipeline, rather than sold
through conventional pipeline sales?
Answer. There have been ongoing discussions between Secretary Schlesinger
and Deputy Prime Minister McEchan and other Canadian officials regarding the
relationship between possible increased exports of Canadian gas and the Alaska
Highway Pipeline project. The discussions have explored methods by which any
increased Canadian supplies might be used to facilitate the financing and construction of the Alaska Highway project. The discussions are continuing at this time.
Question 14. You have given us the costs to consumers of the Alaska gas pipeline but you have not given us the costs to the taxpayers. Please indicate the
expected cost to the treasury through the anticipated use of the investment tax
credit, accelerated depreciation and drilling and production incentives for gas
producers, using the same assumptions as in your paper.
Answer. The national economic benefit calculation recognizes income taxes as
a cost in two respects. First, a 10 percent real discount rate is used, which is equivalent to a before-tax rate. Thus, to the extent that income taxes represent a surrogate for real resource costs, they are taken account of initially in the calculation of
net benefits. The full capital costs of the project. are treated as a resource cost.
There is no deduction for the investment tax credit or other benefits.
Second, to present a conservative alternative case, the net present value of actual
income taxes that will be paid by the pipeline company are deducted from the
benefits to arrive at the comparative national economic benefits set forth the DOE
Analysis. For example, in the 90 percent cost overrun case with low world oil
prices, the $5 billion advantage of the Alaska project over distillate-priced
imported gas is net of approximately the $950 million present value ($3.6 billion
aggregate undiscounted value) of actual income taxes that will be paid by the
project.
No further explicit recognition of income taxes or income tax benefits need be
made from a national perspective. If the Alaska project does not increase the aggregate level of investment in the national economy, it is not likely to increase to any
significant degree the aggregate level of income taxes, tax credits, or deductions.
The oil and gas producing industry under current tax laws has the ability to write
off investment somewhat more quickly than industry generally, e.g., through
intangible drilling costs deductions and expensing of dry holes.i But, the vast
majority of investments that give rise to such accelerated write-off already have
been made at the Prudhoe Bay field. The incremental investment for gas production is predominately capital investment that is subject to normal income tax
treatment. Therefore, it is not believed that the construction of the pipeline
project would generate significant incremental accelerated tax write-offs or credits
that differ materially from those that would pertain to alternative capital
investments.
I There Is a theoretical possibility that a trivial amount of ANS gas would qualify for
a depletion allowance. An independent producer could receive a 15 percent depletion
allowance up to 6 mmcfd of gas or oil equivalent. which would be allocated over all
domestic production of that producer. IRC Section 613A.

39
To the extent that the Alaska project does give rise to a
level
expenditures than otherwise'would prevail in the economy, higher would of capital
there
be
mental tax deductions or credits. but they would be more than offset by the increincremental tax revenues that would be generated by the capital investment.
In regard to the actual tax consequences of the project, there are two principal
components-the investment tax credit and accelerated depreciation. The investment tax credit would be 10 percent of something over 90 percent of the direct
capital costs of the project. For the pipeline, the investment tax credit would be
approximately $500 million in the 30 percent cost overrun case and $750 million
in the 90 percent cost overrun case. The conditioning plant would generate an
investment tax credit of approximately $150 to $175 million.
The project would also generate to accelerated depreciation. The gross
of taxes paid over the life of the project would not vary between straight amount
depreciation and accelerated depreciation. However, the present value of line tax
the
payments would be less with accelerated depreciation. Under the FERC regulations, the present value advantage or benefit is not retained by the company,
it is flowed through to the gas consumers. From the perspective of the government,
however, the accelerated depreciation compared with straight line depreciation
would reduce the present value of the pipeline project's tax revenues by approximately $250 million in the 30 percent cost overrun case 2 and $375 million in the
90 percent cost overrun case. Accelerated depreciation for the gas conditioning
plant would have a similar effect to the extent of approximately $75 million.
VENEZUELA

Question 16. Have you explored the question of Venezuelan heavy oil?

Answer. DOE maintains close consultations with the Venezuelans to seek solutions to a wide range of energy problems. As you know, Deputy Secretary O'Leary
has just returned from a visit to Caracas, where he discussed Venezuelan plans
for heavy oil development and possible R&D cooperation in enhanced oil recovery
techniques with Venezuelan officials as part of an overall cooperative energy
program.
Question 16. What are your estimates of recoverable heavy oil reserves
in
Venezuela?

Answer. Estimates of heavy oil in place range from 750 billion to
trillion
barrels. The bulk of the Orinoco Belt crude is less than 100 API, is very3 viscous,
and has a high sulfur (4+ percent) and metal (vanadium and nickel) content.
These characteristics present a variety of producing,'transporting, and processing
problems. Estimates of recovery rates range from 5 percent to 25 percent.
Question 17. What are your estimates of production costs?
Answer. Estimates of production costs range from $7-11.50 a barrel, divided
about equally between production and upgrading costs. These estimates include
a 15 percent rate of return on investment but no taxes or royalties. Because of
the high metal and sulfur content, large capital investments in processing installations and protection against damage to equipment and pipes are required. In
view of the complex engineering problems and uncertainties inherent in new technologies, these cost estimates should he considered speculative. '
Question 18. Why is this oil not being produced? What is the Department's
policy toward its development being accelerated?
Answer. The physical and technical characteristics of Venezuelan heavy oil are
substantially different from those associated with conventional crude oils and
involve a wide range of new engineering problems and uncertain ultimate producing costs. Venezuela still has significant undeveloped resources of light, conventional
crudes. The GOV has expressed interest in developing its heavy oil but must make
a series of decisions involving technological approaches, investment mechanisms,
and the other difficult questions associated with the development of new energy
resources. In making these decisions the GOV will have to make difficult politcal
decisions on the balance between indigenous resource development and foreign
technological assistance. DOE and Venezuelan officials are consulting to determine
areas where cooperative programs might be of mutual interest.
Question 19. Has the Department explored opportunities for channeling capital
into this effort through the regional banks?
2 1`7 of s,,s
,f Years Digits of Depreciation-1pV of Straight Line
X Cost of Depreciable Asset, assuming 18-year life for tax purposes DepreciationXO.46
and 8 percent cost
of long term debt to U.S. Government.

40
Answer. DOE believes the international financial institutions can make a major
contribution to international energy development. We support the recent World
Bank decision to increase its lending for oil exploration and development. The
energy lending policies of the regional banks, in particular, the Inter-American
Development Bank, should be reviewed to determine the appropriate role of
energy lending, and, in particular, the optimal balance between lending for energy
and for basic human needs. The Department is currently consulting informally
with staff of the Inter-American Development Bank on a proposal for expanding
the IDB's commercial and political guaranty and insurance authority for Latin
American mineral and energy projects.
Question 20. What about opportunities for increasing oil production in other
Latin American countries like Guatemala, Argentina, Brazil and Peru: Does the
Department have a policy that would enan-c production in Latin America as a
whole and wouldn't this have benefits in terms of the security of our imported
oil supplies?
Answer. DOE considers that diversifying sources of U.S. oil imports. particularly from Latin America, could significantly enhance our energy security. DOE
supports existing programs of expanded World Bank lending and OPIC provision
of political risk insurance for oil exploration and development. We expect oil
exploration and production in Latin America to increase between now and 1985.
DOE is establishing a Foreign Energy Supply Assessment Program (FESAP)
which will make in-depth geological and technical assessments of hydrocarbon
resources in several countries, including Latin America. We expect these assessments will contribute to our understanding of the prospects and lead times for
bringing on new supplies. Expansion of productive capacity in Latin America
could:
Increase aggregate world oil and gas supplies as early as 1985, thereby limiting
both the demand on existing suppliers and the probability and magnitude of oil
price increases.

Further U.S. security interests (including nuclear nonproliferation objectives)
by enhancing the political, economic, and energy position of other oil-importing
countries.
Reduce the need for the U.S. to importune its existing suppliers to extend
production beyond the levels these countries consider optimal.
Extend the period available for improving and installing the alternate technologies that will become increasingly important over the long run.
Improve the security of U.S. supply.

Senator McGOVERN. Thank you, Mr. Chairman.
Senator BENTSEN. Thank you, Senator McGovern.
Now Congresswoman Heckler, please.
Representative HECKLER. Mr. Secretary, coming again from the
Northeast, we are very concerned about our energy policies and we
feel that the burden upon the consumer there is probably the heaviest
in our part of the country, and it has to be taken into account in
terms of energy solutions.
Just recently the Washington Post ran an article on your discussion
of Mexican gas in the meeting with Diaz Serano, director of the Mexican National Oil Co.
I understand from the Post that this was a very stormy meeting.
At the meeting you told the Mexicans that the private commercial
negotiations which had been successfully completed between U.S.
companies and Pemex would be blocked by the U.S. Government.
You say they are pricing themselves out of the market, but it is
apparent that the Mexicans did have six buyers for their gas.
Was it a stormy meeting, and why was it a stormy meeting?
Secretary SCHLESINGER. Well, the question, I think, is: Was it a
stormy meeting, and if so, why.
Representative HECKLER. Are you saying the Washington Post was
incorrect in its analysis?

41
Secretary SCHLESINGER. I would say that the articles written in the
Washington Post bear very little resemblance to reality. [Laughter.]
But I mention this in relation to the coverage of the speech I gave
on gas policy in New York.
If one read the Wall Street Journal or the New York Times, which
were quite accurate, they were far afield from the article that appeared
in the Washington Post.
We welcome-and it was stated in the speech-natural gas from
Mexico.
Representative HECKLER. You simply would not allow for the sale;
is that correct?
Secretary SCHLESINGER. I don't know precisely what you are
referring to in the article.
As I recall, the headline said "Dim on Natural Gas Sales From
Mexico." That is totally wrong.
Representative HECKLER. But as I am told, you had announced to
them that you would block this, that this was the position of your
Department.
Secretary SCHLESINGER. As I have indicated earlier, Congresswoman
Heckler, the discussions with the Mexicans started in January of 1977.
I indicated to the chairman earlier that if the committee would like
it, I would be happy to meet with it with the appropriate Department
of State officials to go over the negotiating record from the very inception of those discussions.
We have indicated that our problems were, first, that we did not
want to tie the price of natural gas to the price of distillate in New
York Harbor in an attempt to avoid raising natural gas prices in the
United States.
Second, that we were concerned about any price, particularly
before the gas flowed, that would upset the Canadian border price.
This was repeated; indeed, there were further negotiations with
Mexicans during the summer of 1977.
Other proposals were put forward which the Mexicans accepted
and then for some reason subsequently reversed themselves on.
In December they broke off discussions.
Representative HECKLER. Senator Bentsen, I think it would be
useful for us to have a complete session on the Mexican gas negotiations, because, frankly speaking, there are so many questions that we
could devote the whole session today to that subject alone. I would
personally like to have the State Department here to testify and
explain to this committee exactly what their rationale was.
It seems to me that their thinking is very out of date in terms of
developing better relations with Mexico.
My main concern is with the problems and ramifications for the
consumers of New England.
Nonetheless, if I were a Mexican, I think I would be quite outraged
about the negotiations as I understand them.
So, to hear a clarification of exactly how they took place would be
very enlightening, indeed.
Secretary SCHLESINGER. I want to say, Congresswoman Heckler,
that I would not in any way accept the characterization of "treating
Mexico as a banana republic."

42
Indeed, what we have done is to treat Mexico in precisely the same
way that we bargained with the Canadians. There are Canadians who
have certain national resentments about the United States but we
have treated the border price at the Mexican border in precisely the
same way as at the Canadian border.
We have conducted negotiations with regard to that price. In both
cases, we are not prepared to simply submit to a monopoly price.
I should underscore that since the Canadians have emphasized
that they would raise their prices immediately to whatever price was
accepted on the Mexican border, that the impact on New England
consumers would be devastating if we were to do as you apparently
are suggesting.
Representative HECKLER. It is my understanding that the Canadians are prepared to raise their price at any rate.
Secretary SCHLESINGER. The Canadians have never suggested that
the price of gas be at the Btu equivalent of distillate in New York
Harbor.
Representative HECKLER. Well, we will discuss this, hopefully, at
another time.
Mr. Secretary, I want to go to another subject concerning the whole
aspect of the energy question because, in New England, where we are
dependent to a ridiculous extent on imported oil, we are obviously
concerned with price.
We are dependent on decisionmaking of OPEC.
In view of that, as well as the overwhelming evidence available to
us-the Brazilian experience with racing car drivers' preference for
gasohol and the extensive support in the State of Nebraska for gasohol
-and the knowledge that this high octane fuel could lower emission
standards and improve production and performance of most car
engines, I wonder why we are dragging our feet on gasohol which could
in some measure, considering our gasoline consumption, reduce our
prices.
I know we are studying the issue, but how long will we study it and
why are we so late when Brazil has already mandated the use of
gasohol?
Secretary SCHLESINGER. The Brazilians, of course, are backing away
from it because it represents a requirement on the agricultural sector
that is detrimental to the food supply.
Let me underscore in this connection that the reason the gasohol
is moving now is because of action taken by the Congress in the
national energy plan in which the 4-cent-a-gallon tax was removed.
As we know, gasohol is somewhat more expensive. Alcohol used in
gasoline is somewhat more expensive than the oil itself. But the removal of that tax by the Congress in the national energy plan is
encouraging that movement.
Indeed, for the reasons that you have mentioned, the augmentation
of octane ratings, gasohol looks like an effective substitute for leaded
gasoline and I would think that it would move increasingly into the
U.S. market.
Representative HECKLER. I would like to bring to your attention,
Mr. Secretary, the fact that alcohol can be derived not only from
expensive grain products but through a process being researched presently at Natick Laboratories in Massachusetts. This process of conversion uses waste materials: old newspapers, garbage, municipal and

43
industrial waste, and converts that waste into a usable resource which
produces a methanol which can be used instead of alcohol in the 90/10
mixture. The process potentially offers us a way of dealing with the
problem of waste disposal in not only the Northeast but other sections
of the country; and, second, creating a gasohol mix that recovers from
a waste product a product that can be utilized as a substance of value.
This process could answer the questions of expense, of the grain
which is presently used from the farm belt and is the main source of
the alcohol.
So, I hope that you, Mr. Secretary, will look favorably on these
potential alternatives because the state of the art is advancing rapidly
and I think, frankly speaking, if one looks at the gas mileage attained
through the use of gasohol, the increase in cost is far outweighed by
the higher performance and the better mileage Which the car achieves.
Secretary SCHLESINGER. Those are well-taken points, Congresswoman Heckler.
I think that generally speaking as an augmentation disproportionate to the energy input, the augmentation of energy output
through higher octane ratings makes this fairly attractive.
Representative HECKLER. No further questions, Mr. Chairman.
Senator BENTSEN. Thank you very much.
Congressman Brown.
Representative BROWN. Thank you, Mr. Chairman.
Mr. Secretary, the current loss of Iranian oil production amounts
to 10 percent of the free world's supply, and 5 percent of the U.S.
consumption. I understand about 42 percent of that or 40 percent
has been picked up by increased Saudi production, at least for a
short time. Nonetheless, we have a change in the pricing- situation.
in the world.
Six months ago the price of the world market oil was below the
OPEC set price.
Now that we have this world shortage, it is considerably above the
OPEC set market price.
Now, you are currently Secretary of the Department of Energy;
you have formerly been Secretary of Defense, formerly the head of
the CIA.
I would just like to ask a couple of questions about all that from
what is a rather unique background that you have.
First, it seems to me that our inability to take military action in
the Iranian situation is apparent. Those are long supply lines to get
us into that area.
Our diplomatic position has been somewhat fickle, to be kind.
First, we were for the Shah forever, then we decided that the Shah
should go; all this within the last couple of Weeks.
Now we support the Bakhtiar government and the new chairman
of the Senate Foreign Relations Committee was on television the
other day saying that he thought that that was premature and perhaps we ought to be supporting Mr. Khomeini.
It seems unlikely to me that the conflict between the religionists,
represented by Mr. Khomeini, who thought the Shah was modernizing too fast, and the students, who feel that the Shah was modernizing
too slowly, is going to terminate any time in the near future. That
threatens us With the prospect that we will not have a restoration of
the supply of free-world oil and U.S. oil from Iran for some time.

44
Now, with that background and with the problems that we have
had, that I understand have been explored earlier by members of this
committee with you this morning, referring to the strategic reserve
getting established in this country-and I understand the new budget
recommends a considerable slowing of the establishment of that
strategic reserve which I find rather surprising-but what are you
recommending to the President with reference to his single-handed
authority on oil prices under the EPCA legislation as of the end of
May?
Are you telling him that he ought to lift the domestic price of oil so
we could encourage domestic production or are you telling him that
we ought to hold down that price for domestic oil, with, of course, what
has had the result of a deterioration of American production, so as to
support his effort to beat back the fires of inflation?
Secretary SCHLESINGER. Let me not state what my own advice is,
Congressman Brown, but let me try and answer your question which
goes to the heart of the dilemma.
Representative BROWN. Is that privileged?
Your advice is privileged because of your relationship with the
President?
Secretary SCHLESINGER. I think that the position of the Energy
Department is reasonably well known and differs from that of other
advisers.
Representative BROWN. If I knew clearly what it was. I wouldn't
have asked the question, Mr. Secretary.
Secretary SCHLESINGER. The heart of the issue is the problem of
anti-inflation policy as opposed to energy policy.
From the standpoint of energy policy, there are various areas in
which increased prices, indeed the ultimate freeing up of this market,
would be beneficial.
That, I think, has been reflected in the general views of this
Department.
Representative BROWN. Is that What you have recommended to the
President?
I hate to keep pressing the point, but I am not clear. You say
everybody knows what you have recommended to him.
Secretary SCHLESINGER. The position of this Department has been
in favor of moving to the replacement cost of energy, of eliminating
controls, but the timing of that is the critical problem.
We have urged that at an early date, consistent with other responsibilities of other senior officials, particularly in the inflation area.
Representative BROWN. Your position, then, I gather, is to some
extent in conflict and the President must ultimately make this
resolution.
Is that fair?
Secretary SCHLESINGER. I think there is a disparity of views.
There are a range of views. Quite obviously, members of the administration who have particular responsibility for fighting, inflation look
with some apprehension upon substantial increases in the price of
old oil, to a lesser exterft of new oil.
Representative BROWN. The President could immediately raise the
price to somewhere above the world price, in effect, immediately
decontrolling the price of oil.

45
Secretary SCHLESINGER. You mean after June 1, Congressman?
Representative BROWN. Yes; he has that authority, doesn' the,
under EPCA?
Secretary SCHLESINGER. After June 1?
Representative BROWN. Yes.
Secretary SCHLESINGER. Yes, sir.

Representative BROWN. Or he could do it on a gradual basis. He
could recommend a step increase or recommend that we keep the
controls where they are; isn't that correct?

Secretary SCHLESINGER. Yes, sir.
Representative BROWN. Now, have you selected in that range
your position?
Secretary SCHLESINGER. I have.
Representative BROWVN. And it is to do what: raise thepriceimmediately, take it in steps, or leave it Where it is?
Secretary SCHLESINGER. I think I could say this, that my general
position has been in favor of a more rapid approach to world prices
and more rapid movement toward decontrol, if that is obtainable.
That has been the advice of some others.
I emphasize that we have dual objectives in this country, at least,
and there is a disparity of views.
Representative BROWN. I paint a somewhat grim picture with which
you have not taken exception with reference to Iranian oil.
Let me ask you, in view of that somewhat staggering policy about
the Shah and Bakhtiar and Khomeini that seems to be emanating out
of Washington, what is your feeling about where the Saudis may wind
up? Are we likely to continue to share their production as generously
as we have in the past? Are they likely to be as generous with us in
terms of oil, or is there some danger that the Saudis may decide that,
since they are unsure of whose side we are on in various places-Taiwan, People's Republic of China, the Shah, Bakhtiar, Khomeini-are
they likely to be seeking a position that would see their oil distributed
not only in the free world but perhaps also through other nations and
into the Communist world?
Secretary SCHLESINGER. It is certainly conceivable, Congressman
Brown, and let me make a general comment and then a specific
comment.
My general comment is that in the face of the unrest, the disturbance, the concern throughout the Persian Gulf region, that clear,
unequivocal indications of American strength and steadfastness are
necessary to shore up all of the countries of that region other than
Iran.
Representative BROWN. Is that why we sent the F-14's over and
then announced thatSecretary SCHLESINGER. The F-15's, you mean?
Representative BROWN. F-I 5; yes.
Secretary SCHLESINGER. I presume so.
Representative BROWN. And then announced that they were
unarmed? [Laughter.]
Secretary SCHLESINGER. That was more equivocal than I would have

preferred, Congressman.
Representative BROWN. Was it done by the same person or was that
just confusion within the administration?

46-126 0 - 79 - 4

46
Secretary SCHLESINGER. I cannot answer who had the responsibility
for that. I presume that it was a position taken by the Department
of Defense.

Representative BROWN. So I gather what you are telling me is, we

need to firm up our policy with reference to the Middle East and the
oil situation in particular unless we are going to risk the loss of some of
that Saudi production?
Secretary SCHLESINGER. It's not only a question of the energy issue,
Congressman Brown; it's the geopolitical position of the Middle East.
Unless these nations see firm and unequivocal western policies, the
position that they have enjoyed and we have enjoyed since World
War II could be dramatically shaken, and consequently, the geopolitical setback would be even more significant than the impact on
energy.
That's the general comment.
With regard to the specific comment: The Saudis, as you know,
have established an 8.5-million-barrel-a-day limit on production. They
have, as you have indicated, as a result of concern about oil supply,
permitted that to go above 8.5 million barrels a say in recent months,
but they have not changed their general policy.
Representative BROWN. How long are they likely to keep that
absorption of the Iranian loss going?
Secretary SCHLESINGER. We do not know the answer to that. They
have been attempting to accommodate us and the other industrial
nations-indeed the LDC's as well. Their desire-I think this is the heart
of your question-to make what they regard as sacrifices to accommodate us will be influenced by their perception of our general strength
and the long-term reliability of the support that they will receive from
western nations.
Representative BROWN. And some

Secretary SCHLESINGER. To the extent that they lose some of that,
they may be less unwilling to turn elsewhere.
Representative BROWN. And regarding some of our other relationships, the Iranians were supplying oil to the Israelis, were they not?
Secretary

SCHLESINGER.

That is correct.

Representative BROWN. Are we prepared to pick up that slack from
our-whatever it is-supply of oil in this country and supply the
Israelis?
And, if we do, how is that likely to impact on the Saudi reaction to
picking up the world's slack?
Secretary SCHLESINGER. The United States is obligated under the
1975 Sinai II Agreement that, if the Israelis are unable to obtain oil
elsewhere in the world, to provide oil to Israel, approximately 70,000
barrels a dav.
I think that to the extent that the United States demonstrates its
continued determination to live up to its agreements, that that will
not be taken by anybody around the world as a reason for turning
away from the United States.
Representative BROWN. Are we prepared to ration to accomplish
that, ration here?
Secretary SCHLESINGER. I don't think that 70,000 barrels a day
would be significant enough to cause rationing. It's a very, very small
part of our total consumption.

47
Representative BROWN. A final question from me, Mr. Secretary;
my time is up, and I appreciate the chairman being very generous
with me.
Let me ask: Are we going to pay the Mexicans, when we reach an
agreement on natural gas supply from them, more than what we would
be paying the Texans and Louisianans at the same time?
Secretary SCHLESINGER. Both the asking price by the Mexicans and
the counteroffers by the United States are above the new gas price for
our domestic producers. We went into this somewhat earlier, Congressman Brown; the point that I was making was our desire to use domestic
production because of its lower cost. Senator Kennedy indicated that
he felt we were having a protectionist policy, and my point was that
we have the very opposite of a protectionist policy. We are not protecting high-cost domestic production; we are attempting to make use
of lower cost domestic production before turning to higher cost external
production.
Representative BROWN. Finally, if I may, Mr. Chairman, I would
like to submit for the record to the Secretary a question that was
prepared by Senator McClure, who was unable to be here. If I can
submit that for the record and also for the Secretary, perhaps you
would be kind enough to answer that and respond to Senator McClure.
Secretary SCHLESINGER. Yes.
Senator BENTSEN. I would like to ask you, Mr. Secretary, a question
about the supply of unleaded gasoline. Unleaded gasoline has been in
tight supply. We have had some spot shortages, and it sells from 5 to
7 cents a gallon more than leaded gasoline.
Alfred Kahn recently said that it might be necessary to put an additional tax on leaded gasoline. Are there any plans at all to do that?
Secretary SCHLESINGER. No, sir; there are no such plans. I think
that there has been some discussion of removing the tax on unleaded
gasoline as a way of bringing those into price balance.
Senator BENTSEN. To keep unleaded consumers from substituting
leaded gasoline, right?
Secretary SCHLESINGER. Yes, but I have heard no suggestion of an
increased tax on leaded gasoline.
Senator BENTSEN. I would like to ask you about a decision on an
ICC case that affects San Antonio, Tex., which has major implications
for the entire Nation. The Burlington Northern Railroad asked for
an increase in transportation costs for coal that was approximately
twice the price for transportation that they had originally told the
city of San Antonio would be charged them. That original price played
a very major role in their decision to convert to coal in trying to
implement your coal conversion policies.
Your Department intervened in behalf of the city of San Antonio
before the ICC for which I am most appreciative. But we lost.
Do you have any feeling of what that decision is going to do to your
coal conversion programs in this country? Do you think any legislation
is necessary to deal with this area?
Secretary SCHLESINGER. It would be premature to say, Mr. Chairman, whether legislation is necessary, but I think the situation should
be carefully watched. Indeed, as you indicate, this Department did
intervene with the ICC in regard to the rates charged by the Burlington
Northern. There was some reduction from the request, although the
rate does remain quite high.

48
We are involved in the generic proceedings on coal rates, Docket
No. 357, of the ICC, which bears very closely on the question you
raise. If we are to allow the increases-the prospective increase in coal
demand in this country to be skimmed off in the form of rate increases
in the transportation sector that makes coal uneconomical, then we
would have not only struck a devastating blow against the coal conversion program, but we would have eliminated the traffic that the
railroads hope to enjoy in the future.
That would be a case of killing the goose that laid the golden egg
from the standpoint of the railroads while damaging the national
interest in moving toward coal.
Senator BENTSEN. Mr. Secretary, you have heard almost unanimously from this committee a deep concern about possible negotiations
with Mexico on natural gas.
I have lived on that border. It is part of my life. I feel, whether
either nation likes it or not, that our futures are in part intertwined.
There are 63 million Mexicans. If you extrapolate their present mortality rate and birth rate, that country's population will double in size
in 19 years. And by 2025, without a break in that trend, you will see
more Mexicans than Americans. The problem of spillover is apparent.
It is terribly important to us consequently that we have a country, a
neighbor there, that is economically and politically stable. It is in our
mutual interest. So, the question of Mexican natural gas has very
broad implications, far beyond issues or price.
Regarding the stalled negotiations on that gas, what happened at
the Export-Import Bank when they were talking about financing
the pipeline coming up through Mexico? That loan was denied. But
all the U.S. negotiators did was turn around and get a consortium of
banks, American banks and foreign banks, to lend the money they
need.
I just don't see how the Eximbank's actions contributed in a positive
manner to trying to work out a deal with Mexico. Would you explain
that to me?
Secretary SCHLESINGER. Yes, sir. Let me do two things.
First, I endorse in their entirety the general comments that you have
made. Second, with regard to the Export-Import Bank loan, from time
to time we have encouraged the Eximbank to make-to grant credit
to Mexico. The Eximbank cannot or could not, according to its
procedures, issue a loan prior to the signing of a contract; a clear
indication with regard to price. Consequently, the Eximbank never
completed that loan.
That is a part of the procedural question. I would recommend
Eximbank financing, Mr. Chairman, and this is one of the areas in
which we as a nation are inhibited, but the Eximbank does not grant
loans, front-end capital, as the World Bank is presently moving to do.
The Eximbank is restricted only to granting loans if they will move
American goods and services.
I think your point is well taken that there is room here for front-end
money, particularly with PEMEX capital shortage, critical as it is.
Other nations are not so restrictive in their lending policies. If the
Congress were to review that, there may be the opportunity to broaden
the charter of the Eximbank.
Senator BENTSEN. I think that is a good suggestion. I think Eximbank officials may have interpreted their policy rather narrowly in this

49
situation, because we are Mexico's No. 1 customer and they, in turn,
are a top customer of ours. We have had a trade surplus generally with
Mexico, and whatever they do that brings about progress in their
country means a lot more sales of American products in Mexico.
So I would certainly encourage that kind of interpretation.
Mr. Secretary, I think from what you have heard and from the
substantial number of members we have had in attendance during
this hearing, that there is intense interest in what you have had to say.
There have been some very strong and diverse opinions offered, and
we appreciate the manner in which you have handled your testimony
and in the way you have answered our questions.
Thank you very much. Just a moment-I beg your pardon.
Congressman Brown.
Representative BROWN. Mr. Chairman, I am advised that Senator
McClure wanted me to get that question on the record here. Is it
possible for me to read the question and for the Secretary to respond?
Senator BENTSEN. Yes, of course.
Representative BROWN. Thank you, Mr. Chairman.
In 1970 we had the disruption of foreign oil supplies caused by a
break in the Tapline in Syria. In 1973 and 1974 we had the Arab oil
embargo resulting from the October 1973 Middle East War. And
today we have the loss of Iranian oil due to internal political disruption
in that country.
Throughout this entire period the Congress and the administration
have had one consistent response: Discourage domestic energy production and encourage increased dependence on foreign imports. The 1975
Energy Policy and Conservation Act is perhaps the most striking
example of this irrational response to a critical threat to our national
survival. As you know, under this act the U.S. Government forces
producers of domestic oil to subsidize importers of foreign oil. This
degree of irrational behavior borders on the edge of a national deathwish, as viewed by both our allies and our enemies overseas.
In addition, we have the continuing administration opposition to the
development of nuclear energy. Last year it was my understanding that
this opposition had been somewhat modified, particularly with regard
to the Clinch River breeder reactor project and related safety activities.
As you know, the President agreed not to terminate Clinch River and
to move ahead with the related safety work.
And yet, reading the President's budget, I see that the administration again proposes to terminate the Clinch River LMFBR project. I
see also that the funding for safety research is to be reduced from the
agreed upon figure of $48 million to $36 million and that agreed upon
funding for phase 2 of the Safety Research Experiment FacilitySAREF-has been totally eliminated.
The question is: Does this represent an administration oversight
by the Office of Management and Budget or does it mean that the
President is reneging on his agreement?
That is Senator McClure's question. Would you care to answer that?
It would certainly make some of the other questions mild by comparison.
Senator BENTSEN. Mr. Secretary, (1o you think it is possible to keep
the answer shorter than the question? [Laughter.]
Secretary SCHLESINGER. There are three aspects: Fiist, I think that
Senator McClure does point to some inconsistencies in our policies

50
over the last 7 years. We have not been of one mind nor have we been
totally rational in adopting national policies to move toward lessened
dependency.
Second, whether or not those harsh words about the EPCA are
justified, I would not be prepared to say. I was not one of the authors
of the act.
Third, with regard to the nuclear issue, as you know, the President
did agree that he would not veto a Department of Energy authorization bill that contained $540 million for its first fiscal year. He would
approve $513 or $520 million-I forget the exact numbers-in subsequent years, if we could get the agreed on arrangements for the
Clinch River breeder reactor. The phrase that was used was "discontinued," "termination" sounding somewhat harsh. We are still
prepared to fulfill those arrangements with regard to the breeder
program.
I do not think that the President in any way has reneged on his
position. Whether or not the Office of Management and Budget had a
role to play in the budget levels, I think, is a question that perhaps
answers itself.
Senator BENTSEN. Thank you very much, Mr. Secretary.
Secretary SCHLESINGER. Thank you very much, Mr. Chairman.
Thank you, Congressman Brown.
Senator BENTSEN. The committee is recessed.
[Whereupon, at 11:58 a.m., the committee recessed, to reconvene
at 10 a.m., Thursday, January 25, 1979.]

THE 1979 ECONOMIC REPORT OF THE PRESIDENT
THURSDAY,

JANUARY 25, 1979

CONGRESS OF THE UNITED STATES,
JOINT ECONOMIC COMMITTEE,

Washington, D.C.
The committee met, pursuant to recess, at 10 a.m., in room 1318,
Dirksen Senate Office Building, Hon. Lloyd Bentsen (chairman of the
committee) presiding.
Present: Senators Bentsen, McGovern, and McClure; and Representatives Long, Mitchell, Brown, Heckler, and Rousselot.
Also present: John R. Stark, executive director; Louis C. Krauthoff
II, assistant director-director, SSEC; Richard F. Kaufman, assistant
director-general counsel; John M. Albertine, Lloyd C. Atkinson, Kent
H. Hughes, L. Douglas Lee, Deborah Norelli Matz, and William D.
Morgan, professional staff members; Mark Borchelt, administrative
assistant; Katie MacArthur, press assistant; and Robert H.- Aten,
Stephen J. Entin, and Mark R. Policinski, minority professional staff
members.
OPENING STATEMENT OF SENATOR BENTSEN,

CHAIRMAN

Senator BENTSEN. It is 10 o'clock, and this hearing will start.
As wve begin the second clay of our annual hearings on the economy,
the Joint Economic Committee will focus on the problems and the
potential in the area of international trade.
We are privileged to have as our first witness the President's
Special Trade Representative, Ambassador Robert Strauss, who is on
the verge of completing one of the most complex, sensitive, and significant trade agreements ever negotiated-a treaty that is going to be
reviewed in great detail by the Congress but has to be accepted or rejected by the Congress without amendment. Ambassador Strauss accepted a difficult assignment and, as usual, he has worked it out very
well. We are pleased to have you here.
Following Ambassador Strauss to the witness table will be a distinguished panel composed of Mr. William Eberle, who has also served
as a trade representative and who played such an important role in the
enactment of the 1974 Trade Act. Mr. Eberle -will be joined at the
table by Prof. Robert Baldwin, professor of trade policy, University
of Wisconsin; and Mr. Philip Trezise, a well-known trade authority.
Ambassador Strauss, depending on the arithmetic one prefers, our
balance of trade deficit was somewhere between $29 billion and $35
billion last year. It was, in other words, equal to the budget deficit
projected by the President for the coming year.
(51)

52
Our trade deficit with Japan was about $12 billion, which has
prompted the comment that the United States is still the land of
opportunity if you happen to be a Japanese businessman.
In my opinion a trade deficit of that size is an intolerable, totally
unacceptable deficit, and we just can't permit it to continue. That
kind of a deficit erodes the value of our currency abroad, it causes
inflation at home, and it destroys the financial system-it is a clear
and present danger for the economic future.
Before you begin your testimony, I would like to make a couple of
points, Mr. Ambassador.
We appreciate how hard you have worked for the Geneva agreements, but we also know that that is not some kind of a magical
"fix" to all of our trade problems. I would hope, however, that you can
tell the committee how, and to what extent, congressional approval
of the treaty will improve our ability to compete on a basis of equity
in the international marketplace, in other words, what we stand to
gain on the MTN.
I also understand that you have been a long and a consistent proponent of free trade. Lately, however, some of us have begun to
question whether that trade really flows equally in both directions.
I don't seek to export a blame for the trade problems; I know that a
lot of these trade wounds are self-inflicted; but I also know that we
bear some pretty nasty scars on our backs and some of our partners in
international trade, the same countries that clamor for access to our
markets, have no qualms about finding ways to deny us export opportunities in their markets. I just don't want to see free trade become
a one-way street and I know you don't either.
I would be interested in hearing your comments about enforcement
mechanisms that exist in the treaties you have negotiated. Specifically,
how do we guarantee-on a timely and effective basis-that our partners are adhering to the codes?
Finally, if we are unable to resolve our trade problems on a multilateral basis, it is obviously important that unilateral measures such
as the surcharge protect us from unfair competition. I am concerned
that we may be getting the short end of the stick with the Japanese
and, if this is the case, I am one who is prepared to try to do something
about it. I have asked the General Accounting Office to look into
Japan's nontariff barriers to trade, and we are asking American
industry for examples of discrimination.
If it develops that the Japanese are retaining nontarifi barriers to
American goods, then I think we should look very carefully at a surcharge or other barriers, and I think there are a lot of Members of
Congress who feel the same way.
Ambassador Strauss, we look forward to your comments and welcome you to the Joint Economic Committee.
STATEMENT OF HON. ROBERT S. STRAUSS, AMBASSADOR, SPECIAL
REPRESENTATIVE FOR TRADE NEGOTIATIONS
Ambassador STRAUSS. Thank you, Senator Bentsen.
I say to you and the other members of your committee that I propose
to make an opening statement to cover my thoughts on your good
questions. Following that, to the extent that my remarks have not

53

responded to your opening statement, then we will take your questions specifically.
First, let me thank you for holding these hearings and for permitting
me to be here. As you know, I am not a trained economist, and any
understanding I may have of economic events comes mostly
practical experience. In my recent work, however, I have had from
close
association with some of our Nation's leading economists and, while
they have taught me much, the only thing they have convinced me
of, is that this is a time of tremendous confusion.
We are faced today with a high underlying rate of inflation
defies conventional economic logic. The prognosis from manywhich
economic forecasters is a pessimistic one. Yet the continuted performance
of our economy has been very strong. The fourth quarter of 1978 gross
national product came in at an annual rate of growth of 6.1 percent,
adjusted for inflation, easily topping the 2.6 percent of the third
quarter and above most estimates. There is little indication of any
impending softening in orders or sales. In particular, recent gains in
employment have been substantial, and the labor market is becoming
as tight as it was during the business upswing of 5 years ago.
I know that Chairman Schultze of the Council of Economic Advisers will discuss the economic outlook with you in some detail soon.
He is a trained and competent economist, and this is his preserve. I
think that when you have considered the evidence, you will agree that
our economy is fundamentally solid and sound. Real wages and earnings are at record highs, and the dollar is steadying on international
money markets.
This does not mean that we are satisfied. Along with the rest of the
world, we are in a period of slow growth, although we are growing
faster than many others, and at a better rate than many predicted
last fall. Our trade deficit continues, as you commented, at an unacceptable level. Our export capability must be improved. All of this
serves as a backdrop for our trade negotiations and makes our success
in these talks even more crucial.
Let me describe to you in some detail now where we stand in international trade-not only through the multilateral trade negotiations
in Geneva, but especially with respect to Japan.
As you know, President Carter reported to Congress on
4
that we are in the final phase of negotiating the first major January of
new set
trading rules in over 30 years. While the six preceding rounds of
multilateral trade negotiations that have taken place since World
War II dealt largely with multilateral and reciprocal reductions in
industrial tariff barriers, the Tokyo round has been more
Besides a further reciprocal reduction in industrial tariffs,ambitious.
sought to conclude a major liberalization in agricultural tradewe have
barriers
and others.
Most importantly, we have negotiated for the first time international codes of fair conduct in international trade in the areas of
government procurement, product standards, customs valuation,
subsidies and countervailing duties, import licensing, commercial
counterfeiting, aircraft, and safeguards.
Finally, we have sought to develop internationally acceptable dispute settlement procedures for managing areas of trade conflict both
inside and outside those areas covered by the codes.

54

We are close to a final agreement, but we are not yet there. Just
as there remain questions on how those of you in Congress will come
out, there are many voices in the European Community, for example,
who feel they have given up too much for what they got.
Let me make it very clear that we are far from certain that the
Council of Ministers of the European Community will approve what
we are attempting to negotiate. We believe that they will; we feel
strongly that they should.
On the tariff side, the package we are now talking about will represent duty reductions opening up billions of dollars worth of new export
opportunities for U.S. manufactured goods and farm products. In
agriculture alone, we estimate that there will be reductions in trade
barriers covering trade worth about $3 billion to this country.
When I took this job, Mr. Chairman, I appeared before you and
other members of the Finance Committee, and I said that I intended
to overperform and not overpromise. I am not going to start overpromising at this late date, but I do want to point out what some of
the nontariff trade agreements can mean to our economy.
The proposed subsidies code represents the most extensive attempt
ever made to subject actions designed to distort fair trade to uniform
tests and the application of uniform penalties. The code will greatly
streamline the cumbersome dispute settlement procedure in this area.
Similarly, through the safeguards code we will ease export opportunities by achieving better regulation of import restrictions applied by
countries protecting their domestic producers. The Government procurement code will open up as much as $25 billion a year in foreign
government purchasing markets that are now closed to U.S. exports.
The standards code will force major movement by other nations
toward the U.S. system of openness in drafting standard-setting procedures and reduction of the use of standards as hidden barriers to
trade. In much the same way, the aircraft agreement will promote
fairer as well as freer trade in this important U.S. export sector.
Now let me turn more specifically to the critical concern of our
trade deficit with Japan. Mr. Chairman, yours has been one of the
most articulate voices in Congress. warning that the American people
are not willing to accept ever-growing trade deficits with Japan.
I strongly agree with you, and this conviction has guided our trade
negotiations with the Japanese. In past negotiations Japan has been
permitted to stay on the sidelines, making few contributions and reaping the benefits of tariff cuts made by others. We did not let that
happen this time. We mounted an all-out campaign to get Japan's
tariffs down to levels about the same as ours, especially for key products, and we insisted that Japan assume full obligations in all the
nontariff barrier codes.
What are the results? In the tariff area, Japan will reduce its tariffs
to roughly the same level as our tariffs, both on an average basis and
in key product areas. Overall, Japan will be cutting its tariffs on
industrial imports from the United States by over 60 percent from the
rates it has bound in GATT, with the cuts covering some 3,000 items.
The average Japanese tariff on industrial imports from the United
States will be 2.3 percent, while our own tariff on imports from Japan
will be just under 4 percent. After these cuts are fully put into effect,
Japan will have one of the lowest tariff structures of any developed
nation.

55
In addition to overall compatability, we concentrated on getting
Japan's tariffs down to our levels in product sectors of key export
interest. As you will see, we have done so in such key sectors
as
computers, color film, and integrated circuits, for example.
In agriculture, the Japanese made concessions covering some 150
items and amounting to about $1.5 billion in U.S. agricultural exports.
A significant concession is a duty-free binding on soybeans,
for
example. In addition, high quality beef imports are going from 6,800
in 1977 to 30,800 tons by 1983. Japanese orange imports, on a fresh
equivalent basis, taking into account the concession on concentrated
orange juice, are going from 25,000 tons in 1977 to 136,000 tons in 1983.
In agricultural tariffs, of 21 concessions on fruits and vegetables,
most are 50-percent cuts or greater, and only 6 are less than 40-percent
cuts. Most of the fish concessions are cuts of 40 percent or more.
cottonseed oil and corn oil, the cuts are all 50 percent. For turkey For
and
chicken, the cuts are at least 50 percent. While not covering all items,
these are representative of the kinds of Japanese agricultural concessions we have negotiated.
Let me say this, Mr. Chairman, as an aside. If anyone expects me
say that we have received all that we wanted or even all that we to
are
entitled to, that this is a 100-percent or A-plus negotiation, of course
my answer would be "no." If anyone asks me on the other hand,
Mr.
Chairman, have we made significant progress, do the pluses far
outweight the minuses, my answer is a strong affirmative "yes."
While tariffs receive a great deal of attention because they are visible
and easy to measure, what may have the greatest payoff over
longer term-especially with Japan-are the codes on nontariff the
barriers. Let me give you some specific examples.
1. GOVERNMENT PROCUREMENT

Up to now, foreign suppliers have found it virtually impossible to
sell to Japan's Government because the procurement is negotiated
behind closed doors. This code will force Japan and others to adopt
a
high degree of visibility of purchase opportunities so that foreign
firms
can compete. We are still pushing the Japanese for greater coverage.
2. STANDARDS

This code will insure that the Japanese no longer set standards that
create unnecessary trade barriers. If we are dissatisfied, the code
provides an international dispute settlement mechanism.
83.SAFEGUARDS

In the past, Japan has frequently agreed to restrain its exports
to
other markets, increasing the pressure to export to our market.
This
code will for the first time bring some discipline over voluntary export
restraints, as well as providing for more open procedures on safeguard
actions.
4. CUSTOMS VALUATION

Another major problem in exporting to Japan is the arbitrary
havior of Japanese customs officials in raising the appraised value beof
an export for duty purposes. The customs code will prevent this
by
carefully specifying valuation methods.

56
to
There are other advantages of each of these codes too numerous the
already received detailed information on
mention here. You have
these
provisions of each code; the Japanese have agreed to abide by
provisions in each case.
in
We are finally at the point where we can see some improvementour
It is still too early to tell if all of
our trade figures with Japan.
latefforts over the past year are really paying off, but the data for the
1978, is encouraging.
est available 3 months of September-November
same
In this period, U. S. exports to Japan were up 57 percent over the
After averaging over $1 billion a month
months for the previous year.
We
from January to July, the deficit has come down to $674 million. for
a long shot, but the direction is right,
are not out of the woods by
a change.
than
We have put more effort into improving our trade with Japan
any other nation. We are opening some warped doors and making
with
should
changes. Progress must be carefully monitored, and Congress
to keep the heat on.
continue
this
Perhaps the easiest way to understand the importance of
is to consider the consequences of failure or disapproval.
agreement
In the absence of this substantial effort to discourage unfair Governworkment intervention in trade, and to devise fairer rules and more
it is likely that trade conflicts
able dispute settlement mechanisms,
and distortions between nations will grow worse.
The stakes are enormous. Today we trade one-sixth of everything
grown or made in this country on the world market. We are increasingbut of
ly dependent on both exports and vital imports, not only of oil,
materials on which our domestic productive capacity
industrial raw
as well as export capability is based.
and
It is easy to say that we are suffering from import competitionmind
We must bear in
that the answer is to shut it off at the border.
same
that, if we take that course, we will also be cutting off at the earn
time about $1 out of $6 that our domestic investors and workers
from exports.
We can promote-through these trade agreements-American
of
enterprise, technology, and productivity to the benefit of all sectors
in the sand, and hope
our economy. Or we can duck, stick our head
that we don't see disaster when it hits us from behind.
Mr. Chairman, we must not make the easy mistake here of saying
that the glass is one-third empty because of what these negotiations
we
did not accomplish. There are many things that I could list that
we need to concentrate on that part of the glass
did not agree on, but
that is two-thirds full.
What we have been able to accomplish is greater than I dreamed
fill
possible when I first took this job. 'These accomplishments will not
only the opening paragraphs of a book that
the book on trade; they are
charts a course and creates a climate which the Congress, the executive
many
branch, and the private sector can add to, and implement, for
to come.
years
The opportunities for orderly and fair trade which will flow from
export
this agreement can result in the real gains from a renewed have
needs. At the very least, we will
thrust that our Nation so badly
free
removed a great number of the barriers which have prevented the
flow of trade in our past.

57
I think, Mr. Chairman, it might be well if I stopped here and took
your questions.
Senator BENTSEN. All right. I ask that we observe the 5-minute rule
and, as I have in the past, I will recognize those members in the order
in which they arrived at the committee meeting, starting with the
chairman.
Ambassador STRAUSS. Mr. Chairman, I see you are still conducting
your business as you always have
Senator BENTSEN. Let me say, Mr. Ambassador, there was not
anything in that statement of yours I could not agree with enthusiastically, and I think you have made remarkable headway. I think we
still have a long way to go. The New York Times reported today that
Japan had a record trade surplus in 1978. That surplus of $18.3 billion,
on a customs-clearance basis, nearly doubled the 1977 level, and that is
despite repeated pledges to reduce the trade balance. They always
seem to have a large surplus. I understand they say they have a
problem in trade with us, but that they just need a little more time.
Well, I can recall that their 1977 trade balance with us w'as about
$8 billion. The next year it went to $12 billion, an increase of 50 percent.
Here are some of the games they are playing. They are smart, they
are tough, they are able traders. I saw one the other day where they
take care of part of this trade balance they report with us by doing
the financing job on American airplanes that are sold by an American
company to an American purchaser. They bought the plane, supposedly, in their name, but then leased to an American company so
that it helps them reduce their trade surplus with us.
Look at this situation. I hear them say that one of the problems with
the Japanese is that they just don't eat beef. Well, beef over there
sells for about $20 a pound, and they don't eat beef for the same reason
we don't eat caviar-the price is just a bit high. Total imports of
beef into Japan from all countries are the equivalent of about one thin
hamburger patty per Japanese per year.
Now, in their recent concession, they have added a quarter-pounder.
[Laughter.]
These are my concerns. You have made significant headway, but we
are talking about a $250 million gain and a $12 billion problem.
I firmly believe that there has to be a redress of those imbalances
and, if we don't get more significant concessions, then we can well see
unilateral action taken here, and I don't want to see it taken. I think
it is far better if we can work these things out on a reasonable basis.
Ambassador STRAUSS. Mr. Chairman, I certainly. share those
concerns with you as the members of this committee know. We
did not, any of us, create the trade problems that we have right now,
and we are trying to go about mending them.
As I clearly pointed out, the things we have negotiated in the Tokyo
round are not going to take care of our trade problems; they are a
step in the right direction; and I am not going to say anymore than
that.
With respect to beef, of course that is true. When I got into this
thing, it was six or seven times less-we increased it sixfold or sevenfold. You must keep in mind, as I know you do and members of this
committee do, beef in this country is difficult to negotiate in any faster

58
fashion or rate than we have done. I am sorry that we started at too
low a base.
Senator BENTSEN. Just look at price tags. Look at price tags in
Japan and price tags here on comparable products. Why does a
Toyota sell for the same price here as the Ford Pinto and the Pinto
sell for twice as much there as it does here? I have not been able to
get satisfactory answers to that, and it concerns me very much.
There is a question of textiles, and I understand that you have made
some headway on that.
Ambassador STRAUSS. Senator Bentsen, with respect to the textiles,
you say you understand. I know that you probably are referring to
the story that we are in negotiation with our textile people in the
textile industry, both labor and management, and we are in the process
of doing some negotiating with that industry. I have met with union
and management people a great deal in the past 3 or 4 weeks.
We have a terribly difficult problem there. On the one hand, we
have a sensitive industry, we have jobs that are at stake, we have
people that must be kept employed and an industry that cannot be
permitted to deteriorate.
On the other hand, we have the problem of consumer interests in
this country and inflation, and we are trying to strike, I think, in a
cooperative way with the industry, a balance. Whether we will be
successful in doing so, I don't know. I think the approach we are
making now is right. You recall the President issued a proclamation
setting forth the course of the general, broad outlines of a domestic
program, at the time he vetoed the legislation removing textiles from
the MTN, and we are trying to implement that now in a sensitive and
responsible way that would not be inflationary, but still protecting
jobs here in this country.
Senator BENT EN. Mr. Ambassador, my 5 minutes have expired.
Congressman Heckler.
Representative HECKLER. Thank you, Mr. Chairman.
Mr. Ambassador, I feel that you are more than an able negotiator.
Ambassador STRAUSS. Thank you, ma'am.
Representative HECKLER. And I feel that I agree with so much of
what you have said; I find that in this Congress we are faced with
developing a compatability among opposites, between the environment and the economy, and free trade and jobs at home.
As you know, I come from a region of the country where the textile
industry is of major significance. I have a great deal of interest in
preserving our global marketplace, and I see the world as interrelated and interdependent. I see the pursuit of free trade as a goal for
all nations.
At the same time, while I take that global outlook, as I look at the
impact of our trade policies for the last several years on the textile
industry and on the apparel industry, I would have to say that, if we
were to rate it on a scorecard, the rating would be in terms of striking
a fair balance, and that is exactly what I am interested in.
As you know, the textile industry has decreased probably 25 percent
since 1967. In the apparel sector the decrease is even greater, and right
now we are reaching the pitch of high anxiety, with good reason.
At a recent public meeting in Fall River with Sol Chaikin, the head of
the Ladies Garment Workers Union, one member of the union, a

59
lady. garment worker, raised her hand and said, "I am not
about wage and price controls; I am worried about working worried
a 5-day
week."
She is working a 2L-day week right now.
I feel that the impact of negotiations in the textile industry,
and
especially the apparel sector, will have to be taken very, very
seriously.
I remember when we discussed the sugar subsidy and the dependence
of the United States on its own capacity to produce sugar
the arguments raised. Isn't there also a question of goods, was one of
is to translate that into military terms, "to produce our and if one
uniforms,"
when we wipe out this industry? We are talking about survivability.
We are wiping out skills that the country badly needs.
I think there is a great misunderstanding about the impact
consumer of all of these things, because when imports started on the
to
the market the consumer was the initial winner, lower prices flood
product from Hong Kong made the item much more attractive for a
than
the locally produced item. For many, many families with tight
budgets,
I can understand that, but the times have changed, and prices
have
changed.
I have two really almost identical, I think, ski caps here,
look the same to me-perhaps some expert could see a and they
difference.
They are the same pattern, made in virtually the same wav
same materials. One made in Taiwan is sold to the wholesaler with the
at
a dozen. One made in the United States is sold to the wholesaler $6 50
at $15
a dozen, and the wholesaler sells both for $36 a dozen. So the
consumer
no longer is the winner ini this free trade or domestic production
dispute.
My question to you is: While we would hope for an
trade negotiations in terms of reaching fair balancesA-plus in our
with
countries of the world, how would you rate yourself in terms other
of the
apparel industry and the knitted outerwear? What relief do
you offer
to them, because, frankly speaking, we are coming down
to
Considering the large segment of our America workers involved that.
in this
area, if we are going to turn our backs on their desire to
earn
own livelihood in the name of perhaps negotiating a somewhat their
international agreement, I question the justice of the course better
of that
policy by the United States.
What do you offer us? What new approach would you offer
these
industries?
Ambassador STRAUSS. Congresswoman Heckler, let me respond
to
that very precise question in a precise way. With respect
to the
negotiations that we have had, bilaterial negotiations under
fiber arrangement, I think the industry will tell you we the multihave been
effective. In terms of accomplishing what they asked us to
do, they
set goals for us, we have achieved those goals. Now, Congresswoman
Heckler, those goals that were set were not sufficient, were
not precise
enough, and through no fault of the industry or of our negotiators,
the fact that it did not work as well as we thought it would
or
thought it would puts no blame on anyone. We are presently as they
in the
process of working with the textile industry to renegotiate
the bilaterals, and within the last week we have completed, No.
negotiation with Japan in textiles. I can't make it public1, the first
yet; it is
still private; but let me say this to you: The Japanese negotiation
was approved by the industry advisers, both business
and labor.

60
Both sides sat in with us in those negotiations. They know the
results. They have approved them. and we are now in the process of
negotiating with Hong Kong, with Taiwan, with Korea, and with
others. The Hong Kong negotiations will resume in February-I
think it is on the 12th. We hope to achieve the same results there.
The negotiations that Senator Bentsen referred to that are taking
place between my office-Mr. Chaikin, Mr. Findley, representatives
of the mills, and others on the business side-we hope will achieve
a balanced approach, one that really will take into account all of the
sensitive areas of this Nation, and I think, indeed, we will be able
to satisfy the very wise concerns that you have.
Representative HECKLER. Mr. Chairman, I understand that my
time has expired.
Senator BENTSEN. Congressman Rousselot, you are next.
Representative ROUSSELOT. Thank you, Mr. Chairman.
Mr. Strauss, we are delighted to see you again, I, too, want to
express my own appreciation to you for the hard-nosed approach that
it appears you are taking in trying to work for the benefit of our
country in these negotiations, and I know that it is not easy.
Ambassador STRAUSS. Thank you.
Representative ROUSSELOT. Can you describe a little further than
you did the progress as it relates to citrus with Japan?
Ambassador STRAUSS. We have an increase in our orange quota from
15,000 metric tons in 1977 to 82,000 in 1983. In our grapefruit juice
quota we went from 400 metric tons in 1977 to 6,000 in 1983.
Oranges, from 15,000 tons to 82,000 tons. In orange juice, 600 tons
to 6,500 tons in that period of time, from the time I entered this job,
until 1983. In grapefruit juice we go from 400 to 6,000 tons in 1983.
We have got some midyear productions in grapefruit and lemons and
limes and in lemon juice. And let me say this. I think our production
will run in excess of 40 percent of the tariff reductions there.
Representative ROUSSELOT. And they will not engage in these
other practices of other potential ways to increase the cost?
Ambassador STRAUSS. Congressman, what I am trying for-let me
answer that in another wav.
Representative ROUSSELOT. You mentioned the customs procedure.
Ambassador STRAUSS. Those things we are in the process of cleaning
up.
Do we want these quotas over there? Of course not. We are trying
to liberalize, we are moving toward an open market. We cannot
liberalize that market overnight. Congressman, it is not my opinion,
it is a fact; to do that they are going to have to get a better horse than
me.
Representative ROUSSELOT. We thought you were a pretty good
horse.
Ambassador STRAUSS. I tell you one thing, I never worked harder
for a few bushels of oranges in my life. If there is anything left over
there, somebody else is going to have to go get it now.
The citrus industry, you will be pleased to know, and Senator
Bentsen will be pleased to know-we work closely with the citrus industry-is pleased, they are happy. Of course, they want more, they
are entitled to more.
Representative RoUSSELOT. I have heard that.

61
Ambassador STRAUSS. Senator, in our own valley our citrus growers-I don't have to tell you-we just got a handwritten resolution
of appreciation and signatures of several hundred growers on that.
Senator BENTSEN. I would be delighted to add my signature to it.
Ambassador STRAUSS. Thank you, Senator.

We don't have what they want; they don't have what they are entitled to. They have a lot more than they had 2 years ago.
Representative ROUSSELOT. Thank you. I was not being critical.
Ambassador STRAUSS. I know that. I am just trying to say I
appreciate your question.
Representative ROUSSELOT. Now, another area, all within my 5
minutes of course. The Washington Post reports this morning-I
know they are always accurate-that the trade negotiations with
Europe have been jeopardized by sudden U.S. demand for concessions
in paper products, and by a sudden decision to affect our agreement
to abolish the American selling price system for some chemicals by
raising our tariff on all chemicals. Now, have the negotiations in this
area hit a snag?
Ambassador STRAUSS. Mr. Congressman, this is a very delicate
subject, and I want to answer it with candor. We have not introduced
anything new. We started out firm, we started out wanting a reasonable, fair arrangement. I started out with the conviction that we had
not always been firm enough and we have hit snags-yes, there are
snags there.
There are some of the European countries that feel that we have
received more concessions than we have granted. I disagree with that.
I think we have negotiated a fair and balanced package. It should be
that way; it ought to work both ways. That is the position of this
administration and it is the position I am going to stay with right now,
and I hope we can convince them that we do need some additional
concessions in certain areas; and obviously we are going to have to
give something to get it. It is a negotiation; nothing is for free. There
ain't nothing for nothing. I have found that out, Mr. Congressman.
Representative ROUSSELOT. Yes, I have, too. [Laughter.]
Ambassador STRAUSS. I like the idea that people think I negotiated
well for this country; I take great pride in it; but everything we have
got we have paid for; it has come out of the hide of somebody in this
country.
Representative ROUSSELOT. Thank you, Mr. Chairman.

Senator BENTSEN. I am sorry we have the limitation of 5 minutes,
but the Ambassador has to leave at 11 o'clock and we have such fine
attendance at this hearing that I want to be sure that each member
has a chance.
Representative ROUSSELOT. It is good to limit me to 5 minutes.
Senator BENTSEN. Congressman Mitchell.

Representative MITCHELL.
Ambassador.

It is good to see you again, Mr.

Ambassador STRAUSS. Thank you.

Representative MITCHELL. I suppose, as a strategy, we should try
to improve our trade negotiations first; that is our most immediate
problem. However, it seems to me that the future of the balance of
trade and the future of our own economic growth lies in the development of markets in the lesser developed countries. That is the longrange strategy that we should be pursuing.

46-126

0 - 79 - S

62
What steps, if any, are being taken or do you contemplate taking
to cultivating that kind of economic interaction with some of the lesser
developed countries, particularly the African nations which are so rich
in many of the mineral resources for our own industrial growth and
well-being?
Ambassador STRAUSS. Mr. Congressman, in the Tokyo Round there
are 98 countries participating, and as we are putting in place the final
touches on what I hope will be an approved agreement with the Japanese, the European Community and our American Congress-as we put
that together-we are now moving far more aggressively with respect
to the LDC's and we have tried to do it wisely.
We have said that there are some countries less developed than
others and that as some reach a developed posture, they should be
treated as developed and those who are far less developed than that
should get more preferential treatment in other ways.
The first time I went to Europe we met with the other nations that
are not the major nations in the trade negotiations, so we are making
every effort to involve them, to find the commonality of interest so that
we can do just as you suggest.
Representative MITCHELL. Well, that is encouraging.
I have time for another question.
I read somewhere that 5 percent of the American businesses-just
5 percent of them-provide 95 to 98 percent of all the export products
in this country.
Ambassador STRAUSS. That is correct.
Representative MITCHELL. I think that reflects the exclusion, really,
of small business from export-import areas.
More specifically, I am asking you what arrangements do you contemplate or what steps have you taken to facilitate the entry of small
businesses into this whole export-import area.
Ambassador STRAUSS. Mr. Congressman, without telling you how
hard I am working, I got up at 5 o'clock the other morning and went
west to speak to 500 small business men and women and flew back that
afternoon in time for some meetings here at 5 o'clock in the afternoon.
Now, I am not telling you that to show how hard I am working, but
to show how high a priority I put on that.
You have touched on a very significant thing. The Du Ponts, the
IBM's, the Fortune 500's have the means and the capital to acquire the
skills to develop export markets; small business does not.
The first thing we have to do is provide capital for them to do it.
Second, under these rules we have to put a bit more certainty in
where a man or woman can risk $25,000, $50,000, or $75,000 to get into
that business.
Third, we have to teach them how.
We don't know how in this country. Secretary Kreps of the Commerce Department is working very hard on that.
Representative MITCHELL. Pardon me, Mr. Ambassador. My time
has nearly expired.
During your tenure, what specific successes have you achieved in the
area of introducing small businesses into the export markets?
Ambassador STRAUSS. Mr. Congressman, I play a very rather insignificant role in direct relationship with small business because what
I do is negotiate trade agreements-agreements between nations-and

63
I don't really have anything to do with the export thrust of our
country.
What I have to do is negotiate the rules by which others will implement that-the Commerce Department and the other departments
in this country's Government.
The reason I attend these small business meetings is that I like to
be there and I like to tell the story and sell the medicine, if I can, of
what exports mean to this country.
I have not done a darn thing, very frankly. If you go to the Eximbank, the Commerce Department and the others, they are making
progress-not to satisfy me and not to satisfy you and President
Carter and themselves, but we are working.
Representative MITCHELL. Thank you.
My time has expired.
Senator BENTSEN. Senator McGovern.
Senator McGOVERN. Mr. Ambassador, I want to join with the
chairman and other members of the committee in commending you
on the fine effort you have made as our trade negotiator.
As I understand it, when the trade negotiations are completed,
Congress will receive the final package and be voted up or down, but
that there will be no opportunity for amendment; is that correct?
Ambassador STRAUSS. Thank goodness. That is correct, Senator
McGovern. [Laughter.]
Can you imagine that I will be spending the rest of my life picking
up two oranges here and something else there? Not me. [Laughter.]
Senator McGOVERN. I just wanted to make sure we understood
the ground rules.
Ambassador STRAUSS. One of the first things I read was the 1974
Trade Act that you voted on and I found that in there.
Senator McGOVERN. Let me ask you this: For 30 years when we
negotiated the International Wheat Agreement that has been handled
as a separate treaty.
Ambassador STRAUSS. Yes, sir.
Senator McGOVERN. It has traditionally been referred to the Foreign
Relations Committee and then approved there. It requires a two-thirds
vote before it goes into effect.
What are the present plans for handling the International Wheat
Agreement?
Ambassador STRAUSS. My recommendation is very definitely it
will be folded in with the MTN implementing legislation.
Although there has been no decision made, I am going to recommend
that it does. I think it is a better way of treating it, but no decision
has been made yet.
Senator McGOVERN. You make that recommendation, I assume,
Mr. Ambassador, with the understanding that the Senators from the
wheat States who might find problems with the International Wheat
Agreement could find this policy puts them in a position where, if
they are opposed to the International Wheat Agreement, they have
to vote against the whole package.
Ambassador STRAUSS. Senator McGovern, that is why I said no
decision had been made.
I am going to come up here and work this Hill before I make a
decision on that to find out what makes more sense and what would
be more practical.

64
Let me say one thing to you, that we have got to be involved in
drafting, for the next 3 months, the implementing legislation.
We are going to stalk the Halls of the Congress, as I have been
doing over the past 2 years, to find out my areas of maneuverability.
I don't have any great strength as an economist or any great
strength as an international tradesman.
If I have any strength here, it is knowing the temper and ability
of the field and the sensitivity of the Hill.
Every step of the way for the last 2 years I have been doing that.
As we prepare this implementing legislation, I will be sitting in your
office and in other offices making that decision jointly and one in which
we are all behind, so I tilt toward holding it in, I hope, trying to
convince you.

Possibly being contrary will be the case.
Senator McGOVERN. On another matter that has not been touched
on here today, but one which I think bears on the overall question
of expanding the U.S. exports, we have a practice as you know,
Mr. Ambassador, called the most-favored-nation practice. It is Teally
a misnomer, in my judgment.
What it means, really, is that there are certain countries we don't
discriminate against and we call those countries the most favored.
If you are not on the list, you are up against a discriminatory trade
practice.
In some cases, it seems to me the results of that policy are not to
make countries behave the way we think they ought to behave or
change their ideology to conform to ours, but instead we are encouraging them to trade with other people.
I wonder if you have given any thought to whether or not that whole
practice might be obsolete.
I can see where there might be certain countries that are so obnoxious where they would not want to trade with them at all but it
seems to me if we are going to trade with countries and make a
judgment that it is in our interest to do so, we ought not to encumber
it with all these things.
Ambassador STRAUSS. Senator, I don't want to be cute in my
answer, but it seems that in a democracy, everybody wants to be an
expert on everything, particularly other folks' business.
That is the other folks' business and we have enough trouble with
that.
I have some notions but I don't have any responsibility and it just
would be unfair to the members of this committee and those whose
job it is to deal with that.
Senator McGOVERN. I just want to underscore what Congressman
Mitchell said with regard to developing countries. At the World
Food Conference that I attended in 1974, a strong emphasis was
placed on trying to develop more effective and workable trade relations with these underdeveloped countries.
There are potentially large markets out there and I think the point
the Congressman made is well taken.
Ambassador STRAUSS. Senator McGovern, I understand. Let me
say this to you: In my judgment, no nation has made any more effort,
than we have made in the past 2 years in Geneva in this area and no
individual has spent any more effort on it than has Mr. McDonald
over there, who is my deputy.

65
In every report, we go into what is being done with the LDC's.
We have a special group that is setting up meetings daily, weekly, or
as often as we can, going over their problems.
I think as a matter of fact, our efforts over there-hopefully, will
produce something.
I know they produce goodwill because I know we are trying.
Senator McGOVERN. Thank you, Mr. Ambassador.
My time is up, Mr. Chairman.
Senator BENTSEN.-Thank you, Senator McGovern.
Congressman Long.
Representative LONG. Thank you, Mr. Chairman.
Like everyone here, I do want to congratulate you, Mr. Ambassador.
I have participated with you in negotiations over the last few years,
and all I can say is that I am sure glad you are on our side.
Ambassador STRAUSS. Thank you.
What I am afraid of is that some of the people I am trading with
are glad I am on this side.
Representative LONG. Does the scope of your responsibilities include
recommendations to the President with respect to what might be
done to establish some export incentives, and if so, what type import
incentives have you recommended?
Ambassador STRAUSS. That is not my primary responsibility.
I sit in interagency meetings where we get into that subject.
The Commerce Department has an appropriation. It is not a large
one but it is about $25 million which they are spending on the export
thrust.
There is going on right now an examination of export disincentives-not just incentives-to see what we are doing in that area. It
is negative, rather than just throwing money away on creating incentives that may or may not work.
Representative LONG. At the field hearings that this committee-or
rather one of our subcommittees-has conducted, I have been distressed not only by the lack of knowledge, but also by the lack of
interest by businesses in getting involved in exporting. The lack of
interest seems to be exhibited by medium-sized business and large
business as well as by small business.
They never had to go for this market and they are actually a little
bit scared of it.
Ambassador STRAUSS. That is correct.
Representative LONG. I think there is a major educational program
that is going to have to take place if we are going to have any success
at all in reversing the situation, since it has been in existence for such
a long period of time.
Ambassador STRAUSS. I think that the Commerce Department has
a modest program.
I think they are making some progress over there, as Secretary Kreps
put it, and Assistant Secretary Mark Weil is working on that.
I think we are making progress.
Representative LONG. He appeared before our subcommittee and I
think he is aggressively pushing the program.
Ambassador STRAUSS. Secretary Kreps gives good support.
Representative LONG. I will ask you one other question, if I may,
Mr. Ambassador.

66
You stated in your statement that the Government procurement
code is going to open up as much as $25 billion a year in foreign government purchasing availability.
Ambassador §TRAUSS. "Opportunities" is what I would call them.
Representative LONG. What about the reverse side of that coin?
What about the dollar estimate on how the code is going to open up
similar U.S. markets that are now closed to foreign sources?
Ambassador STRAUSS. Well, the truth of the matter is that there is
not very much of that-less than half.
Our markets have been open. We are trying to see that we both
play with the same rules and the rules are the ones we have been playing with.
Representative LONG. This would be to correct an inequity that has
existed for a considerable period of time?
Ambassador STRAUSS. That is correct, Mr. Congressman.
Representative LONG. Thank you very much, Mr. Chairman.
Thank you, Mr. Ambassador.
Senator BENTSEN. Senator McClure.
Senator MCCLURE. Thank you, Mr. Chairman.
I am tempted to go into the question that Congresswoman Heckler
raised with respect to sugar because the sugar industry, at least the
beet sugar industry, in the United States is about to close up. One of
the major producers in the West has announced plans to get out of the
industry completely. Their plants are on the block.
If their plans are carried out, then we will have about 100,000 acres
of the best land in Idaho transferred from producing sugar to producing
other crops that are now in surplus. I don't want to spend a lot of time
on that because I think it is a particular problem and I hope we can
work out a solution between the Congress and the administration,
I think it has an absolute priority and must be solved.
Ambassador STRAUSS. Yes, sir.
Senator MCCLURE. The second question that I think we need to
spend some time on is this question of the nontariff barriers. I look at
the export of round logs to Japan and at the same time Japan refuses
to allow entry of finished lumber products into their markets. That is
an old problem. I have been working on it for 10 years with more than
one administration.
We still have the same problem. They still want to have our raw
material to process in their plants and we, in essence, then are providing the raw materials to furnish their jobs in their own markets, denying our own workers the opportunity for those jobs and at the same
time creating a potential shortage of material in this country. W e are
now importing 20 percent of our softwood requirements in this country.
Rather than spend a lot of time on those, there are a couple of
others that I want to adldress.
First of all, we talk about 2- or 3-percent changes in tariffs and yet
we saw a 40-percent change in relative value of currencies. That is
certainly a more massive economic shift than a small change in tariff
and yet during the same period of time on that change between Japan
and the United States, for example, it favored the United States by
4
0-percent readjustment.
The trade from Japan increased and became more favorable to them.
That has to indicate that they have been more than slightly successful
in their nontariff and tariff barriers to trade.

67
Ambassador STRAUSS. Senator McClure, that is a very perceptive
observation that you made. I didn't intend to get into that today, but
there are so many things that we could talk about here and I hope
you and the chairman will focus on that, because there are no answers
to this, but it raises a lot of questions.
You know, we heard about the J curve, how the trend goes for a
while and then begins to take hold. Well, maybe in the last few months
it has. It is running about 12 months late. They told me that that J
curve was going to help me 12 months ago. It is still J-ing, but it is
just now curving.
The change in currency goes to Senator Bentsen's concerns. You
look at questions such as: Is a surtax going to do any good? You
talk about 10 or 15 percent and the amount of time it might take to
set in when we hear these discussions, Senator Bentsen and I have
chatted about this on a personal basis informally. If you didn't get
help from a 40 percent dollar devaluation vis-a-vis the year, why is a
15-percent surcharge going to help?
It comes back. It almost convinces me that I am on the right
track in putting emphasis on these nontariff barriers.
That is the guts of the thing, Senator. The tariff things help a
little here and a little there, but the guts of it is are you going to get
the artifical barriers removed?
Senator MCCLURE. Mr. Ambassador, I agree with that statement
because obviously if nontariff barriers can offset whatever we got on
the 40-percent currency revaluation, they can easily offset whatever
you give in tariff reduction.
Ambassador STRAUSS. I agree. What I don't want to leave here is
the impression that I am up here preaching that what we have done
is going to solve all the problems-we are just not going to do it.
We are going to begin to solve them and give an opportunity for the
executive and private industry to move in and monitor and push.
That is the way you solve these problems. It is a long drawn out
process.
Senator MCCLURE. Mr. Ambassador, there are a couple of things
on our side that are barriers to our trade, too, that we have erected
here addressed to-and I will not ask the question. I know my time is
up.
One was the absolutely incredible illogic of trying to create some
kind of control on proliferation of nuclear products that led us in
the Congress with the help of the administration to pass a bill on
nuclear licensing of nuclear exports that makes it impossible for Westinghouse to sell a U.S.-produced plant to the People's Republic of
China at the same time that same plant can be furnished by the French
to the People's Republic of China with Westinghouse licenses subject
to approval of the U.S. Government.
While we won't approve the export, we will approve the license
so that the French can supply the plant.
Second, it has been estimated by a study commissioned by EPA
that environmental controls and costs add about 25 percent to the
costs of our exports as compared to other countries. That figure may
be arguable, but that was a study commissioned by them and they
came to that conclusion. There are a number of people who are thinking in terms of trying to find a way to establish an environmental

68
tariff both to equalize the economics of trade and, second, to encourage people in foreign countries to take the steps of cleaning up
the environment that we have found to be in our national interest and,
I think, in the international interest.
We don't have time to really explore either of those policies at
length here.
I thank the chairman and the committee for indulging me for a
couple of extra minutes.
Senator BENTSEN. Thank you very much, Senator McClure.
A closing question, Mr. Ambassador.
With regard to the normalization of relations with the mainland of
China, do you see that as a boon or a threat to our trade balance?
Ambassador STRAUSS. I think it will eventually prove to be a great
boon to this country. I think we run a great risk of misleading the
American public-the American business public particularly-to believe that overnight there is going to be 900 million people in China
drinking Coca-Cola every day and buying every used car and truck
and everything else we have to sell over there.
I think, according to the figures I saw, that they need about $200
billion in the next 10 years to meet their capital requirements if they
are really going to catch up with the industrialized countries of the
world.
I think as we move into this, if we look wisely and prudently, it
will be a major market for American business.
Senator BENTSEN. Thank you very much, Mr. Ambassador. We
appreciate your attendance this morning. The members of this committee have a great interest in your work.
Ambassador STRAUSS. Thank you. I appreciate being given this
opportunity.
Senator BENTSEN. We will now have the following members of the
panel: William D. Eberle, former Special Trade Representative;
Philip Trezise, acting program director, the Brookings Institution;
and Robert Baldwin, professor of economics of the University of
Wisconsin.
Will you gentlemen please come forward.
Bill Eberle, we are delighted to have you back and to have you here
this morning. If you would like to proceed first, please do so.
STATEMENT OF WILLIAM D. EBERLE, FORMER SPECIAL REPRESENTATIVE FOR TRADE NEGOTIATIONS
Mr. EBERLE. At this time I would like to request that my prepared
statement be made part of the record and I will cover the highlights
and save you some time.
Senator BENTSEN. That will be done.
Mr. EBERLE. Mr. Chairman, I am delighted to be here, especially
as the predecessor of your star witness this morning-it is nice to follow
Ambassador Strauss.
It is important, I think, that you have recognized that the subject
you are addressing-the American economy-is now so vitally tied
to the international economy that our foreign economic policy is part
of your annual hearings. This subject is important to every American
worker, business executive, and policymaker. I don't have to put this

69
into focus any more than did the Ambassador but I would like to add
a little more to the statistics so that you have a good feel for it.
Our exports and imports now approach 20 percent of our gross
national product.
Senator BENTSEN. Would you say that again? We are getting a lot
of background noise here. I want to be sure I hear it.
Mr. EBERLE. The imports and exports of the United States now
approach 20 percent of the gross national product of the United States.
It used to be that our trade was primarily with Japan, the European
Community, and Canada. No more. Today 40 percent of our exports
go to the developing world. I might add' here that I agree with Congressman Mitchell that the future of the U.S. economy is partially tied
to the developing countries. The industrialized world will have a
future growth rate of 3 to 5 percent. The growing developing world will
have a growth rate of 4 to 10 percent. If we can share in sales to that
part of the world, we will improve the growth rate in the United
States. This is why I think it is so important that this year, 1979,
we-in business and Government and the Congress-focus on these

issues.

I understand you would like me to talk about three areas-the multilateral trade negotiations; what are the next steps in export policy; and
our relationship with Japan. The policy decisions you make in these
areas will affect the course of our economy for years to come. They will
determine the volume and the direction of our trade, which sectors of
our industry and agriculture are going to flourish or be cut back, and
they will determine the kind of growth pattern the United States and
the world will have.
Let me, first, focus on the Tokyo round. I am pleased to comment
on the MTN since I have been a member of the President's Advisory
Committee. In addition to that, I feel a responsibility to you in Congress because I was somewhat responsible for getting you into this
a few years back.
While there is still much left to be negotiated, I can say to you that
the broad thrust of the agreements that Ambassador Strauss and his
team have negotiated carry many more pluses than minuses for the
United States. Even though I must reserve final judgment, which we
all must do, there is one very important thing we should all be able to
agree on and that is that everyone must urge them on to complete
the negotiations satisfactorily as quickly as possible.
Some real pluses go to the new rules on subsidies, which will be
critically important for the future trading system. In his opening
comments the chairman said we need equity. This code will bring
equity. The Government Procurement Code. The Customs Evaluation
Code. All of these are important, but what does this mean for Congress? Congress must vote up or down on these agreements, as you
have indicated. If you do vote them down later on because you find
them unsatisfactory, you will be creating great uncertainty internationally and domestically to business plans.
Although I will not suggest whether you should vote up or down
at this time, I am recommending. several things to you this morning.
The first is that Congress should promptly act to waive the application
of countervailing duties until these negotiations are completed.

70
The intent of the 1974 act was to allow duties to be waived until
did not
the end of 1978 to permit negotiations to be concluded. We counterclose enough on the subsidies
meet the target, but we are
entire
vailing code that not to extend the waiver will jeopardize the when
to evaluate the agreement
negotiations. You will have a chance
you vote up or down on the MTN results. I encourage you to proceed
with the waiver extension promptly.
The second recommendation I would make is that you would
or
refrain from legislating an exemption from any sector of industry
from the trade liberalization of the trade agreements.
agriculture
do
For the United States to take such action at this late date wouldand
harm to our ability to conclude the negotiations
irreparable
compromise the interests of some other segments of American industry
the
or agriculture. Again, you will have plenty of time to review
wait until you see what this package
agreements and I urge you to
looks like before you take any action.
the
The third recommendation I have is that you look hard at will
legislation-for example the domestic laws that
implementing
carry out these agreements. This legislation will be the key to whether
the agreements will succeed in the future or not. The implementing
and
legislation will be part of the package that Ambassador Strauss
will be coming forward to discuss with you in the coming
his team
months.
This is an important matter. It is going to be a great opportunity
Let's
to facilitate export growth-to build our trade on a sound basis.
get on with it.
Let me move to the export policy side. What are the next steps?
I commend this administration for flagging export expansion
talk
as an important goal. I have to note, however, that when we and
about slower growth abroad, relatively higher inflation at home the
oil import as the causes of our trade deficit, that is only half
equation.
The other half of the equation is exports. While our imports have
continued to grow, the rate of growth of our exports has not kept pace.
Indeed, it has declined. It has stagnated in our agricultural sector
the
and the rate of growth in our industrial sector has declined in
our share of exports to the entire induspast 4 years. As a result,
trialized world has slipped.
This problem has been discussed in the business community, in
the White House and in Congress-much of the focus has been on
promoting exports, for subsidizing them and for help, as well, to
"protect" domestic producers from imports.
The problem is too complicated for me to present in a short analysis
a comprehensive cure, but let me talk about a few of the things that
give
I think you ought to think about. We hear today that we ought tosome
the same kind of support and subsidies to American exports as
of our competitors abroad do. I think this is absolutely wrong.
I believe that it is the responsibility of the American businessman
out
and the American farmer to see that we export. As you pointed
only 200 U.S. firms account for 80 percent of all exports today.
earlier,
I suggest there is a different role for our government to play.
First of all is the education of the small and medium business coman
munity. It should be made a higher priority, we do not have
program today in the Commerce Department.
adequate

71
The Commerce Department could be reoriented to go out State
by State to select the products, show them where -the export markets
are and get going. Talk does little good. We need action. This will
be doing more than trying to compete on subsidies around the world,
particularly when we are trying to balance the budget.
Second, eliminating the disincentives in current Government
policies would make a good start. It is something under our control
today.
Let me start out by pointing to the need to expedite export licenses.
We do need some limits on high technology, but do you realize that
every product that has any advanced technology must secure a license
from the Commerce Department? I once chaired the interagency
committee that makes the decisions and I can tell you that every
product-and I am only talking about products now, not technology
as such-goes through an interagency fight and every time they
have to refight the same issues over again. It takes from 9 to 12
months, and it is an outrageous situation because in the meantime
our competitors from France and Germany and Japan have the business in hand.
It seems to me that the Commerce Department could establish
general guidelines on what technology products can be shared and
then makes exceptions to that rather than refight every issue. Assistant Secretary of Commerce Frank Weil is very favorable to this
and I urge you to think about how we can speed this up.
There is also regulatory spillover which is unbelievable. Today we
have the OSHA, the CPSC, the FDA, all of whose requirements
apply extra territorially, whether or not considerations to similar
regulations are applied abroad. Twenty-five percent is probably
a reasonable guess for increased costs to U.S. exporters.
Even if we require ourselves to do these things domestically, we
should not say, in effect, that we don't want to export. Competition
is the "name of the game" and our regulatory commissions ought to
face this. The President should move on these problems.
We have environmental reviews on all applications for Eximbank
financing. Can you imagine anything more ridiculous? If foreign
customers want to buy it, it is a good project. Why hold it up? We
are losing business on a daily basis because our Eximbank cannot
permit this, and our foreign government can
The U.S. flagship requirements that prohibit Eximbank financing on
foreign vessels is another example. I might point out two others. The
Freedom of Information Act permits competitors access to proprietary
information from bills of sales on exports, which discourages some
companies from wanting to export. Also, there is a U.S. company that
produces machinery, which wants to challenge the Japanese market
and is going to do so, but because of U.S. tax laws, is going to do it
out of Hong Kong
These are the kinds of things that you can do something about.
Let me conclude by saying: Isn't it about time that Congress makes
exporting a more essential part of U S. policy along with full employment? If it is good enough for Japan and Germany, is it not also good
enough for us as national policy? Then our Departments will start
to understand we mean business. It does not take long to do this.
I have two other suggestions. I think it is time that we repeal the
Jackson-Vanik amendment and that we get on with granting the mostfavored-nation treatment to both China and Russia.

72
I, like all of you, abhor and am concerned about human rights
and discrimination, but restricting exports is not the way to do it.
What we are really saying is, "Let somebody else do the business and
we will stand on high moral grounds and not trade." Political leverage
is where the real leverage comes, not in trade.
In sum, it is time that Congress face up, along with our administration, to eliminating the export disincentives.
While I do not believe we need subsidies in the business arena, but
I do think we need aggressive government support in two areas.
The first area to which Ambassador Strauss alluded, is we must be
out there every day combating unfair practices of foreign governments
and firms. We must be sure we execute our own laws. Mr. Chairman,
the business community has lost total confidence in the Treasury
Department's ability to deal with countervailing and antidumping.
Until Treasury restores that confidence, you are going to have everybody coming to Congress asking for protection. We put time limits
into the 1974 Trade Act and Treasury has flouted that law consistently
since.
It is not that they make good or bad decisions. They just don't make
decisions and they drag their feet. I think it is time appropriate congressional oversight committees look into this and remedy the situation.
The second area concerns export subsidies. It is time the voluntary "gentleman's agreement" on export financing in the OECD
became a mandatory international agreement which is enforcible. It
may be covered in the pending MTN subsidy code-I don't know-but
if it is not, you can push the administration to be more forceful.
Let me close by commenting on bilateral relations with Japan. These
relations have special characteristics but they share many of the same
general characteristics of our total trade problem. The trade balance is
totally out of line, and we should have concern for it. But that concern,
I would urge you, must be tempered by a perspective on the multilateral context because while the United States has a trade deficit with
Japan, we have a trade surplus with Canada and Australia.
We must put pressure on both surplus and deficit countries to move
toward balance. It is important that we bring the pressure within the
OECD and our international financing institutions to see that this
is done.
While we must wait until the end of the Tokyo round before
determining what ought to be done next, there are several things that
government and business can do in the meantime to ameliorate the
problem with Japan.
First of all, our businesses have not vigorously attacked the problem
of exporting to Japan. As a matter of fact, if you look at the trade
statistics, you will find that our declining share of trade with Japan is
in the very products where there are no barriers-food and machinery-where our share of the market has declined from 1969 to 1978.
This is both a business problem and a Government problem. It is a
business problem because we have not sufficiently aggressive exporters.
It is a Government problem because in the case of nuclear reactors we
were cut off from selling to Japan. In the case of food, we stopped our
soybean exports. And with all respect to my good friends, Senator
McClure, we have had a problem with logs: In the good years we

73
want to sell to Japan and in bad years we don't. We cannot be
inconsistent.
Such inconsistency in U.S. Government policy has hurt efforts to
do more export business with Japan. But the American business
community has to do a better job too.
There are several areas in which the Government can be a great
help and where we need to continue to keep the pressure on Japan.
However, we must look at where Japan is today, and not let our pentup frustrations over their heavily protectionist past policies motivate
us. They have removed a great many barriers and they are now
truely a part of the trading system. There are two areas where continuecl U.S. Government pressure is needed.
The first is in the area of certification of products. It takes months
and even years. The very bureaus which are closely allied to Japanese
businessmen are the ones that certify our products. They don't have
self-certification. Our products must be certified by a Japanese bureaucrat in Japan whereas virtually all of their products exported here
are self-certified under our system in the United States. It makes a
big difference.
Second, we must continue to keep the pressure on them to restore a
normal U.S. share of food imports which are controlled by the Government. This alone would increase our sales over $1 billion if we got it
back to just the same rate as in 1969.
Let me conclude by saying that we have some very important areas
to move in. Your real responsibility is to take away the disincentives.
American businessmen must then get out there aggressively and sell,
which I think we can (to. Thank you for letting me be here. You have
a major challenge and I know you will rise to it.
Senator BENTSEN. Thank you very much. Mr. Eberle.

[The prepared statement of Mr. Eberle follows:]
PREPARED STATEMENT OF WILLIAM D. EBERLE

My name is William D. Eberle. It's a pleasure to be here this morning to take
part in your hearings on the state of the American economy.
It wasn't so long ago, Mr. Chairman, that international economic policy issues
were low priority concerns to the American people, the business community and
our government. However, ballooning trade deficits, a declining dollar, dramatically rising oil prices, and the waning competitiveness of some American industries
have made the arcane subject of international economics a topic of vital interest
to workers, business executives and government policymakers.
The importance of our economic relations with the rest of the world to our own
economic welfare has never been greater. And it's continually growing. About one

out of every seven or eight manufacturing jobs in this country is dependent upon
our ability to export. One out of every three acres of land under cultivation produces food or fiber for our export markets. We depend on foreign sources of supply
for more than half our annual consumption of aluminum, tin, nickel, zinc, manganese and seven other critical industrial raw materials. Import competition has.
beneficial effects in stimulating domestic innovation and restraining inflation. In
sum, international trade has very direct effect on the state of our economy with
imports and exports now accounting for approximately 20 percent of our Gross
National Product.
It used to be that our trade was dominated by transactions with Canada,
Europe, and Japan. No more. U.S. exports to developing countries now approach
40 percent of our total. Furthermore, the United States exports more manufactured
goods to LDCs than to Western Europe, Japan, and the Communist countries
combined. The future vitality of our economy will be increasingly linked to the
development prospects of the LDC's.
Because of its growing importance, trade policy has become highly politicized.
The Congress has responded appropriately by seeking and achieving a bigger

74
role in the conduct of our foreign economic policy. This Congress must confront
and resolve several extremely controversial trade issues.
Congress must decide whether to extend its authority to the President to waive
the application of countervailing duties. It must evaluate and pass judgment
on the results of the Multilateral Trade Negotiations. It must examine our export policies when it considers the Export Administration Act. Finally, it must
confront inevitable pressures to restrict imports-pressures that will certainly
grow in intensity if economic growth slows.
The policies you establish in resolving these and other trade issues will have
very direct and large effects on the state of our economy and upon the daily lives
of our citizens for years to come. These decisions will determine the volume and
direction of our trade. They will influence which sectors of our industry and agriculture flourish through better access to export markets and which sectors will
experience domestic adjustment, sometimes painful, to foreign competition. They
may stimulate the development of new domestic products and more efficient production processes and they may cause older products to be replaced by cheaper
or more innovative foreign substitutes. Finally, they will directly affect our ability
to restrain inflation.
I will now try to touch on each of the three topics you have asked me to address
this morning: the MTN, next steps in U.S. export policy, and our bilateral relationship with Japan.
CONCLUDING

THE TOKYO

ROUND

After more than five years of negotiations, the Tokyo Round is nearing a conclusion. The President has served notice of his intention to enter into trade agreements which the Congress must approve or reject. Mr. Chairman,I have follo'we d
these negotiations very closely as a member of the President's Advisory Committee
and I do feel a sense of responsibility to Congress because of my role in working
with you in writing the Trade Act of 1974 that got us started on this road.
While much ofthe work of the negotiators is completed, they are still meeting
as we talk today to conclude unresolved and important issues-both with respect
to the nontariff measure codes and the tariff negotiations. It's therefore impossible
for me to give you a definitive evaluation of the result and recommend whether
the agreements warrant your approval. I can say that substantial progress has
been achieved in many areas of great importance to the United States.
The code on subsidies promises to bring new international discipline to
bear on export and domestic subsidies on industrial and agricultural goods.
Subsidies are among the most often cited foreign trade
practices that inhibit
U.S. exports.
The codes on government procurement and standards should combat
foreign discrimination against U.S. exports and introduce greater openness
in foreign government procedures to provide better access for U.S. goods.
The codes on customs valuation and licensing should remove some of the
administrative impediments governments use to restrict trade.
I believe it is in our national economic interest to bring these negotiations to
a successful conclusion. If our negotiators fail to conclude an agreement that
meets with Congresional approval, the costs to our economy could be substantial.
First, the failure of governments to reach an acceptable agreement will cast a
shadow of uncertainty over business plans that may have a chilling effect upon
investment and production decisions. Second, we will have lost a great opportunity
to change the ground rules of international trade to conform to the present reality
and create new mechanisms to deal with future disputes. Finally, domestic pressures here and abroad for merchantilistic trade policies might achieve a momentum
that would be difficult to contain.

The Congress should therefore do what it can to encourage a rapid conclusion
to the negotiations and begin itself to evaluate the results. I would like to make
two recommendations to you on that score.
First, Congress should act immediately to extend the authority it has given
the President to waive the application on countervailing duties to subsidized
imports. This extension need only be for the time necessary to complete negotiations on the Subsidies Code and for the Congress to evaluate the result-perhaps
until October. But it is essential that the extension be granted to defuse the political issue that the expiration of the waiver has created so that the MTN can be
wrapped up.
The deadline set in the Trade Act for the completion of this aspect of the
negotiations could not be met because of the recession of 1974-75 which effectively
suspended bargaining and because this has been the most difficult and controversial
issue tackled in the MTN. An agreement is now so close. I believe you should

75
extend the waiver and evaluate the agreements on their merits once negotiations
are concluded.
Second, Congress must refrain from legislating an exemption for any industry
from the trade liberalization that will result from this negotiation. For the United
States to take such action now on behalf of any industry would be deemed an
act of bad faith by our trading partners. It could do irreparable harm to our
ability to successfully conclude the negotiations.
It's true that some domestic industries and certain farm products are challenged
by stiff competition from abroad. But foreign manufacturers and foreign farmers
in other sectors face equally tough competition from our own citizens. We can't
expect to provide more business opportunities for our dynamic export-oriented
growth sectors if we take unreasonable steps to restrict imports into the United
States.
That brings me to the next topic you've asked me to address: export policy.
UT.S. EXPORT POLICY: THE NEXT STEPS

To explain our trade deficits, economists have pointed to slower rates of economic growth abroad, relatively higher inflation here at home, and our increasing
dependence on oil imports. These factors explain only half of the equation: the
growth in U.S. imports. While imports continue to grow, the rate of growth for
U.S. exports of manufactured goods has declined for the past four years. The rate
of growth of U.S. agricultural exports has been stagnant for the last three years. As
a result, the deficiencies or, indeed, the absence of any concerted U.S. export policy
has been the subject of much discussion in recent months in the business community, in the Congress, and even at the White House.
This problem is too complex for me to present this morning a thorough analysis
and a comprehensive prescription for a cure. But let me give some thoughts on
the subject.
U.S. firms sometimes find themselves losing in competition with foreign firms
that have substantial foreign government backing and assistance. The answer
given in some quarters is that the U.S. government should emulate foreign governments in promoting and subsidizing U.S. exports. I believe this approach would be
wrong. In our economic system, it is the responsibility of businessmen and farmers
themselves to succeed in competition in the world market. The fact that only 200
U.S. firms account for 80 percent of U.S. manufactured exports shows the private
sector has its work cut out.
The role of the U.S. Government in actively promoting exports must be limited.
An illustration of a useful government function in such a limited role is providing
more and better information to small and medium sized U.S. firms about business
opportunities abroad and the technical assistance to exploit such opportunities.
Undoubtedly, the funding priorities of the Department of Commerce can be reoriented to direct more resources to this activity.
Rather than asking ourselves why our government doesn't do more to promote
U.S. exports, a more appropriate question is why doesn't the government do less
to hold back U.S. firms from competing abroad?
Expediting Export Licenses.-There clearly can be legitimate reasons to restrict
exports such as protecting our national security. When restrictions are necessary,
however, it's essential that our control system be efficiently administered. Unfortunately, that is now not the case. It's not unusual for the Commerce Department
to take more than nine months to process export license applications. As a result,
the United States is viewed as an unreliable supplier in many foreign markets. Sixty
to ninety days is more than adequate time for the government to evaluate a license
application.
Limiting Regulatory Spillover.-American firms also lose export opportunities
because of the extraterritorial application of U.S. laws and regulations. The exportinhibiting spillover effects of regulations that promote other objectives must be
taken into consideration in cost/benefit evaluations of these policies. Examples
include:
OSHA requirements, CPSC standards, and FDA requirements which are
applied extraterritorially and preempt foreign government decisions;
Environmental reviews which may limit export financing;
Pesticide regulation which exceed foreign government standards;
U.S. flagship requirements which prohibit Export-Import Bank financing
for freight costs on foreign vessels, even when U.S. flagships are not available;
Freedom of Information Act requirements that can result in government
disclosure of proprietary business information valuable to foreign competitors.

76
U.S. tax policy has had some interesting trade spillover effects as well. In a recent
article in Foreign Affairs ("Facing Up to the Trade Gap with Japan," Fall, 1978,
pages 146-168), James Abegglen and Thomas Hout point to the case of a U.S.
machinery manufacturer who chose Hong Kong rather than the United States as
a base for exporting to Japan. The reason? U.S. tax laws. The result: lost U.S.
exports.
Repeal of Jackson-Vanik.-In other areas much more fundamental action is
required. Our policy of using exports as a tool to promote foreign policy objectives
has failed the acid test of any policy: it does not work. And it should be stopped.
Americans who export are concerned about human rights and discrimination
against other Americans-as concerned as any of us. And us. And as a result of
decisions based on these considerations they have lost business opportunities to
foreign competitors and suffered the economic consequences. But their sacrifice
has yielded no result.
The classic case is the Jackson-Vanik Amendment of 1974. The evidence suggests
this amendment has not achieved its intended result-an increased rate of emigration of Jews from the Soviet Union. In the meantime, however, U.S. firms have
lost business to their foreign competitors.
A similar situation exists with respect to China. President Nixon "opened the
door" to China with the Shanghai communique of 1972 and the Japanese have
been walking in and out with growing speed ever since, carrying contracts for
millions of dollars worth of business. Now that we've established formal diplomatic
relations, it's time to establish the appropriate environment for the conduct of full
commercial relations as well. In sum, I think it's time that Congress granted most
favored nation status and export credits to both the Soviet Union and China.
Aggressive Government Support.-Mr. Chairman, earlier I said it was not appropriate for the United States to deal with foreign competitors who do business with
the backing and assistance of their governments by emulating them. But, there is
nonetheless an important role for the U.S. government here. It is to vigorously
combat-both through international negotiation and domestic measures- the
unfair practices of foreign governments and firms. At this point, it looks as though
the Multilateral Trade Negotiations will establish new international rules and
mechanisms that will make this task easier. But the agreements we have negotiated
are mere pieces of paper and will have no impact unless the domestic implementing
legislation that is now being drafted is clone effectively. In addition, our government must make a firm commitment to vigorously pursue the rights it has negotiated under these trade agreements on behalf of U.S. firms. In these two activities
the Congress has a critical role to play-both in drafting the legislation and in
overseeing its execution in the years ahead.
A final area where the U.S. Government has an important role to play is in
seeking firm agreement with other countries to restrict competition among governments in granting export credits. Foreign government export credit subsidies, as
much as any other single factor, shift business to European and Japanese firms
and away from American firms. The existing international ("Gentlemen's")
agreement on this topic negotiated earlier this year is purely voluntary and is
not sufficiently comprehensive. These deficiencies must be remedied in new
negotiations.
BILATERAL

RELATIONS

WITH JAPAN

While our trading relationship with Japan has several special characteristics,
the problems which characterize it are not unique. To a large extent, they are
magnified versions of problems that characterize our trading relationships
generally. First, there is the deficit and then there are the related problems of
American business initiatives to penetrate the market and the problems of restricted access for U.S. exports.
From 1973 to 1975, our bilateral trade deficit with Japan grew from just over $1
billion to just under $2 billion. It then jumped to $5.4 billion and $8 billion in 1976
and 1977 respectively. This year it's projected to be $10-11 billion.
These alarming annual figures mask a development in 1978 that may indicate
that our deficit with Japan may be peaking. The table that follows shows that
U.S. monthly exports have grown slowly, though hardly dramtically, since April.
Meanwhile, Japanese exports to the United States have leveled off with the result
that our monthly bilateral trade deficit has declined gradually but steadily since
last spring. I must emphasize this is not a dramatic shift in our economic relations
with Japan, and even eight months' trade data is insufficient from which to draw
any firm conclusions. But the shift bears watching nevertheless.
The fact that we have a deficit in our bilateral trade with Japan or with any country should not normally justify special attention or policy actions. Multilateral

77

N'

balances may negate deficits or surpluses with individual countries. For example,
Japan has trade deficitswith both Canada and Australia; the United States has
surplus trade balances with those countries. Nevertheless, the trade deficit
with Japan is so large that it is a key component in the overall balance of payments
deficit which the United States is currently running and it has been an important
factor in the recent decline in the value of the dollar.
UNITED STATES/JAPAN TRADE BALANCE, JANUARY-NOVEMBER 1978
[Dollars in millions, seasonally adjusted]
Exports
January -743
February ----c
March
----------------------------------------------------------April -970
May -1,
June -1,046
July-1,
August-----------------------------September ,, ,
OctoberNovem ber --------------------------------------------------------

Imports

Balance

1,756
1,---------------- 2,000
869
'016
2, 044
2,242
009
1,961
2,059
047
2,197
1092
2,015
1,193
2,094
1,249
2, 087
1,369
2,043

-1,013
-1,131
-1, 028
-1,272
-952
-1,013
-1,150
-923
-901
-838
-674

Source: U.S. Department of Commerce.

We must, of course, recognize that countries have a natural propensity to be
in surplus or deficit at different stages of their economic development. Nevertheless, even in a regime of floating exchange rates, we must insist that surplus
countries as well as those in deficit assume equal responsibility for keeping the
system in balance.
Both for these reasons and because of the fact that several dynamic developing
countries (including South Korea, Taiwan, Hong Kong, Singapore) are emulating
the Japanese economic development model and the problems we face with Japan
today may characterize U.S. trading relationships with a number of these countries
in the future, special attention to our deficit with Japan is warranted.
The U.S. side of the Equation.-It is customary for us to place responsibility
for the deficit on Japan, and particularly on the government of Japan. There
have been good reasons for this. However, we must also look to ourselves, both
to the business community and our government, to explain a good part of the
problem. I would like to explore that latter aspect of our relationship first and
then return to the more familiar topic of what Japan can and must do.
As this Committee is aware, the U.S. share of world trade has declined steadily
over the last decade, reflecting a general erosion of the U.S. competitive position.
This has been true in Japan, as it has in other countries. The U.S. share of Japanese
imports of both manufactured goods and many categories of raw materials and
food has declined. This trend cannot be explained by the existence of Japanese
trade barriers with which all our trading partners must also contend. And the
answer to this problem must therefore be found at home, not in Tokyo.
Then there is the question of the level of initiatives by the American business
community: are we trying hard enough to sell to the Japanese? Certainly the
Japanese market presents difficult and special problems for foreign firms seeking
to do business there. These have been well documented and while there may be
good reasons for the current low profile of American business in Japan, the fact
nevertheless remains that there are probably fewer American businessmen in
Japan today who speak fluent Japanese than there are people in this room. How
many Japanese businessmen fluent in English do you suppose are working in the
United States at this moment? The success stories of companies like Coca Cola,
Polaroid, Lipton, and Schick in Japan suggest other U.S. firms can succeed too.
We cannot blame the Japanese for not buying from us if we have not made a
determined effort to sell to them.
Past U.S. Government policy is also partially to blame for some of the problems
in'the United States-Japan trading relationship. As in the case of other countries,
as I have pointed out, the credibility of the United States as a reliable supplier
is in question in Japan. Japanese skepticism has a real foundation. Our abrogation
of soybean contracts, our restrictions on exports on North Slope crude oil, and
our long-time restraints on exports of logs go a long way toward explaining the
motivation for Japan's diversification of its sources of supply for these materials
and the erorlng U.S. share of the Japanese market for them.

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78
Japan's Role.-All this is not to say Japan is blameless. Japan's determined
and very successful effort to exclude foreign products from its market for most
of the post-World War II period has been a source of enormous frustration to
American business. I'm confident that over the years all of the members of this
Committee have been regaled with descriptions of Japan's restrictions, both
formal and informal, on U.S. exports, It is ironic that Japan, the country that has
gained so much from the liberalization of the trading system, has been so slow
to accept that liberalization itself.
However, the judgments we make now and the future policies you set must be
based on an accurate perception of the current situation and not motivated by
pent up frustration over past Japanese practices. We can only go forward. I want
to focus on the prospects for improving the current situation.
Largely motivated by strong pressures exerted by our own government over the
past decade, Japan has already dismantled most of the formal barriers that inhibit U.S. exports. A number of formal restrictions still exist on products of great
export interest to us. In addition, residual informal barriers are also substantial,
as anyone who has even thought of conducting business with the Japanese Government or attempted to obtain Japanese government certification to health and
safety standards for its products knows all too well. There are two ways to attack
these problems.
One is through formal negotiation. Many of the problems U.S. exporters face
in Japan have been the subject of bargaining at the Multilateral Trade Negotiations. I have high expectations here but we must await the conclusion of the MTN
before we can render a judgment about the result. In addition, we must seek formal
bilateral agreements with the government of Japan in specific problem areas to
achieve a higher level of U.S. exports, such as with respect to food.
Second, the United States must continue to apply firm pressure upon the Government of Japan so that internal changes are made in bureaucratic practices and
attitudes to erode the frustrating informal barriers to U.S. exports. This will be
very important in areas such as standards certification and government procurement, notwithstanding any multilateral agreements in these areas. We must be
vigilant to protect the rights we negotiate in any codes in these areas in the Multilateral Trade Negotiations.
CONCLUSION

Mr. Chairman, all these issues are important and the stakes for U.S. business
in their successful resolution are very large. The 96th Congress does, indeed, have
a major challenge facing it in managing the evolution of our foreign economic
policy. It will need the leadership and guidance of the experts on this Committee to successfully meet that challenge and I appreciate the opportunity to have
been able to give you my views today.

Senator BENTSEN. I think we will go through each of your statements before we have questions because of the time limitation.
Mr. Trezise, I know you have a particular knowledge of the Japanese
economy and a great deal of experience in Japan.
STATEMENT OF PHILIP H. TREZISE, ACTING PROGRAM DIRECTOR,
THE BROOKINGS INSTITUTION
Mr. TREZISE. I have submitted a prepared statement, Senator, and
I will summarize very briefly what I have provided in my prepared
statement.
On the MTN the outcome so far as we know it now seems to me to
be substantially-indeed more than substantially-responsive to the
mandate that Congress gave the Executive in the Trade Act of 1974.
I think that both branches of the Government can take credit for this
and can together, take some pride in what Ambassador Strauss has
now put before you.
The so-called MTN agreements that have been negotiated seem to
me to be a response to section 121 of the Trade Act a greater response
than I would have expected. I think if they can be carried through,
they will serve to modernize and strengthen the General Agreements

79
on Tariffs and Trade. This is long overdue. It can only help to move
us toward the fairer and more open trading system which the Trade
Act calls for.
The tariff bargain in the MTN, as I understand it, would cut existing duties by an average of 30 or 35 percent over the next decade.
This is not a small reduction and I think, contrary to what many
people say, it is a very important reduction. It will serve to move
resources from less to more efficient uses in this country and around
the world. Moreover, the fact that we are going to do this gradually
means that the adjustment problems for individual firms and industries
should not be very serious.
The agricultural package is, I think, less encouraging, but it does
at least represent an effort to put some order into a sector of the
world trading system that has been marked primarily by a progressive
increase in intervention and governmental control.
The pending wheat agreement is quite innovative, particularly in
its provision for buffer stocks. I think that it would have been more
helpful had the wheat agreement been extended to coarse grains as
well where we, of course, are the world's leading exporter.
Finally, on the whole package, I would remark that except for the
tariffs, nothing in it is self-executing. Whether we make something
of the agriculture package and the nontariff agreements depends upon
how we and other trading nations perform. In our case it seems to
me this is going to be a matter for both the Congress and the Executive-the Congress in its oversight responsibilities and the Executive
in carrying forward the agreements we have made.
I don't see how we can realize the real hopes that are here unless
both arms of the Government cooperate and act with a degree of
forebearance on occasion as well.
Now, Mr. Chairman, I would say a few words about Japan. Let
me say, first of all, that I think the present imbalance in Japan's
external account is not very healthy for Japan and it is not very
healthy for the world economy. It will be to the benefit of everybody
that it should come down to more manageable numbers.
Now the explanation for the increase in the current account surplus
of Japan is not quite so simple as is sometimes said. One explanation
is that this is all a matter of protectionism. There is, of course, a bedrock of protectionism in Japan, perhaps more substantial than in
most other industrial economies. But I don't think we can explain
away the increase in the surplus by protectionism because, as Bill
Eberle has said a few minutes ago, protectionsim,. in fact, has been
coming down. Tariffs have been reduced on two occasions in the last
6 years. Many of the quantitative restrictions have been either removed or liberalized and other nontariff barriers have been lowered
or eliminated.
Thus it is difficult to accept the proposition that rising protectionism has led to a rising surplus. I don't think either that there is a
general conspiracy against imports from Japan. There are barriers
that are not official, led primarily by the language but also in the areas
of custom and habit. If we can deal with the official barriers, if we can
progressively bring those down, those that are based on law or on an
official direction, then we can do all that is really humanly possible
anyway. We cannot change the language and we cannot change the
character of the Japanese people, and I don't think we need to.

80
I don't think either that there is an explanation to be found in
Japanese export subsidies. The Treasury in 1976 made a comprehensive examination and investigation of 21 alleged subsidies that the
Government of Japan was supposed to be operating. In the end they
found that two were subject to countervail, and the amount of countervail was two-tenths of 1 percent in this case.
One of the subsidies was the deferral of taxes for small business
exports, which is a low order of DISC, and the other was the provisio
of services for export promotion, not unlike what our Commerce Department does in the same field. So much then, for official subsidies.
What is more relevant, I think, was the official policy of Japan,
particularly in 1976 and 1977, to restrain the rise in the exchange rate.
I think this was an unfortunate and costly mistake for Japan and for
the rest of the world, and it did contribute substantially to the growing
external imbalance.
We need, however, here to look at the exchange rate in real terms
rather than in the nominal terms that Senator McClure was suggesting.
Through 1977 the effective exchange rate in fact got back only to
its 1973 level. Inflation in Japan was lower than for most of its trading
partners so that the impact of the nominal change in the exchange
rate was essentially zero.
Last year, pressures on the rate got so strong that the central bank
could no longer contain them, and it did go up in real terms very substantially. Through October, it was up 21 percent, a very large amount.
Now that we have had a recovery of the dollar, the real yen rate is
13-14 percent above its value of 1 year ago, still a very healthy increase. But we have had only a relatively brief time in which this
change could work.
In addition to the exchange rate and even more fundamental has
been the very sluggish economic recovery in Japan from the 1974-75
recession. Private investment, which used to be a principal force for
growth, has slowed down very, very sharply in recent years. The result has been to keep imports low and to leave capacity for exports;
in short, to generate all the conditions for a trade surplus.
This would not have been quite so much the case if Japan's main
trading partners, especially the United States and Southeast Asia,
had not been themselves operating at much more closely to their production potential.
So much for the diagnosis. The question is: Is this going to change?
Well, there are some pretty good indications that it is changing. The
sizable appreciation of the yen is beginning to work, I think. This has
shown up in the volume of exports which has been declining ever since
last March. Domestic demand is up. It was up last year 7 percent, which
is considIerably above the rate of growth of GNP.
Import volume has finally begun to rise, and I think that the OECD
forecast that the current account surplus in 1979 will be reduced by
half is probably a reasonable one, depending to some extent on the
policies of the new government in Japan and a possible supplementary
budget next fall.
Beyond 1979, Mr. Chairman, one can't obviously make very sensible
predictions in any specific way. I would think, however, that Japan
for the longer run-say, for the next decade-is probably going to have
a surplus on current external account and that this will have to be

81
balanced by flows of capital, official and private, to the capital-needy
parts of the world.
There is no way we can expect the world to make the kind of progress
we hope for, with more output and rising incomes, unless capital is
flowing from the capital-surplus countries to the capital-deficit
countries. Japan is certainly going to be a capital-surplus country.
This flow will be facilitated if certain changes are made within
Japan itself, and these I think will and must be made. In effect, what
we should look forward to is Japan financing its own export surplus as,
indeed, we did through most of the period since 1945.
Thank you, Mr. Chairman.
Senator BENTSEN. Thank you very much.
Mr. Baldwin, please proceed.
STATEMENT OF ROBERT E. BALDWIN, PROFESSOR OF ECONOMICS,
UNIVERSITY OF WISCONSIN, MADISON
I should like to comment on the international trade agreements
covering nontariff trade matters that are currently in the final stages
of negotiation in Geneva. As you know, the President, as required by
the Trade Act of 1974, informed Congress on January 8 of his intention
to enter into these agreements with other GATT members not less
than 90 days from that date.
A final appraisal of these agreements cannot be made until the
various gaps and bracketed language in the tentatively agreed-upon
codes are removed and especially until one hears the answers by our
trade negotiators to questions I hope the Congress will ask them concermng just what they expect from the agreements and why they
accepted various provisions in them. However, on the basis of the information available thus far, I would conclude that on balance the
new codes are in the interests of the United States and should be accepted and implemented by Congress.
I do, however, have some concerns about them. To start with, I
doubt that what actually will come from the new codes is what many
groups in industry, labor, and agriculture had hoped for and perhaps
thought had been promised. Many leaders in these sectors firmly believe that most of the severe import competition and export difficulties
faced by U.S. industry and agriculture is due to various nontariff
measures adopted by foreign governments, and they hope these will
be eliminated after the Tokyo Round of negotiations is concluded.
There is no doubt in my mind that many foreign governments do
indeed use various nontariff devices to restrict imports and artificially promote exports much more than the U.S. Government does.
But two points should be made.
First, foreign NTB's are not the main cause of the pressures for
industrial adjustment that are being placed on the structure of U.S.
production. These pressures are much more related to such basic
economic factors as the worldwide spread of technology and rapid
improvements in human and physical capital in other countries that
are leading to faster development rates in many other areas.
Second, although the elimination of much of the type of Government intervention that U.S. business and labor leaders are concerned
about would improve the U.S. trading position to an appreciable degree, there is, in my view, almost no chance for the kind of sweeping

82
modifications these leaders want. This has nothing to do with the
ability of our negotiators but rests upon the rights of other governments to take social and economic actions that they believe are in
the interests of their people. Their actions may have the effect of
supplying foreign markets with higher cost foreign production rather
than lower cost American goods, but this is usually a deliberate decision made for noneconomic reasons by these sovereign governments.
What especially concerns me in this connection is that the U.S.
reaction to these facts of current international life will lead to a further
push for protectionism in this country. An overselling of the results
of the Kennedy Round negotiations was, I think, partly the reason
for the strong protectionist pressures that emerged in this country
in the late 1960's. So one must be realistic in his appraisal of what
will come out of the Tokyo Round. And I was glad to hear Ambassador
Strauss talk about that.
The new codes can eliminate some obviously unfair trade practices
and might in the long run lead to fundamental improvements in
the framework of international trade, but we should not expect too
much in the future. If countries intended to dismantle most of their
trade distorting measures, the negotiations would not have taken
the form of new codes but of hard bargaining on the reduction of
specific measures such as quotas or particular subsidies.
It is in relation to the longrun implications of the Tokyo Round
negotiations where I have another concern. There is the danger that
the negotiations will turn into being a step in the direction of what is
called "managed" free trade.
This concept actually has considerable appeal among some American
business and labor leaders. Basically it involves international planning aimed at sharing markets in an orderly manner and preventing
so-called "excessive" expansions in capacity in several key product
lines.
However, it runs against the spirit of U.S. antitrust legislation
which is based on the belief that this kind of planning is likely to
lead to price-increasing cartels and a reduction in the rate of economic
progress. The United States is faced with very strong, new competitive
pressures in the world, especially from the developing countries.
But in my view we should and can pursue an active adjustment policy
that humanly treats those who are adversely affected by economic
change without at the same time preventing the kind of adjustments
needed if we are to maintain adequate growth. And, it is this growth
that is needed to expand the various social programs we desire.
One concern on this point relates to the International Steel Committee recently established under OECD auspices and possibly to
the aircraft agreement being concluded, although there is not enough
information on the latter agreement to make much of a judgment.
The text of the mandate to the Steel Committee includes among its
objectives the need to "avoid encouraging unjustifiable investments
while recognizing legitimate development needs" and to "facilitate
multilateral cooperation consistent with the need to maintain competition, to anticipate and, to the extent possible, prevent problems."
These phrases sound to me as the possible basis for output-restricting actions that are not in the longrun economic or political interests
of the United States.

83
The mechanisms for dealing with the appointment of panels and
dealing with their decisions is another aspect of the codes that bears
on longrun prospects under the agreements. The key to improving
the codes and turning them into meaningful behavior rules that expand
world trade and promote international political stability is to build
up gradually a body of forward-looking "case law" arising from
specific disputes.
While the language establishing such panels varies from code to
code-and indeed does not seem to be entirely consistent-preference
is usually given to government officials as panel members. As I think
past experience has indicated, government officials do not, in these
circumstances, have the degree of independence needed for impartial,
institution-building decisions. Some panel members in the past have
had to make a decision concerning, say, a specific U.S. trade action
and then the next week sit down and negotiate with the United States
on a matter such as the amount of foreign aid his country will receive.
This does not make for impartiality.
Even more important, however, is the so-called Committee of Signatories that each code has. These committees receive the report and
recommendations of any panel established under the disputes settlement mechanism and then make appropriate recommendations themselves. This is the stage at which longrun progress in reducing NTS's
must be made. All signatories to the various codes are members of
these committees. However, the tradition of the GATT is that matters
are not decided by voting but by general consensus. This has meant
that if one of the major trading powers such as the United States, the
European Community, or Japan opposes a particular action, it is not
implemented. Thus, what I fear will happen both in the short term
and long term is that many of the NTB cases raised by the United
States and the developing countries, especially, will not result in
significant changes because of what is, in effect, the veto power of
other large countries who do not share our views.
Again, it is a fact of international life that you cannot force other
large countries to do what they do not wish to do. However, it seems
to me that by pushing for greater authority for the GATT Secretariat
in dispute settlement matters, there was a greater possibility for promoting in the long run not only U.S. interests but those of the world
economy generally than has actually been achieved under the agreedupon disputes settlement provisions. But, one would want to ask our
negotiators about their efforts in this regard before reaching firm
conclusions.
Now let me turn briefly to some of the specific codes. The key ones
from our economic interest are the ones covering subsidies and countervailing duties and government procurement policy. There are appreciable market opportunities available for U.S. firms if foreign subsidies can be made less trade-distoring and if foreign governments will
in their purchasing policies reduce their hidden preferences for domestic producers.
Our leverage in trying to secure better control over subsidies has
been the possibility of introducing an injury clause into our countervailing duties law. All other major countries have such a provision as
does the original GATT code on this matter. While one can in theory
argue that all subsidies that distort trade are bad from a global view-

84
point, it is sensible from a selfish viewpoint to accept an injury clause,
since, if there is no material injury to any domestic industry, it seems
foolish not to give domestic consumers the benefits of the willingness
of foreign citizens to pay part of the costs of the goods they consume.
We also have left open another route for dealing with subsidies that
does not require material injury to be established. This so-called
('serious prejudice' route hopefully chili be useful in dealing with subsidies that take away U.S. export markets.
That can be a very powerful device, say, for dealing with the Japanese problem.
In return for accepting an injury clause the United States has
obtained GATT provisions that make it more difficult to provide
hidden export subsidies. The door has also been opened for trying to
mitigate the trade-distorting effects of domestic subsidies. This, in my
view, is the most important part of all the agreements. Unfortunately,
in the short run I do not.see much progress in this area. The European
Community has resisted the U.S. initiative in this area and since the
tentative section on domestic subsidies was drafted by the Community,
I doubt if many changes will be made in Community subsidy policy,
which I think is quite restrictive as far as U.S. trade is concerned.
The best prospects for change rest on the likelihood that the EC
will itself come to appreciate the high costs and adjustment-interfering
nature of domestic subsidies and move towards less distorting means
of providing social and economic assistance. But, as I have also said,
I would have liked to see a better mechanism for facilitating such a
change than seems to exist in this and the other codes.
The government procurement code is very much in the interests of
the United States, since nonmilitary purchasing by govenments and
government-owned or controlled firms is much more extensive than in
this country. It appears that its applicability will be considerably
more narrow than the United States had hoped, but it is a very worthwhile start.
There is insufficient time to make more than passing comments
upon the other codes. The one on safeguards is the least complete so
little can be said about it. One regret is that there is not more emphasis
on adjustment as a prerequisite to trade-restricting assistance, but
this also applies to our own trade law. The codes on standards, licensing
customs valuations, and commercial counterfeiting will help to eliminate blatant trade-distorting practices in these areas and bring about
more uniform procedures.
The final code on which I wish to comment deals with the reform of
the GATT. One section of this code deals with improving the general
disputes settlement and surveillance procedures of GATT. Again, as
with the specific codes, I think we need to learn more from our negotiators how they expect undue "big power" pressure to be avoided
under these procedures, and how an increasing degree of adherence to
non-trade-distorting practices can be secured from these reforms.
Another important part of this code deals with differential and
special treatment in favor of developing countries coupled with their
gradual assumption of greater GATT responsibilities. It is the developing countries toward which the United States will be devoting an
increasing amount of economic and political attention in the future,
and it is essential that we lay the foundations for more harmonious
relations with these nations.

85
As they continue to compete more successfully for markets in the
industrial countries, we must take advantage of the growing export
markets they provide rather than adopting inward-looking protectionist policies. Otherwise we are likely to be faced with a growing
degree of political hostility that endangers the foundations of world
peace the United States has worked so hard to build over the last 40
years.
The part of the GATT reform code dealing with the developing
nations is somewhat helpful in promoting better relations, but I
would not be overly optimistic concerning the implementation of the
broad objectives set forth. What the developing countries really want
and need is an easing of the quantitative restrictions that the industrial countries, including the United States, have introduced on imports of such goods as textiles, shoes, TV sets, and steel. But this
cannot be achieved until both the developed and the developing nations devise effective industrial adaptation policies that do not impose adjustment costs on affected industries that are too high and too
rapid to be politically acceptable.
Thank you, Mr. Chairman.
Senator BENTSEN. Thank you very much, Professor Baldwin.
Congresswoman Heckler.
Representative HECKLER. Thank you, Mr. Chairman.
I would like to thank the members of the panel.
Mr. Eberle, I would like to have you pursue your earlier comments
on the lack of business confidence in the countervailing and antidumping remedies because this is the experience that I have often
heard recounted, that the remedies presently are so burdensome that
it takes thousands and thousands of dollars to fight the case and then
get it through the bureaucracy. There are innumerable steps which
only the richest corporations can survive, and only they can possibly
pursue what should have been available for any business.
Now, what my question is: Should there be a change in the law?
Because, obviously, I have a lack of confidence in it, and the business
community, as I listen to people, has a lack of confidence. Furthermore, the implementation of these provisions is less an automatic
working of the law than it is the will of the administration. And I
don't mean that in a political sense. I say, isn't there a way that we
can tighten this procedure and develop business confidence in it so
that fair competition can be the modus operandi of the marketplace?
Mr. EBERLE. I am not sure what the best solution to it is. But
the problems goes back all through the 1960's where Treasury simply
never made any decisions. Many of the same people are there even
though the law changed. The law changed in 1974. Treasury has been
required to speed things up, but they have simply ignored the law.
Part of Treasury's rationale that I used to hear was they didn't
have enough people to do the job. My guess is that because it can be
a disturbing element in our foreign policy, that the operation is not
independent enough of the pressures from the other agencies and from
the Secretary of the Treasury. It leads me to believe that, although
there should be some foreign policy check, obviously, with the President, there needs to be more independence in the decisionmaking and
speed. Really it is the question of timing that is probably more
important.

86
Even if the decision came down against business, I think they
would be happier just to have the decision on a timely basis because
then they know what they have to do. Both the shoe and the textile
industries thought they were going to get some decision and relief and
never got it, and now in many cases it is too late.
Representative HECKLER. Therefore, what are you suggesting?
Mr. EBERLE. I guess I am suggesting that when you look at the
implementation of the new code that you find some way of giving
independence to the Government decisionmaker that will handle this.
Representative HECKLER. Yes, sir.
Mr. EBERLE. I know it can be done. I don't care whether it is in or
out of Tresasury so long as there is more independence and there is
a faster answer.
If they don't have a finding pro or con, perhaps it ought to go in
favor of the business automatically-that is, if they don't make a
decision.
Representative HECKLER. The time frame should be in the plan one
way or the other.
Mr. EBERLE. It is like the up or down vote you will make on the
trade agreements. It is certain. You are going to act and make a
decision.
On a certain day there ought to be a decision, and if they don't do
it, then the allegation ought to be presumed to be true.
Representative HECKLER. In terms of that, I think that is a very
practical piece of advice in the sense of setting perhaps a time frame
that would be fair and pinning it down so that the decision can be
made, because then at least business could make its plans with that
sense of reality instead of this expectation of a favorable response.
In terms of our expertise in the import area, obviously, certain
firms-those magic 200-are experts but really I find an enormous
interest in developing export expertise in small companies in my
area. Yet when I attend these seminars, I must say I think I am not
a business person, but I do think all of us know that the advice which
is given is fairly limited.
Now, isn't there a way of presenting a more sophisticated insight
into this so that small- or medium-sized firms could be brought up
to snuff in a sophisticated way and then decide whether they make
the extra investment in promoting a product for export?
Mr. EBERLE. My judgment is there are two basic problems. One
is the cost problem to smaller firms to equip themselves to understand it all, and second, is the lack of understanding of small firms
as to how big that market is out there. It seems to me that one of the
best things that could be done is to approach this on a State-by-State
basis. For example, there is a proposal before the regional governto
ments of Washington, Idaho, and Oregon to do exactly that, which isthe
with export potential, and identify
study regional products
markets. The idea is to have an independent firm determine that,
and then go into the market in cooperation with two or three companies to demonstrate that they are right in their recommendations.
I think that kind of project proves that it can work with smallmedium-sized companies is what will have to be done.
It is not good enough to send 300 people from the Commerce Department to cheer and give awards. That is not going to do us very much
good.

87
Representative HECKLER. I see.
I thank you very much.
I just would like to say, Mr. Chairman-and I know my time has
expired-I think that we are trying to avoid this heavy-handed, and
in some sense, protectionist policy by seeking a fairer policy.
I personally am interested in innovative trade groups,
we have lost jobs to other countries, we are not dealing but when
with innovation there; we are dealing with labor costs.
When I look at this Government which has increased
security costs and the regulatory costs of every business the social
and the
cost of doing business on every single operator and if we, at the same
time, will then allow the small employee who is working for $4 an
hour in a factory to be wiped out simply because we are interrelated,
there is something very unjust about this.
Representative LONG. [presiding]. Thank you.
Congressman Rousselot.
Representative ROUSSELOT. Thank you, Congressman Long.
Mr. Trezise, you seem to indicate, as I listened to your statement,
that the objective of the United States is to increase exports and
achieve a trade surplus.
Well, why not revalue the dollar just as Japan has revalued the yen?
Mr. TREZISE. We have done a pretty good job of devaluing the
dollar, I think, since 1975, when in fact the dollar was overvalued
very substantially.
Since then, it seems to me, there has been a little trouble about the
extent of the decline in the value of the dollar, so much so that I find
my friends in the Treasury rather sensitive now if you suggest that
maybe the other currencies could appreciate a bit more and help our
trade and external deficit problem.
My own preference is to see what the foreign exchange market will
do, within limits anyway. But I recognize that this can be overdone.
There are other factors other than the trade and current account
surpluses that affect the exchange market and I am not
favor of wholly unrestricted movements in exchange rates.exactly in
But it is
one way to adjust surpluses and deficits.
Representative ROUSSELOT. Do either one of you want to comment
on that?
Mr. BALDWIN. I might make the point that, of course, the dollar is
affected by much more than trade in goods. We have a tremendous
volume of investment dollars overseas that are particularly subject
to speculative reactions. This speculation led, a few months ago, to a
dramatic depreciation of the dollar. Sometimes the speculative pressures are so strong that they dominate the exchange rate forces coming
from our trade account.
Representative

ROUSSELOT.

Mr. Eberle.

Mr. EBERLE. With the volume of imports that we have and with its
ramifications for the lack of confidence in the dollar, this has a tremendous impact around the world. I also think we have to focus on
our domestic policies.
Representative ROULSELOT. So devaluation is inflationay?
Mr.

EBERLE.

Absolutely.

Representative ROUssELOT. Professor Baldwin, you heard Mr.
Eberle, a former negotiator on. our behalf, mention and put strong
emphasis on the problem of regulatory burden that is imposed on

88
exports and he listed, as you indicated, too-he called it "limiting
regulatory spillover" and gave us quite a list of things that needed to
be done to modify that, to change that burden.
What about that regulatory burden? Do you want to comment on
it?

Mr. BALDWIN. I agree with him.
Representative ROUSSELOT. With his list?
Mr. BALDWIN. With his statement about these regulations.
Representative ROUSSELOT. He listed the OSHA requirement,
CPSC standards, FDA requirements, environmental reviews which
limited export financing. You don't find yourself in disagreement?
Mr. BALDWIN. No; I would suggest that a committee be set up in
Government, if there is not already one, to go systematically through
all our regulations and try to ascertain their impact on exports and
try to determine whether they can't be framed to still do what they
are designed to do dometically but without having an adverse effect
on exports.
One hears, in story after story, from businessmen it is the redtape
we have imposed upon ourselves that is a great burden on our exports.
Representative ROUSSELOT. He mentioned also the U.S. flagship
requirements that prohibited Export-Import Bank financing of freight
costs. So you agree with that whole list?
Mr. BALDWIN. I do, indeed, and I am sure there are many others in
the service areas.
Representative ROUSSELOT. Thank you.
Mr. Eberle, you mentioned in your testimony the case of the U.S.
manufacturer who chose to locate in Hong Kong rather than in the
United States as a base for exporting to Japan, and the reason was
because of the U.S. tax laws. What specific tax laws do you believe
need to be changed to prevent this situation from happening again?
Mr. EBERLE. There is a range. The particular one
Representative ROUSSELOT. Maybe you want to submit them in
writing.
Mr. EBERLE. I would like to give it to you in specifics.
Representative ROUSSELOT. Good. Now the question is can you get
Congress to listen?
Mr. EBERLE. You are listening.
Representative ROUSSELOT. So you will submit it?
Mr. EBERLE. I will submit it to you.
Representative ROUSSELOT. That will be helpful.
[The following information was subsequently supplied for the
record:]
* * *. One area in which the U.S. government might play a useful role is in
the review of tax laws that can make it difficult for an aggressive U.S. comllpany
to cut price into Japan. The issue here is transfer price between U.S. parent and
overseas sales subsidiary and the degree to which price cutting from the parent
is viewed as an effort to displace income to a different tax jurisdiction. The Internal Revenue Service can hinder U.S. companies from repaying the Japanese
in kind and price cutting into the Japanese competitors' home market.
A case in point is a U.S. machinery manufacturer, a dominant and low-cost
world producer. A major Japanese company entered its product area, and by aggressive sales of small-size products took a major share of the Southeast Asian
and West European markets. By the time the U.S. producer awoke to the threat,
its share in many markets was second to the Japanese company's. The threat is
now being met by the U.S. company. But the most effective strategy is to attack
the Japanese company in the Japanese market. The Japanese firm's sales there

89
are large, the U.S. company's negligible. Sharp price
cutting into Japan could cut
off the cash flow that is supporting the Japanese company's
worldwide attack.
The U.S. company intends to do so, but because of
go into production in Hong Kong as a supply base U.S. tax laws has chosen to
for attacking the Japanese
market.
Source: Aheggical
Janies C. and Hlout, Thomas
Japan." Foreign Affairs, Fall, 1978, pages 111-162. 2M., "Facing Up to the Trode Gap With

Representative ROUSSELOT. Anyone else want to comment
on that.
Mr. TREZISE. No.
Representative ROUSSELOT. Mr. Baldwin.
Mr. BALDWIN. No, I don't have any particular expertise
there.
Representative ROUSSELOT. My time has expired.
Representative LONG. Congressman Brown.
Representative BROWN. Thank you, Congressman Long.
Mr. Eberle, and to all of you, I guess, I would like to
pose sort of
a general and long question.
We are all aware, I think of the rising protectionist
the country and, as I understand from my brief review sentiments in
mony, all of you express or imply opposition to it, but itof your testiseems
it is more complicated than that. I have a specific problem to me
district that I can understand because I have a newspaper in my
and I have been through all this before in the committee business
problems that my newspaper business faces, but I want about the
now to the steel industry, because that focuses on an areato relate it
where we
are having export problems and import problems.
A steel mill in my area has been having trouble over the
last few
years and the Government blames that on labor and
implied at least by the wage/price guidelines. Is there a management,
way that we
could make the point about the impact of what inflation
does to the
ability to compete?
Do you know of any studies that would give me the
tion on the inability of U.S. manufacturers to compete, effect of inflajob losses are multiplied throughout the community and how the
when a firm
closes down?
Now let me give you a couple of the impacts here that
ment has. The Government has been blaming labor the Government. I have been blaming the Government, and labor and manageand
ment have been quiescent to some extent in the Government manageprogram.
Let me give you the problem.
Old equipment begins to wear out; the company has to
equipment; the company has had its profits taxed away replace the
at a
rate; but when you go to buy the equipment, the equipmentcertain
costs
more than three times than when it was originally installed,
or perhaps four times or two times, but at any rate a great deal
more and,
of course, that replacement cost under the principles
of accounting
should have been deducted from profits, but it was not.
The higher phantom profit because of inflation was there
taxed because inadequate depreciation was taken away. and it was
of that we have not had any steel mills built from the As a result
ground up in
the United States in I don't know how long.
Then we legislate in air and water quality standards,
which is an
enforced expenditure that the steel mill has to undertake,
that does
not relate in any way to productivity. In other words,
we mandate
them to do that and to put it in the price of their product
or depreciate
it at the inadequate depreciation rate.

90
And
Then we mandate things like occupational safety and health.
thing I guess I ought to throw in. Inflation requires
there is another
even
the worker in that mill to ask for more income just to keep
of our increased tax bite on inflated earnings,
after taxes because
and so raises the wage cost of the steel mill.
a
Now all of that is a follow-on of inflation. Part of what I said is
at the Federal level and some
result of our environmental concerns
other concerns, safety and health and so forth.
inDo you know of any studies that give us the effect of the rate of we
things, like depreciation, and jobs, and how can
flation on these
to
make it clear that inflation is part of what is destroying our ability
compete abroad?
The
Mr. EBERLE. Congressman, I know of only one precise study.
done a study on inflation, on investment.
Conference Board has
Representative BROWN. Who has done it?
can
Mr. EBERLE. The Conference Board in New York. I will see if I
find it.
Representative BROWN. But that is just the depreciation aspect?
Mr. EBERLE. Yes.
The Salomon Brothers have done another. I don't know if anyone
has done all that you have asked for, but I know there are a number
around.
Representative BROWN. I used to work in the chamber of commerce.
They used to say you could get a new manufacturing plant, multiply
waitthe jobs in the community by six times, because the cocktail people
and the home builders and all those
resses and the cab drivers
is
would have to be employed because you had this new plant. That
what I am looking for.
of a
Mr. EBERLE. There are several studies on the multiplier effect
industry.
new industry or an improved
Representative BROWN. I am not asking that. We have all of that.
is.
I want to know what the depressing effect of the rate of inflation
Mr. Trezise.
Mr. TREZISE. Yes. We do have one paper at Brookings which I will
than
be happy to send you, which does that just a little more broadly
cover the inflationary question.
you suggest, but it would
There is no doubt, it seems to me, that inflation is the biggest
be
domestic problem we have in our foreign trade. it could not
otherwise.
There are some complications, of course, because the exchange rate
has
has been moving, too, so the corrective force of the exchange rate
of inflation, but obviously not enough.
somewhat modified the impact
Representative BROWN. So, floating currencies are a necessity when
we have inflation going at the rate it is?
Mr. TREZIsE. I am afraid that is right. Bill Eberle says the depreciating dollar is inflationary. Well, it is depreciating because we have
been inflating so much. I think the President's new emphasis on
dealing with inflation is not only justified but well overdue.
I don't see how in the community we can have constantly increasing
rates of inflation without doing damage to the whole structure of our
system.

91
Representative BROWN. If you can provide me the Brookings information and Mr. Eberle will get the Conference Board study to me,
and maybe the Joint Economic Committee can study this effect.
Mr. BALDWIN. I don't believe you can get one figure. I think there
are components around by which you could put together what you
want.
Part of it is a macroeconomic problem that has generated inflation.
This will be partly offset in the exchange rate and depreciate and thus
restore part of the competitive powers that you lose, but it won't be
entirely restored; it will have a differential effect on industry, partly
because of their different capital intensities.
There have also been some studies done on the impact on, say, the
United States compared with the advantages of these various environmental controls and so forth.
I could get you some information on that.
Representative BROWN. That is kind of a regulation thing that is a
separate issue.
Some of that has been done from the Joint Economic Committee
but I want to suggest that you do a study on our ability to export.
I was startled in the President's remarks the other night anid then
I am amazed at your contradiction of him, Mr. Eberle, because he
said in his speech that w-e now are exporting agricultural products at a
record rate, and in your remarks you said, ' The rate of growth of U.S.
agricultural exports has been stagnant for the last 3 years."
Can you clarify your contradiction of the President for me so that
perhaps he won't feel badly about it?
Mr. EBERLE. Far be it from me to contradict the President. I would
only suggest that if you take the inflation factor out, that you will find
that the big increase has been one of value, not in units.
Representative BROWN. The President was talking about inflated
dollars and not about increased exports.
Mr. EBERLE. I don't know what he was talking about.
Representative ROUSSELOT. You don't know what he was talking
about?
Mr. EBERLE. I don't know what numbers he used.
I think, if you look at the units, we are on a stagnating basis on the
side.
Representative BROWN. I have two more questions, Congressman
Long, if I may ask them.
Representative LONG. Go ahead.
Representative BROWN. You mentioned it and we have just had a
discussion of it, also, which embraced the handicap regulations placed
upon exporters, but it seems to me that as is always the case-and this
is Where I was getting to with my first question-that inflation and
regulation falls heavier on small- and medium-sized businesses.
You don't seem to see a lot of little businesses getting into the export market out in the world. It seems that it is always the biggest
companies in whatever the field is.
There are some areas of export where the businesses may not be
as large as General Motors or something, but in the field it is usually
the largest company that is the major exporter.

92
My question is whether or not there is a way to encourage smalland medium-sized businesses to get into the field or is that a hopeless
situation as long as we have the regulations that we have from the
Government and also the inflation rate that we have currently?
Mr. EBERLE. I responded this way: It is not hopeless. First of all,
the conditions have changed. The exporting has grown from about 4
percent of the GNP to two times that. Many businesses must look to
exports for the first time if they are going to grow and expand. There
is an automatic incentive.
Representative BROWN. Of which the biggest company can take the
best advantage.
Mr. EBERLE. That is correct. But small companies can do it too.
There is a small candy company in Tacoma, which has 45 percent of
its business overseas and it did it because its president had a desire
to create an export market and worked at it. So it can be done. But
we have the largest common market in the world in our 50 States and
it is a lot easier to sell here than it is abroad.
Smaller companies need help to be shown that they can be successful overseas, and to -find ways in which it can be done. There are many
ways it can be done, but it has to be done on a pragmatic basis.
Representative BROWN. Do either of you want to make a comment?
Mr. BALDWIN. I think it is enormously expensive and risky to go
into overseas markets and for most business it is just not feasible.
We can have many of these promotional programs and I don't
think they are going to have a great deal of effect.
If you really want to have an effect, I think you would need to have
very aggressive type of export promotion policy by the Government.
a
We should learn from the developing countries on this point.
These nations have whole government divisions set up for export
promotion. They go out and find the markets, that is, they assume the
risk of exploring for markets, then come back to small businessmen
and say, "We found the market for you; now, go and fill it."
Representative BROWN. So, you think more could be done?
Mr. EBERLE. Definitely.
Representative BROWN. It is an educational procedure?
Mr. EBERLE. Yes.
Representative BROWN. Are the banks doing their part?
Mr. BALDWIN. I think, in general, yes.
Representative BROWN. Let me turn that around just a minute. I
come from a town of 12,000. We have two banks in town. We have at
least one business in town which is in the business of overseas export,
but I asked one of my bankers if he is encouraging that and he said:
Are you kidding. With what the Comptroller of the Currency is laying on me
with regulations, I have time and funds to encourage the little businesses in this
town to get into the export market.

And he just laughed me out of the room.
Is he irrational?
Mr. EBERLE. Congressman Brown, I would suggest that he call up
the Eximbank which maintains an open-window discount, a very
large percentage of that paper, which I believe is 90 percent, is available to support him.
Representative BROWN. Is it an 800 number?
Mr. EBERLE. It has been several years since I was employed in
Washington.

93
I don't know.
Representative BROWN. Do you have any comments?
Mr. TREZISE. I don't know how you get the small business to
export. I suspect a whole range of things, some of which you touched
on.
Small businesses are simply not equipped to be exporters and perhaps we need to persuade somebody to set up trading companies as in
Japan. Japan's trading companies do draw in goods from. a lot of
small businesses which would not in and of themselves be able to
export; they simply would not have the capability. I don't know
whether that is a general answer or not, but it might in some cases
be the way. Indeed, that is the way we export our grain, through the
grain companies. No farmer could be an exporter of grain; he would
not have the capital and skills.
Representative BROWN. You have made the connection that I
was working toward, and that is that the smaller the unit in the
United States, the smaller the unit of production, the more difficult
it is, and the smaller the finance source the more difficult it is, and I
think we need some special attention.
Now, let me try my radical question on you.
Some years ago, in order to establish monetary policy in this
country, we established the Federal Reserve Board as an independent
operation in the banking community to try to stabilize that element
of our economy.
Are we approaching the time when we ought to have-independent
of the President, of the Congress-an independent agency to promote
and set tariffs and assure the distribution of American products
abroad?
If I had had more time, I would have laid a longer predicate to my
question, but I want to remind you of our experience a few years ago
where the Japanese bought a lot of soybeans and we said that we
were not sure we are going to deliver them because the price was
high, the labor unions were interfering, and a lot of other things
were interfering.
Is the timing for us to consider that radical idea now appropriate
or do you think it is a likely decision that we should make some time
in the future?
Do you understand what I am suggesting?
Is it a new idea or an old idea?
Mr. EBERLE. I certainly feel that now is not the correct time.
I think we can do a much better job to clean up the disincentives
that are in Government before you create a new bureauracy to add
on top of all the problems we now have.
So, I would urge that you focus to do the disincentives first while an
effort is made at developing export markets for small business.
Representative BROWN. What disincentives are you talking about?
Mr. EBERLE. My testimony listed a whole range of disincentives
from taxes to regulations.
Representative BROWN. You are talking about the-Mr. EBERLE. Purely domestic.
Representative BROWN [continuing]. Impediments that we imp.ose
on ourselves?
Mr. EBERLE. And adding a whole new bureaucracy on top of that
before you clean it up seems to me to be a serious mistake.
46-126

0 - 79 - 7

94
Mr. TREZISE. I agree with Mr. Eberle. I don't think this is the
time for a new agency.
More than that, you mentioned the soybean embargo which was a
terribly unfortunate mistake but I don't believe we could have any
agency so independent of the President of the United States that it
would not be possible to make that mistake over again.
This was, after all, a decision that was made at very high levels in
the Government and for reasons that I am sure at the moment were
quite persuasive and compelling.
I thought at the time it was a disaster and I think it has been, but
I don't think you could create an agency so remote, so independent
that it would not be found to do things like that in the stress of
circumstances.
Representative BROWN. Well, domestic, political, and economic
circumstances and that is what I am trying to avoid.
Mr. TREZISE. We were running a price control system at that time.
Representative BROWN. But I am trying to get our foreign trade
away from that and see if we cannot develop a consistent and agressive trade pol cy that would help sugar and rice in Congressman Long's
area of the country, and soybeans and steel in my area, and movie
stars and orange juice and oranges in Congressman Rousselot's area.
Representative ROUSSELOT. We are already exporting movie stars.
Mr. BALDWIN. I think that trade is tied in so closely with our foreign
policy that it would not be possible to separate those two.
We do find that at many times it seems commercial relations are
sacrificed for broad and vague foreign policy interests and often that
frustrates us but I think it is something that, on balance, we have to
accept.
Let's go for reducing nontariff barriers through the new trade negotiations, trying to increase our export in this way as well as for improving our domestic controls and regulations and trying to before we
move on to some of these more radical proposals.
That would be my suggestion.
Representative BROWN. Thank you, Congressman Long.
Representative LONG. Gentlemen, we have a number of additional
written questions. If it is agreeable, we would like to submit these
questions to you. If you would be good enough to give us those, your
views on these questions, we would be most appreciative.
[The following questions and answers were subsequently supplied for
the record:]
RESPONSE OF HON. ROBERT S. STRAUSS TO ADDITIONAL
POSED BY SENATOR BENTSEN

WRITTEN QUESTIONS

CONGRESS OF THE UNITED STATES,
JOINT ECONOMIC COMMITTEE,

Washington, D.C., February 26, 1979.

Hon. ROBERT S. STRAUSS,

Special Representativefor Trade Negotiations,
Washington, D.C.

DEAR AMBASSADOR STRAUSS: On behalf of the Members of the Joint Economic
Committee, I would like to thank you for testifying before us as part of our annual
review of the American economy. Your testimony will be of substantial assistance
to the Committee. And beyond your testimony, we are all appreciative of your
months of toiling in the trade vineyard.

95
Unfortunately, time prevented us from asking some important questions. With
your heavy schedule in mind, I will limit these additional questions to just one
subject-the matter of a surcharge on Japanese imports.
Last July, Congressman Vanik and four other Members of the Subcommittee on
Trade of the House Ways and Means Committee urged the President to consider
imposing a surcharge on Japanese imports as the only effective way to deal with
the mounting U.S. trade deficit and the rapid depreciation of the dollar. In your
response to Congressman Vanik, you recommended against a unilateral surcharge,
but noted that Section 122 of the Trade Act of 1974 would be a "legitimate option . . ." under different circumstances.
First, I am concerned about whether or not a unilateral surcharge would be
consistent with existing GATT rules.
Second, to what extent could businesses in one country avoid the impact of a
six-month surcharge (the usual limit contemplated by the Trade Act) by tightening
profit margins and other measures?
Third, in discussing the use of a surcharge against one or more countries, the
Trade Act of 1974 (Sec. 122(d) (3)) states that "After such time when there enters
into force for the United States new rules regarding the application of surcharges
as part of a reform of internationally agreed balance-of-payments adjustment
procedures, the exemption allowing discrete rather than across-the-board surcharges authority ... shall be applied consistently with such new international
rules." How will the proposed multilateral trade agreement affect the surcharge
against only one country provision of the Trade Act of 1974?
Fourth, in talking with a variety of Japanese officials as well as a number of
scholars specializing in the Japanese economy, there has been a general preference
expressed in favor of yen appreciation as opposed to an across-the-board surcharge
on Japanese imports. The preference appears to be based on several groundsJapan is no longer singled out for unilateral action; appreciation allows more
gradual (and therefore less painful) domestic adjustment; and appreciation, of
course, would affect all Japanese international economic transactions rather than
only visible trade with the United States. In general terms, would you express a
similar preference for currency appreciation as opposed to the application of a
surcharge? Given the administration's existing commitment to support the dollar,
to what extent would yen appreciation lbe an acceptable eventuality?
Fifth, in treating bilateral economic relations with Japan, the emphasis has been
on Japanese practices that increase her exports and limit her imports. Much less
attention has been focused on the remaining Japanese exchange and capital
controls. How extensive are these controls? To what extent have changes in such
controls been part of our bilateral negotiations with Japan? What impact would
you expect a lifting of Japanese controls would have on our overall trade deficit
and in what period of time?
Finally, in the case of Japan or other surplus countries, what type of bargaining
response can we expect from the threat of application or the application of a unilateral surcharge on their exports to the United States?
Thank you again for your fine testimony and for adjusting your extremely busy
schedule so that you could join us.
Sincerely,
LLOYD BENTSEN,
Chairman, Joint Economic Committee.
THE SPECIAL REPRESENTATIVE FOR TRADE NEGOTIATIONS,
Washington, D.C., May 25, 1979.
Hon. LLOYD BENTSEN,
U.S. Senate,
Washington, D.C.
DEAR SENATOR BENTSEN: Attached are answers to the questions you asked me
to reply to for the record of your hearings.
I appreciate the opportunity to testify before your Joint Economic Committee.
Please call me if I can be of additional assistance.
Sincerely,
ROBERT S. STRAUSS.
Attachments.
Question 1. Is a unilateral surcharge consistent with GATT rules?
Answer. The GATT provisions on trade measures for balance-of-payments
purposes allow quantitative restrictions to be imposed. However, under the

"Framework Agreement" reached in the Multilateral Trade Negotiations, it was
agreed by GATT members that, when it is necessary to restrict imports as a
balance-of-payments measure, the restrictions should be applied in a manner to
limit the trade distorting effect as much as possible. As surcharges are generally
recognized as the least trade-distorting restriction, wie believe that import surcharges would argulably be most consistent with the spirit of the new GATT
"Framework Agreement", although signatories have reserved their GATT rights.
As for the unilateral aspect, the Framework Agreement does permit unilateral
actions, but they would be subject to review by GATT members under established
procedures.
Question 2. To what extent could business in one country avoid the impact of
a six month surcharge (the usual limit contemplated by the Trade Act) by tightening profit margins and other measures?
Answer. The question cannot be answered with precision. It depends on many
factors including the size of the surcharge, the size of profit margins (had they
been squeezed earlier by exchange rate changes or competitive conditions in the
market place?) demand elasticities, and future expectations (about business
activity, possible renewal of the surcharge, exchange rate changes).
Question 3. In discussing the use of a surcharge against one or more countries,
the Trade Act of 1974 (Sec. 122(d)) states that "After such time when there
enters into force for the United States new rules regarding the application of
surcharges as part of a reform of internationally agreed balance-of-payments
adjustment procedures, the exemption allowing discrete rather than across-theboard surcharges authority . . . shall be applied consistently with such new
international rules." How will the proposed multilateral trade agreement affect
the surcharge against only one country provision of the Trade Act of 1974?
Answer. The Multilateral Trade Agreement has no effect on Section 122 of
the Trade Act. We have not yet negotiated new international rules as contemplated by that section of law.
Question 4(a). In talking with a vamiety of Japanese officials as well as a number
of scholars specializing in the Japanese economy, there has been a general preference expressed in favor of yen appreciation as opposed to an across-the-board
surcharge on Japanese imports. The preference appears to be based on several
grounds-Japan is no longer singled out for unilateral action; appreciation allows
more gradual (and therefore less painful) domestic adjustment; and appreciation,
of course, would affect all Japanese international economic transactions rather
than only visible trade with the United States. In general terms, would you
express a similar preference for currency appreciation as opposed to the application of a surcharge?
Answer. In general terms, balance of payments adjustment is better promoted
by currency adjustments in response to underlying economic conditions-backed
up by appropriate domestic policies, especially fiscal and monetary policy, as
well as liberalization of trade barriers by the surplus country-than by trade
restrictions such as a surcharge.
Question 4(b). Given the administration's existing commitment in support of
the dollar, to what extent would yen appreciation be an acceptable eventuality?
Answer. A restoration of balance in Japan's balance of payments accounts
does not necessarily mean continued yen appreciation. As indicated in the previous reply, domestic policies are an important part of balance of payments
adjustment. In the case of Japan, we have encoui aged the Government of Japan
to reduce Japan's trade barriers to achieve basic equity in our trading relations,
and expand domestic demand to attract imports and shift the use of Japanese
resources from export production to domestic production.
These measures appear to be having some success as Japan's current account
surplus has been falling rapidly in the last few months without further yen
appreciation.
Question 5(a). In treating bilateral economic relations with Japan, the emphasis
has been on Japanese practices that increase her exports and limit her imports.
Much less attention has been focused on the remaining Japanese exchange and
capital controls. How extensive are these controls?
Answer. In the past, Japan's foreign exchange and capital controls have been
pervasive. Since the late 1960's Japan has taken a series of steps liberalizing the
controls. At present, the Government of Japan is in the process of overhauling
the entire control system on the principle that all transactions should be free
(uncontrolled) unless specifically prohibited. Examples of the types of controls
that are being reviewed follow:

97
For most import purchases, a declaration must be filed if made under the
"standard method" of settlement. The "standard method" requires that import
payment be made no more than one year after customs clearance. Limits also
apply to repayments. For a few goods, and payment outside the "standard
method", prior approval must be obtained.
Payments for invisibles are subject to verification by foreign exchange banks.
Foreign investments generally must be approved by the Government of Japan
or notified. Foreign ownership, up to 100 percent, is permitted for virtually all
industries, but prior approval is generally required.
Subject to prior approval, which is generally automatic, capital may be transferred abroad and foreign investments may be made by Japanese residents.
Question 6(b). To what extent have changes in such controls been part of our
bilateral negotiations with Japan?
Answer. We have included these issues in our negotiations. In the StraussUshiba Joint Statement of January 1978, Japan agreed to:
1. Relaxing the rules for the "standard method" of settlement.
2. Conducting a sweeping review of its foreign exchange control system and
planning a new system based on the principle that all transactions should be free
unless specifically prohibited. As a forerunner of the new system, certain immediate
measures of liberalization are to be announced soon.
Following this agreement, the rules for the "standard method" of settlement
where liberalized in April 1978 by extending the time limit for import prepayment
and for deferred payment on capital and consumer goods to one year (from four
months). Legislation to revamp the foreign exchange control system is being
submitted to Japan's Diet.
In addition, we have been discussing with Japan ways to provide U.S. banks
with reciprocal marketing opportunities.
Question 6(c). What impact would you expect a lifting of Japanese controls
would have on our overall trade deficit and what period of time?
Answer. We do not have such an estimate. We do believe that our businessmen
can prosper in an open, market-oriented international payments system. We
believe a lifting or liberalization of Japan's controls would increase opportunities
for U.S. business activity in Japan.
Question 6. In the case of Japan or othei surplus countries, what type of
bargaining response can we expect from the threat of application or the application of unilateral surcharge of their exports to the United States?
Answer. It would be inappropriate for the Administration to speculate on the
response of another country to a "threat" by the United States. Japan, however,
is certainly aware of discussion in the United States about the possibility of a surcharge on Japanese goods. Many of the recent decisions Japan has made to reduce
trade barriers and take appropriate measures to reduce its current account
surplus have been made in light of that knowledge.

RESPONSE OF PHILIP H. TREZISE TO ADDITIONAL WRITTEN QUESTIONS POSED BY
SENATOR BENTSEN

Mr.

PHILIP

H.

TRFZISE,

CONGRESS OF THE UNITED STATES,
JOINT ECONOMIC COMMITTEE,
Washington, D.C., February 26, 1979.

Acting Program Director,
The Brookings Institution,
Washington, D.C.
DEAR MR. TREZISE: On behalf of the Members of the Joint Economic Committee, I would like to thank you for testifying before us as part of our annual
review of America's economic problems and prospects. Your testimony will be
of substantial assistance to the Committee.
Unfortunately, time prevented us from asking some important questions.
Would you please answer the following questions at your convenience so that we
can further benefit from your thinking on international economic problems.
1. In your testimony before the Committee, you noted that the real appreciation relative to the dollar did not begin until sometime in 1978. Despite the Administration's adoption of a dollar support plan in late 1978 and the subsequent
appreciation of the dollar, there was still substantial real yen appreciation relative
to 1977. How long will it take for yen appreciation to be felt in our dollar denoinin-

98
ated trade deficit? To what extent will the workings of yen appreciation through a
J curve effect be slowed by non-tariff, Japanese barriers to trade?
2. Over the past two years, a number of the witnesses before the Joint Economic
Committee have noted that the United States has been losing its export share in
Japan. What is the explanation for this loss?
Thank you agai n for your fine testimony.
Sincerely,
LLOYD BENTSEN,
Chairman, Joint Economic Committee.
THE BROOKINGS INSTITUTION,
Washington, D.C., March 13, 1979.

Hon. LLOYD BENTSEN,
Chairman, Joint Economic Committee,
Washington, D.C.
DEAR SENATOR: You have asked me several questions which were not covered
at the hearing of the Joint Economic Committee on January 25.
Question 1. How long will it take for yen appreciation to be felt in our dollar
denominated trade deficit?
Answer. As you know, an unqualified answer to this question is bound to be
somewhat misleading. Studies of exchange rate changes in the past suggest that
the negative of J-curve effects on trade account work themselves out is six quarters,
after which the positive impact comes on strongly, overwhelming the earlier results.
But the effect on trade flows of a change in currency values also depends on the
state of economic activity: that is, an appreciating currency should be accompanied
by stimulative policies, a falling currency by restrictive policies. Ideally, the
countries concerned should act appropriately and together. If these conditions
are not satisfied, the impact of a given change in currency values will be slower,
smaller, and possibly will not occur.
In 1978, it appears, domestic demand in Japan grew quite fast, at about 7 percent, while the U.S. economy slackened somewhat from 1977 but still seems to
have been operating close to its potential. I believe that the decline in Japanese
export volume and the growth of import volume after the first quarter was associated with the yen rate appreciation, the rise in Japanese domestic demand, and
perhaps to some degree the lower rate of growth in the United States. It seems a
reasonable proposition that with continuing growth of domestic demand in Japan,
a still strong yen, and with the expected slowdown here, Japan's current account
surplus, expressed in dollar terms, should register a significant decline in 1979.
The OECD projection if for a fall of almost one-half, on a calendar year basis.
The Japanese government foresees a reduction for the 1979 fiscal year, AprilMarch, of about the same magnitude. Both estimates are based on expectations
about the yen rate and about levels of economic activity in Japan.
Both estimates were made, however, before the recent events in world oil
markets. I do not know how to predict what the reactions will be if oil prices
should rise by much more than the original OPEC announced increase for the
year. On the one hand, Japan's oil import bill will go up more than that of any
other industrial nation, which will tend to shrink the surplus. On the other, it
is recalled that in 1974 the Japanese government, like most others, responded
with sharply restrictive policies which brought on a recession, from which the
economy recovered slowly and incompletely. I do not suppose that will be the
case this time-nor can I foresee what the United States, Canada, and Western
Europe will do-but the uncertainties in the present situation are very
considerable.
Question 2. To what extent will the workings of yen appreciation be slowed by
non-tariff Japanese barriers to trade.
Answer. Non-tariff or, for that matter, tariff barriers are a limitation on the
expansion of imports that the yen's appreciation should induce. Japan's imports
are relatively price-inelastic anyway, because so large a share consists of food,
fuel, and raw materials; trade barriers contribute further to the low elasticity
of import demand. It is pertinent in this connection that imports of semi-manufactures and manufactures, which would be expected to be most responsive to
price changes, rose by 36 percent in the first eleven months of 1978 over the same
period of 1977. Also, while the data I have at hand are sketchy, they do show a
distinctly positive relationship between the increase in volume of manufactured
goods imports and the extent of the decrease in import prices. In the area of
semi-manufacturers and manufactures, at any rate, I would expect that ven
appreciation, on a real terms basis, will foster a rising level of imports into Japan.

99
Relaxation of non-tariff barriers of course will aid this process, but I do not know
how to quantify the outcome.
Question 3. Over the past two years, a number of witnesses before the Joint
Economic Committee have noted that the United States has been losing its
export share in Japan. What is the explanation for this loss?
Answer. On an aggregate basis, the United States apparently has gained rather
than lost market share since 1976. The figures are as follows:
Shares percent
Japan's total
imports (Doltarsin millions)
1976 -64,
-70,808.7
1977
1978(11mos) -71,568.1

Growth rate
percent
19.3

798.9

211. 1

-

-18.6

United
States

European
Community

Southeast
Asia

Communist
countries

18.2
17.5

5.6
5.9
7.6

20.7
21.3
21.7

4.4
4.7
4.9

' 1976-77, December to December.
21977-78, Novemberto November.

As you will note, the United States gain in market share, 1976-78, was relatively
ess than that of the European Community, Southeast Asia, and the non-market
countries. I am not sure, however, that much importance should be attached to
these short run shifts. Japan's imports of crude oil account for 38 percent or so
of total imports. Even a modest change in this category will affect both the
grand total and the shares of non-oil exporters. In any case, it would be risky to
postulate a trend on the strength of data for only three years.
The U.S. share of Japan's food imports jumped from 31.7 percent in 1977
(November-November) to 35.2 percent, and this obviously accounted for the
gain in overall market share. In manufactures, taken broadly to include chemicals,
refined metals, and textile fabrics, etc., the U.S. share fell from 33.1 percent in
1976 to 30.2 percent in 1977, while the European Community's share rose from
22.9 to 26.4 percent. Here are the comparisons:
JAPAN'S IMPORTS OF MANUFACTURES, 1976-78
Shares (percent)
(dollars in
millions)
1976 1977 -12,829.5
1978 (11 mos.) -15,731.6

United
States

11,717.2

33.1
31.5
30.22

European
Community
22.9
24.9
26.4

Southeast
Asia

Communist
countries

20.7
19.7
20.3

4.7
5.1
5.3

Looking at particular categories, the European Community registered a higher
market share in almost all instances. In clothing, for example, it increased its
share from 14.9 percent in 1976 to 17.3 percent in 1978, while the dominant
supplier, Southeast Asia, dropped from 68.3 percent to 63.8 percent. The United
States share declined in all categories except clothing and, a more important case,
electric machinery.
A summary of the import picture by main categories for 1976-1978 is shown
in the appended table.
As I have said, these data are too limited to be used to support longer run projections. At the same time, they do not argue for complacency. Structurally, one
would suppose, the United States should be a major supplier of foods and some
raw and semi-finished materials to Japan. There is nothing wrong with our being
an exporter of, say, feedgrains, which in fact come from one of world's most
efficient and technologically advanced industries. But we should be a vigorous
competitor in most categories of manufactures as well. If we do not improve on
the export record of recent years in these categories as our domestic economic
activity slows clown, it will be a pretty clear signal that something is going badly
and needs to be corrected.
I hope that these comments will be helpful.

Sincerely,
Enclosure.

PHILIP H. TREZISE.

JAPAN'S IMPORTS, 1976-78

Grand
total

Crade
Food materials

Mineral
fuels

NonTextiles
(inter- electric Electric
ProcChemni- essed mediate muchin- machisery
ery
goods)
metals
cals

Toys
Domesand
House- tic elecTransPas- musical
tric
hold
port
equip- Textile equip- equip- senger minsrecars ments
ment
ment
ment products

920.5
178.7 1,960.3 1,212.3 594.0
1
1976 January-December (millions)-----64,799.9 10,281.9 11,1756. 28,287.3 2,602.2 1,733.5
727.1 2234.9 1,235.2 436. 9 1 05.2
5
70, 803. 7 11,339.3 12,575. 31 148.7 2,938.9 1,980.6
January-December (millions)1977
1,308. 1
Junuary-Nosember (millions) ----- 71,568.1 11, 323. 7 12,233.5 28,370.9 3,336. 4 2,411.6 1,131. 1 2,257.1 1,455.8 958.9
1978
Growth rate (pe -cent):
9.2
1.9 -26. 4
14.0
-6. 6
14.3
12.9
10.1
6.9
10.3
9.3
1976-77 isecenbe-ecember
40.5
143.0
30.8
6
14.
78.7
32.6
24.7
.4
6.3
8.9
1
11.
1977-78 Nosembe -Nosember____
Share of imports from (percent):
United States:
3.9
47.1
50.9
53.6
5.6
8.0
40.9
5.1
19.6
31.6
18.2
1976-------------4.4
57.9
51.6
50.8
5.7
489
38.7
4.3
19.6
31.7
17.5
-State
19774.6
43.2
56.6
49.5
4.9
7.8
37.8
2.9
21,9
35.2
1978 -18.8
14.9
22.5
15.7
29.5
21.7
5.6
29.1
.2
.9
4.0
.6
-Community-5
Europen
17.4
25.5
21.2
32.1
26.9
4.9
29.3
.1
.9
4.1
5.9
1977-------------17.3
42.8
19.0
35.2
20.5
6.2
30.5
.1
Li1
4.9
7.e
1978------------Southeast Asia:
68.3
8.1
28.1
3.6
54.3
18.6
7.5
17.7
25.9
22.7
20.7
1976-------------63.9
7.9
21L9
3.7
48.8
19.5
9.1
19.9
25.5
21.7
21L3
-Asi
197763.8
3.5
18.9
3.3
56.3
17.4
8.6
20.9
26.9
20.4
21.7
1978 -.
Communist countries:
9.4
.4
.2
.7
11.6
13.4
3.3
3.4
7.1
3.8
4.4
-------------1976
10.6
1.8
.2
.7
12.1
14.3
3.1
3.3
8.6
3.8
4.7
197710.6
.6
.1
.4
13.4
14.7
2.8
3.4
83
4.3
T7
1978- -4.9
Soorce: The Summary Report: Trade of Japan, Japan Tariff Association.

Manuactured
goods
total
11,717.2
12,829.5
15,731.6

65. 8
78.3
91.8

94.5
92.6
94.7

222.1
285.2
362.6

285.2
301.6
394.2

18.9
28.4

-2.0
12.2

28.4
39.5

5.8
44.1

9.5
35.9

1
18.
15.2
15.1
33.7

30. 8
28.9
28.5
15.9

38.8
34.8
24.0
56.7

44.5
40.8
42.8
21.1

33.1
31.5
30.2
22.9

40.6
41.9

15.6
19.2

61.5
73.5

21.1
18.9

24.9
26.4

14.7
13.5
17.5

51.0 ----53.2 --49.3

28.2
32.3
31.7

20.7
19.7
20.3

.8
.7

4.7
5.1
5.3

6.7
5.9
6.3

.04 ----03
03 -----

-

0

r1o
Representative LONG. Does anyone have any additional questions?
[No response.] Thank you, gentlemen, for being with us, and for the
effort you have put into preparing your testimony.
The committee stands recessed.
[Whereupon, at 12:26 p.m., the committee recessed, to reconvene
at 10 a.m., Monday, January 29, 1979.]

THE 1979 ECONOMIC REPORT OF THE PRESIDENT
MONDAY, JANUARY 29, 1979
CONGRESS OF THE UNITED STATES,
JOINT ECONOMIC COMMITTEE,

Washington, D.C.

The committee met, pursuant to recess, at 10 a.m., in room 1202,
Dirksen Senate Office Building, Hon. Lloyd Bentsen (chairman of the
committee) presiding.
Present: Senators Bentsen, McGovern, Javits, and McClure; and
Representatives Reuss, Hamilton, and Brown.
Also present: John R. Stark, executive director; Richard F. Kaufman, assistant director-general counsel; John M. Albertine, Thomas
F. Dernburg, Kent H. Hughes, L. Douglas Lee, Paul B. Manchester,
and M. Catherine Miller, professional staff members; Mark Borchelt,
administrative assistant; Katie MacArthur, press assistant; Charles
H. Bradford, minority counsel; and Stephen J. Entin, Mark R.
Policinski, and Peter Turza, minority professional staff members.
OPENING STATEMENT OF SENATOR BENTSEN, CHAIRMAN

Senator BENTSEN. This hearing will come to order.
Mr. Schultz, it is certainly a pleasure to have you back to discuss
and comment on the President's Economic Report, and as Chairman
of the Council of Economic Advisers, you certainly played a major
role in the formulation of it, and we really look forward to your
testimony. I think you have done an excellent job under some trying
conditions.
I want to particularly commend you for the sense of realism and
financial responsibility that you brought to the Economic Report.
I hope I am not in a minority.
Mr. SCHULTZE. I surely hope not.
Senator BENTSEN. I think for too long there has been a problem
of the Government having a tendency to overpromise people, to say it
will deliver more than it can deliver. To the attempt to bridge this
gap between promise and performance, I attribute some of our problems of inflation. It places a heavy tax burden on the American people
and has inhibited growth and stability in our economy.
I think your appraisal is an honest appraisal and because of that
it is going to be controversial, because it doesn't give you any simple,
painless, quick fix for inflation. There are also broad differences of
opinion on how that pain ought to be apportioned.
Compared with the other analyses I have seen, you seem relatively
optimistic about our rate of growth.
The CBO, for instance, last week, projected a $41 billion budget
deficit, and primarily due to a slower growth than you assume.
(103)

104
Last week Chairman Miller also suggested that your inflation predictions were on the low side. Frankly, I hesitate to take a position
between economists arguing like this, but I am sure rooting for you
on your projections. Mr. Schultze, because, if the others are right,
I think we are in for some awfully tough sledding this year.
There is another point I would like to make.
It appears that fiscal restraint in this budget is coming more from
the tax side than from the spending side, and in real terms spending
is just about the same as last year, but the tax burden will have
increased substantially by $7 to $8 billion.
One thing that gives me real concern in the information that you
have provided, and one I have been talking about a long time here,
is the question of the loss of productivity in this country.
As I recall the figures, between about 1950 and 1965, we had about
a 2.5-percent increase in productivity. From 1965 to 1973 you had
approximately 2 percent. From 1973 to the present, you have got
down to about 1 percent, and this last year eight-tenths of 1 percent.
Anytime you do that, and that pie is not expanding as rapidly as
it has been, and there is constriction of lack of expansion, what it
really means is that you are not going to satisfy a lot of the hopes and
dreams and expectations of people, and I think in turn it can lead to
great social conflict in this country and great economic unrest. And,
as you pull up the drawbridge on millions of low-income people and
deny them the opportunities of achieving what they had dreamed
for-there are lots of reasons for that that are given; one of them,
of course, is the lack of investment back into the modernization of
the manufacturing capacity of this country. That is one of the major
ones.
Another is that you have a lot of unskilled people coming into the
work force to an extent that we have not had before.
I think what you are going to have to see, Mr. Schultze, is a major
change in the economic approaches of this country and the taxing
purposes of this country.
For a long time we have encouraged consumption. I think we have
to find ways to encourage saving, and not just saving, because that
would give us just a real depression, but attempt a two-pronged attack,
investment into the productive capacity of this country, if we are
going to turn this thing around, and not to have it be just a society
that is encouraging consumption, and to become competitive in this
world.
Do you have any comments, Congressman Reuss or Senator
McGovern?
Representative REUSS. No.
Senator McGOVERN. No.
Senator BENTSEN. Please proceed, Mr. Schultze.
STATEMENT OF HON. CHARLES L. SCHULTZE, CHAIRMAN, COUNCIL
OF ECONOMIC ADVISERS, ACCOMPANIED BY DAVID MUNRO, SENIOR STAFF ECONOMIST
Mr. SCHULTZE. Thank you, Mr. Chairman, Congressman Reuss,
and Senator McGovern.
I have a prepared statement which I trust can be submitted for

105
the record, and I will read it in substantially abbreviated form to
leave more time for questions and, I trust, answers.
Mr. Chairman, when this administration took office 2 years ago our
economy was recovering from the deepenst recession of the postwar
storing a high-level economy.
When idle resources are drawn down to small margins, as they have
been in this recovery, the economy must then make the transition to
slower but sustainable rates of growth. Otherwise, excess demand
pressures would be created, inflation would accelerate, and further
economic progress would be endangered.
As a consequence, to accomplish this need of transition, fiscal and
monetary policy have to shift toward restraint. The need for that restraint at the present time has been made more urgent by several
factors.
Even during the recession and early stages of the current recovery,
the underlying rate of inflation never dropped below 6 to 6.5 percent.
That stubborn rate of inflation increased sharply in 1978.
A significant decline in productivity growth occurred last year
that contributed to heightened inflation and lowered the rate of economic growth consistent with the avoidance of excessive demand.
The necessary transition began in 1978. Firm but measured restraint
must continue to prevent economic overheating, to give the President's
voluntary wage and price standards a chance to succeed, and to insure
that future growth will be moderate and sustainable.
The 1980 budget strongly supports that fight against inflation.
Fiscal and monetary restraint alone could not reduce inflation while
still preserving the economic gains we have made during this recovery.
The President's anti-inflation program, therefore, combines firm restraint over aggregate demand with a voluntary program of pay and
price standards designed to brake the inherited momentum of the
price-wage spiral. Both elements of that program are essential. The
pay and price standards could not work in an overheated economyand so restraint is needed. Restraint alone could not brake-the stubborn momentum of the price-wage spiral, unless applied in extreme
measure over a long period, at huge cost to the economy. And so the
wage and price standards are needed.
The course we have chosen-combining voluntary standards with
restraint in budgetary policies and in the day-to-day conduct of
government-is the only practical course available. Avoiding extreme
solutions to our economic problems offers the best chance to achieve
successfully the difficult transition to sustainable growth and reduced
inflation.

As I indicated earlier, Mr. Chairman, the margin of unemployed
labor and capital resources that existed when this administration
took office has been reduced substantially over the past 2 years.
Present rates of capacity use are not as high as in previous periods
of accelerating inflation, but the amount of unused capacity no
longer is large. Similarly, by late 1978 the rate of unemployment had
declined to the top of the range within which there is an increasing
risk of accelerating inflation. We are not at this time experiencing
excess demand in our economy, but we must slow the pace of economic growth to avoid overheating in the period ahead.

106
Since there are still pockets of substantial structural unemployment in our country, the overall unemployment rate remains unacceptably high. Further reductions, however, must depend primarily
on a concerted attack on the sources of structural joblessness. Efforts
to reduce such unemployment through traditional macroeconomic
policies would run the serious risk of worsened inflationary pressures.
Unlike earlier years in this recovery, when the underlying inflation rate stayed around 6 to 6.5 percent, 1978, as you know, witnessed
a widespread acceleration of prices and costs. Compensation per
hour in the fourth quarter of 1978 was almost 10 percent higher than
a year earlier, in contrast to the average yearly increase of 8.5 percent
during the preceding 3 years. Price increases in 1978 were larger than
in earlier years for virtually all categories of goods and services.
Both consumer and producer prices rose at an annual rate of 9 percent
last year.
The acceleration of price increases stemmed from a variety of
sources. Food prices rose 11.5 percent. The depreciation of the dollar
contributed, and mortgage interest rates also contributed.
Apart from these special developments, however, there was an
increase in the underlying inflation rate. Wage increases speeded up
and productivity growth slowed, leading to a broad acceleration in
the rise of costs.
The faster pace of wage gains began in late 1977 and continued
in early 1978. Although some moderation occurred in the second
half of the year, the hourly earnings index rose 8.2 percent over the
year as a whole, compared with 7.5 percent in 1976 and 1977.
Inflation undermines the competitiveness of our industries abroad
and adversely affects the value of the dollar. Our prestige as a Nation,
and our ability to support expanding world trade, depend materially
on our ability to bring inflation under control.
Inflation also injures our social and political institutions. A democratic society prides itself on maintaining conditions in which its
citizens have a sense of command over their own destiny. When the
purchasing power of the dollar-the yardstick with which we do our
economic calculations-is subject to large and unpredictable shrinkage, an important element of command over our own future slips
away. It is small wonder that trust in Government and in social
institutions is simultaneously eroded.
Mr. Chairman, given these conditions, reducing inflation must be
the primary objective of the Federal Government at this time. We
cannot expect to solve our inflation problem overnight. Inflation has
been building for more than a decade, and it will take time and patience
to reverse its momentum. For this reason, macroeconomic policies
must pursue a course that can be sustained economically and politically

as long as it takes to get the job done.
We will not pursue policies that wring inflation out of the economic
system by sharp increases in unemployment and large losses in output.
That would be unfair and ineffective. Twice in the past decade, inflation has accelerated and a recession has followed. Because prices and
wages have become relatively insensitive to economic slack, the recessions did not make a significant long-term contribution to reducing
inflation. The recessions of both 1969-70 and 1974-75 provided only
limited and temporary relief from pressures on costs and prices.

107
Stop-and-go economic policies that lead to swings between boom
and bust undermine business and consumer confidence, slow the pace
of investment, and involve massive social costs. They do not cure
inflation. What is needed, we think, and what this administration
has adopted, is a durable set of economic policies designed to address
our long-term inflation problem with a long-term remedy.
Let's look at the overall economic policies to fight inflation that are
involved.
The key element in the President's anti-inflation program is a restrained budgetary policy. Federal spending in the 1980 budget has
been kept under tight control. In total, Federal spending will rise
by less than 8 percent from 1979 to 1980, compared with an average
annual increase of 12 percent during the previous 6 years. Adjusted
for inflation, the rise in real Federal spending in 1980 will be less than
1 percent. Restraint in spending will make it possible to reduce the
share of the Nation's output accounted for by Federal spending to
about 21 percent in fiscal 1980.
Those constraints on Federal spending, combined with the revenues
yielded by a moderately growing economy, will reduce the budget
deficit to $29 billion in fiscal 1980.
Spending restraint in the 1980 budget has been severe. Adjusted
fully for inflation, an extension into 1980 of the services and programs
in the 1979 budget would have required outlays of some $544 billion.
In fact, the President's budget recommends outlays of $531.6 billion,
more than $12 billion below that $544 billion level.
Budget reductions of that magnitude have required the President
to make many difficult choices. This budget has not been cut indiscriminately. it has been evaluated program by program, to enable
us to continue to meet the Nation's needs within the boundaries of
fiscal responsibility. Where needs and priorities were high the President
has maintained-and in some cases expanded-program levels.
Now, I know that people will differ among themselves and with the
administration on the ranking of needs and priorities. Debate and
discussion of these matters can only be welcomed. But this budget
reflects, I believe, a fair and reasoned set of choices in an overall
situation in which it must be tightened.
Let me turn to the other maj or element in the anti-inflation program.
Overall economic policies can create an appropriate environment
for unwinding inflation. But after 10 years of inflation, the momentum
of price and wage increases is too strong to be dealt with effectively by
monetary and fiscal measures alone. 'rhe administration has, therefore, set forth voluntary standards for pay and price increases in 1979.
Since these standards have been discussed extensively in the press,
in the Economic Report of the President, and elsewhere, I will not
elaborate on them here. However, there are several points that I
would like to make.
The pay and price standards take account of the widely differing
circumstances and institutional arrangements that characterize the
various sectors of the economy. We are not monitoring each and
every price and wage decision-that would obviously be impossible.
But the standards are meant to serve as guidelines on wage and price
decisions for everyone-businesses, large and small; State and local
governments; educational institutions and those providing professional services.

108
I am encouraged by the acceptance of the standards to date. The
Council on Wage and Price Stability has been receiving between
1,000 and 2,000 letters and phone calls daily, principally from businesses of every size, and from every industry, asking how they can
comply with the standards. And although many labor organizations
continue to respond with caution, the prospects for widespread cooperation appear to be improving steadily. We were particularly encouraged by the wage settlement in the petroleum industry early
this month that met the pay standard.
Public opinion polls report that a large majority of workers express
a willingness to accept a lower vage increase if it will lead to lower
inflation. You can't make any distinction in the polls between union
and nonunion members. They both report the same thing, but one
obstacle to cooperation with the standards, however, is the fear of
individual workers that if they cooperate, others may not, and hence
they would suffer a loss in real income. The President's real wage
insurance proposal is designed to alleviate this concern.
Given this program, Mr. Chairman, let me turn to the economic
outlook as I see it.
Our economy entered the new year in a position of strength. Growth
in 1978 was both strong and balanced, and the $19 billion tax cut
that took effect on January 1 will help to sustain consumer and
business spending during the coming year.
These factors are likely to slow growth, but I expect the slowdown
to be moderate. Real GNP should rise by about 2.2 percent over the
four quarters of this year, well below the 1978 pace, but only a little
below the economy's potential. Labor force growth will remain strong,
and most new workers will find jobs.
I recognize that many forecasters anticipate a recession this year.
Some commentators predict a recession in 1979 simply because the
current economic recovery w ill shortly be entering its fifth year and
historically the average length of recoveries has been less than 5 years.
But as the president of the Federal Reserve Bank of New York pointed
our recently, recoveries don't die of old age but from imbalances and
excesses.
Such problems have not developed on a wide scale during this recovery. Inventories have been kept lean, overbuilding of shopping
centers, apartments, and office buildings has been avoided. Corporate
financial statements are in relatively good condition, and liquidity
remains adequate to support continued expansion. Aside from a few
limited examples, capacity is sufficient to meet expected needs.
The Government is exerting measured restraint to insure that excess demand does not emerge. But restraint is not being applied so
severely as to generate an economic downturn. We cannot fine tune
the economy, and we do not intend to try. But current fiscal and
monetary policies are designed to follow a prudent middle course that
wvill permit continued, moderate growth and yet provide the restraint
needed to fight inflation.
The most important contribution to maintaining a satisfactory
growth rate this year is the prospect that the rate of inflation will
moderate. The combination of Government restraint and widespread
cooperation with the President's pay and price standards should make
possible a significant winding does n in inflationary pressures during the
course of the year. From the fourth quarter of 1978 to the final quarter

109
of 1979, consumer prices are forecast to rise by about 7.5 percent, and
the annual rate of inflation is expected to be below 7 percent in the
final quarter of the year.
Special factors will keep prices rising early in the year. Food prices,
particularly meat prices, will rise significantly. The OPEC oil price
increase will also affect prices, and the delayed effects of the depreciation of the dollar last year will continue to be felt.
As these factors wane, and as the pay and price standards begin to
take hold, the rate of inflation should slow significantly. In 1980 the
effects of policies of restraint and the pay and price standards should
result in a further slowing of the inflation rate. We expect the rate of
consumer price inflation over the 12 months of 1980 to be below 6.5
percent.
I might note, Mr. Chairman, that if one looks at the major published
economic forecasts, our forecasts are about the middle of the pack.
There are-some higher than us and some lower, but we are about in
the middle.
The administration has given top priority to the inflation problem
because we believe that moderating inflation is essential to making
progress toward our longer term economic goals.
This year, as a result of the passage of the Full Employment and
Balanced Growth Act of 1978, special attention has been given to the
longer range concerns of economic policy.
The Humphrey-Hawkins Act requires the administration to set
forth economic goals for the future. This year's Economic Report of
the President contains a discussion of the economic performance
necessary to achieve the 1983 goals of 4-percent overall unemployment
and 3-percent inflation that were stipulated in the HumphreyHawkins Act.
We have looked at long term economic growth in that context.
As you think about it, it turns out you have to answer two sets of
questions, about the feasibilities and problems that those goals set
forth.
The first question is, Can economic output grow fast enough to
achieve that kind of unemployment goal by 1983, while at the same
time moving toward a balanced budget in the Federal budget, as
indicated in the act.
Second, can we reduce unemployment to 4 percent by 1983 while
avoiding an increase in inflation and, indeed, reducing it significantly?
Our analysis of the Economic Report concludes that maintaining
the requisite growth of real GNP and moving to achieving a balanced
budget over the peiiod do not appear to be inherently conflicting aims.
Private investment would have to grow sharply and exceed private
saving by an amount equal to roughly 1 percent of GNP. But this is
within the boundaries of historical precedent.
The principal obstacle to achieving the goals of the HumphreyHawkins Act will stem from the difficulty of lowering unemployment
significantly further while simultaneously reducing inflation. Although
our economy was operating at a level somewhat below its potential in
1978, intensified pressures on wage rates and prices have already
appeared. Continuation of inflation at a high rate would seriously
jeopardize the prospects for maintaining a strong economy and so
imperil our ability to achieve the unemployment goals of the
Humphrey-Hawkins Act.

46-126 0

- 79 - 8

110
The current structure of labor markets makes it especially hard to
reach 4-percent unemployment and at the same time reduce inflation
substantially. Unemployment varies widely across demographic
groups. Measures to address the structural sources of unemployment
have been an ingredient of Government economic policies for more
than 15 years, but differential unemployment rates among groups in
the labor force are greater today than they were 10 years ago. Until
these differentials are reduced, substantial further reductions in the
overall unemployment rate will be very likely to create additional
inflationary pressures.
The sources of structural unemployment problems have been
reviewed frequently. We do spend a good bit of time in the report
examining those various sources. Essentially what we know is that
any number of policies have to be in place to deal with that problem.
Toward that end, we are now pursuing several strategies.
Efforts are being made to target public service employment toward
those most in need. In 1979, the administration will propose a welfare
reform program that will include efforts to use public service jobs
and training programs to combat structural unemployment. The
special employment programs established for youths under the Youth
Employment and Demonstration Projects Act and other legislation will
continue to pay particular attention to the needs of the disadvantaged.
In the President's 1980 budget these youth programs are continued
and supported at high levels of funding.
In 1979, and 1980 new resources also will be devoted to promoting
employment opportunities for the disadvantaged through job opportunities in the private sector. The 1978 CETA legislation authorized a special private sector employment and training initiative that
will finance new job training slots in private business and, in addition,
the targeted employment tax credit, which was enacted last year,
provides businesses a special tax incentive to hire disadvantaged persons, particularly youths between the ages of 18 and 24.
These programs can reduce the labor market shortages and inflationary pressures that otherwise would be associated with achieving
lower overall rates of unemployment. At the present time, however,
we cannot be sure, Mr. Chairman, that continuing or even greatly
expanding these programs would make possible an overall 4-percent
unemployment rate without accelerating inflation. Much work needs
to be done to improve existing employment programs and to discover
new approaches to structural problems if the goals of the act are to be
realized.
In conclusion, our Nation faces new and difficult economic realities
that require adaptations in economic policies. A decade old inflation
persists. We must make progress in regaining price stability if our
hopes for achieving sustained economic growth and prosperity are
to be realized. We cannot avoid the hard choices that this effort will
entail. Budgetary stringency is essential. Sacrifices will have to be
made. Cooperation will be required from private citizens in every
walk of life to make the anti-inflation program successful.
Progress can be made toward reducing inflation in 1979 without
putting the economy through the wringer of recession. It can be done,
and it must be done, to lay the foundation for a strong economy.
As we are successful in sustaining reasonable growth with lower in-

ill

flation, we will create the kind of economic climate in which the growth
in productivity and living standards is most likely to improve.
Thank you, Mr. Chairman.
Senator BENTSEN. Thank you very much, Mr. Schultze.
[The prepared statement of Mr. Schultze follows:]
PREPARED STATEMENT OF HON. CHARLES L. SCHULTZE
I am pleased to appear before the Joint Economic Committee this morning to
discuss the President's economic and budgetary program for 1979 and 1980.
When this Administration took office two years ago, our economy was still
recovering from the deepest recession of the postwar period. In the past two years,
we have made major progress toward restoring a high level economy.
When idle resources are drawn down to small margins, as they have been in this
recovery, the economy must then make the transition to slower but sustainable
rates of growth. Otherwise, excess demand pressures would be created, inflation
would accelerate, and further economic progress would be endangered. To accomplish the needed transition, fiscal and monetary policy must shift toward
restraint.
The need for restraint at the present time has been made more urgent by several
factors:
Even during the recession and early stages of the current recovery, the underlying rate of inflation never dropped below 6 to 6% percent.
That stubborn rate of inflation increased sharply in 1978.
A significant decline in productivity growth occurred last year that contributed
to hightened inflation and lowered the rate of economic growth consistent with
the avoidance of excess demand.
The necessary transition began in 1978. Firm but measured restraint must continue to prevent economic overheating, to give the President's voluntary wage
and price standards a chance to succeed, and to ensure that future growth will
be moderate and sustainable.
The President has sent to the Congress a very stringent budget for 1980. It is a
compassionate budget that responds to the nation's most vital needs within an
overall framework of substantially reduced growth in expenditures and a declining
Federal deficit. The budget strongly supports the fight against inflation.
Fiscal and monetary restraint alone could not reduce inflation while still preserving the economic gains we have made during this recovery. The President's
anti-inflation program, therefore, combines firm restraint over aggregate demand
with a voluntary program of pay and price standards designed to brake the inherited momentum of the price-wage spiral. Both elements of the program are
essential. The pay and price standards could not work in an overheated economyand so restraint is needed. Restraint alone could not brake the stubborn momentum of the price-wage spiral, unless applied in extreme measure over a long period,
at huge cost to the economy. And so the wage and price standards are needed.
The course we have chosen-combining voluntary standards with restraint in
budgetary policies and in the day-to-day conduct of government-is the only
practical course available. Avoiding extreme solutions to our economic problems
offers the best chance to achieve successfully the difficult transition to sustainable
growth and reduced inflation.
ECONOMIC PROGRESS IN 1978

The year 1978 was one of considerable further progress for our economy and
our people. Real GNP rose by 4% percent. During the course of the year:
.Employmentrose by 3.3 million, bringing to over 7 million the number of new
jobs created in the past two years.
The unemployment rate dropped to 5.8 percent by the final quarter of 1978,
down from 7.8 percent in the fourth quarter of 1976.
Employment among minorities grew strongly and the rate of unemployment
among minorities and youths declined, although it still remained at very high
levels.
Industrial production rose 7.7 percent, and by the fourth quarter 86 percent of
the nation's industrial capacity was in use, well above the 81 percent utilization
rate at the end of 1976.
Profits rose more than 10 percent, and business investment in real terms
increased by 8Y percent.
4

112
The margin of unemployed labor and capital resources that existed when this
Administration took office has been reduced substantially over the past 2 years.
Present rates of capacity use are not as high as in previous periods of accelerating
inflation, but the amount of unused capacity no longer is large. Similarly, by late
1978 the rate of unemployment had declined to the top of the range within which
there is an increasing risk of accelerating inflation. We are not at this time experiencing excess demand in our economy, but we must slow the pace of economic
growth to avoid overheating in the period ahead.
Since there are still pockets of substantial structural unemployment in our
country, the overall unemployment rate remains unacceptably high. Further
reductions, however, must depend primarily on a concerted attack on the sources
of structural joblessness. Efforts to reduce such unemployment through traditional
macroeconomic policies would run the serious risk of worsened inflationary
pressures.
The accelerationof inflation
Unlike earlier years in this recovery, when the underlying inflation rate stayed
around 6 to 6% percent, 1978 witnessed a widespread acceleration of prices and
costs. Compensation per hour in the fourth quarter of 1978 was almost 10 percent
higher than a year earlier, in contrast to the average yearly increase of 8% percent
during the preceding three years. Price increases in 1978 were larger than in
earlier years for virtually all categories of goods and services. Both consumer and
producer prices rose at an annual rate of 9 percent last year.
The acceleration of price increases stemmed from a variety of sources. Food
prices rose sharply because supplies of red meat were even more limited than had
been expected and adverse weather damaged fruit and vegetable crops. The
substantial depreciation of the dollar in international exchange markets was
accompanied by higher prices of imports and of competing domestic products.
Mortgage interest rates also rose substantially.
Apart from these special developments, however, there was an increase in the
underlying inflation rate. Wage increases speeded up and productivity growth
slowed, leading to a broad acceleration in the rise of costs.
The faster pace of wage gains began in late 1977 and continued in early 1978.
Although some moderation occurred in the second half of the year, the hourly
earnings index rose 8.2 percent over the year as a whole, compared with 7Y2 percent
in 1976 and 1977.
As wage increases were moving up, productivity growth was declining. During
the four quarters of 1978, productivity rose by less than 1 percent, compared with
the 2 percent rise expected at the beginning of the year. This weak growth of
productivity speeded up the rise in production costs and put additional upward
pressure on prices. It also added indirectly to inflation by increasing demands for
labor. Studies by the staff of the Council of Economic Advisers suggest that the
speed of the increase in employment and the swiftness of the decline in unemployment contributed importantly to increased wage inflation in late 1977 and early
1978.
Accumulating evidence suggests strongly that the longer-term trend of productivitv increase in our economy is significantly lower today than in earlier periods.
Between 1948 and 1965, productivity growth in the private nonfarm sector
averaged 2.6 percent per year. Between 1965 and 1973, this rate declined to 2.0
percent. Since 1973 productivity has grown at an average pace of 0.8 percent per
year. In late 1973 and during 1974, productivity dropped precipitously.
During the first two years of the economic recovery, productivity increased strongly
and preliminary statistics for 1977 suggested continuing improvement. Revised
data for 1977, however, showed a disappointing increase for that year, and preliminary data indicate a further decline in productivity growth to less than 1
percent during 1978.
A wide variety of factors have contributed to the long-term decline in productivity growth. Low rates of capital formation relative to the increase in the labor
force have been a major contributing factor, as have the effects of increased
government regulations. A full catalogue of the sources of slower productivity
growth, and especially its performance in the past year, is not possible. What is
clear, however, is that lagging productivity growth has complicated our inflation
problem and increased the urgency of dealing with it effectively.
The urgency of the inflation problem
The effects of inflation are well-known, but they bear repeating. Inflation
injures everyone. It means that paychecks do not go as far as they once did, and
that savings accumulated for retirement or a child's education become inadequate.

113
The poor and the elderly are especially hard hit. The prices they pay for
shelter, and transportation rise rapidly, while their incomes often increase food,
slowly,
if at all.
Inflation also poses the greatest single threat to the prospects for achieving
full
employment.and greater prosperity for our people. Inflation drives up
interest
rates. It undermines the confidence of businesses in the future and upsets
plans
for investment. Consumers lose confidence in their. own prospects as a result
of
inflation.
Inflation also undermines the competitiveness of our industries abroad
and
adversely affects the value of the dollar. Our prestige as a nation, and our
ability
to support expanding world trade, depend materially on our ability to bring
inflation under control.
Inflation also injures our social and political institutions. A democratic society
prides itself on maintaining conditions iu which its citizens have a sense of
command over their own destiny. When the purchasing power of the dollar-the
yardstick with which we do our economic calculations-is subject to large
and
unpredictable shrinkage, an important element of command over our own
future
slips away. It is small wonder that trust in government and in social institutions
is simultaneously eroded.
For all these reasons, reducing iuflation must be the primary objective
Federal government at this time. We cannot expect to solve our inflation of the
problem
overnight. Inflation has been building for more than a decade, and it will
take
time and patience to reverse its momentum. For this reason, macroeconomic
policies must pursue a course that can be sustained economically and politically
as long as it takes to get the job done.
We will not pursue policies that wring inflation out of the economic
sharp increases in unemployment and large losses in output. That system by
would be
unfair and ineffective. Twice in the past decade, inflation has accelerated
recession has followed. Because prices and wages have become relatively and a
insensitive to economic slack, the recessions did not make a significant long-term
contribution to reducing inflation. The recessions of both 1969-70 and 1974-75
provided only limited and temporary relief from pressures on costs and
prices.
Stop-and-go economic policies that lead to swings
boom and
undermine business and consumer confidence, slow the between investment, bust
pace or
involve massive social costs. They do not cure inflation. What is needed, and
and
what this Administration has adopted, is a durable set of economic
policies
designed to address our long-term inflation problem with a long-term remedy.
Mfacroeconomic policies to fight inflation

The key element in the President's anti-inflation program is a restrained
budgetary policy. Federal spending in the 1980 budget has been kept under
tight
control. In total, Federal spending will rise by less than 8 percent from 1979
to
1980, compared with an average annual increase of 12 percent during the previous
six years. Adjusted for inflation, the rise in real Federal outlays in 1980 will
less than 1 percent. Restraint in spending will make it possible to reduce be
share of the nation's output accounted for by Federal spending to about the
21
percent in fiscal 1980. We will have achieved that goal one year ahead
of the
Administration's original schedule.
Constraints on Federal spending, combined with the revenues yielded
by
moderately growing economy, will reduce the budget deficit to $29 billion a
in
fiscal 1980, less than half the absolute level in the year that President
Carter
ran for office, and only one-quarter as large in relationship to the size
of our
economy.
Spending restraint in the 1980 budget has been severe.
inflation, an extension into 1980 of the services and programs Adjusted fully for
in the 1979 budget
would have required outlays of $544 billion. The President's budget recommends
outlays of $531.6 billion, more than $12 billion below that level.
Budget reductions of that magnitude have required the President
many difficult choices. This budget has not been cut indiscriminately. It to make
evaluated, program by program, to enable us to continue to meet the has been
nation's
needs within the boundaries of fiscal responsibility. Where needs and priorities
were high the President has maintained-and in some cases expanded-program
levels. I realize that people will differ among themselves and with the Administration of the ranking of needs and priorities. Debate and discussion of these
matters
can only be welcomed. But this budget reflects, I believe, a fair and reasoned
set
of choices.
Fiscal discipline is being complemented by firm but careful restraint in monetary
policy. During 1978, interest rates increased significantly and the growth
rates

114
periods of credit
of the monetary aggregates slowed late in the year. In the past, housing. Often, a
tightness have severely reduced the funds available to support
the economy into recession.
collapse of housing has been instrumental in tipping reduced substantially these
Recent innovations in financial markets have
abrupt and often damaging effects of monetary restraint. During 1978, depository
institutions were authorized to issue new savings certificates bearing interest
rates tied to those on 6-month Treasury bills. These new certificates have kept
flows of funds into thrift institutions, and mortgage credit supplies, at a relatively
occurring
high level. As a result, the restraining effects of rising interest rates are Prudently
more gradually and are spread more evenly across the economy.
applied, monetary restraint can now be used more successfully to combat inflation
while still fostering a healthy and stable economy.
Pay and price standards
Overall economic policies can create an appropriate environment for unwinding
price and wage ininflation. But after ten years of inflation, the momentum of and fiscal measures
creases is too strong to be dealt with effectively by monetary standards for pay
alone. The Administration has therefore set forth voluntary
and price increases in 1979.
in the
Since these standards have been discussed extensively in the press, them
Economic Report of the President, and elsewhere, I will not elaborate on
here. However, there are several points that I would like to make.
First, the pay and price standards take account of the widely differing circumsectors of
stances and institutional arrangements that characterize the various decisionthe economy. We are not monitoring each and every price and wageto serve as
that would obviously be impossible. But the standards are meant and small;
guidelines on wage and price decisions for everyone-businesses, large
proState and local governments; educational institutions and those provding
fessional services.
The
Second, I am encouraged by the acceptance of the standards to date. 2,000
Council on Wage and Price Stability has been receiving between 1,000 and from
letters and phone calls daily, principally from businesses of every size, and
every industry, asking how they can comply with the standards. And although
many labor organizations continue to respond with caution, the prospects for
widespread cooperation appear to be improving steadily. We were particularly
month
encouraged by the wage settlement in the petroleum industry early this
that met the pay standard.
Real wage insurance
Public opinion polls report that a large majority of workers express a willingness
to
to accept a lower wage increase if it will lead to lower inflation. One obstacle
the standards, however, is the fear of individual workers that
cooperation with
real inif they cooperate, others may not, and hence they would suffer a loss in
this
come. The President's real wage insurance proposal is designed to alleviate
concern.
Under this proposal, employee groups that meet the 7 percent pay limitation
7
would receive a tax credit if the consumer price index increased by more than
the actual
rate of the credit would be equal to the difference betweenpercentage
percent. The
increase in the consumer price index and 7 percent, up to a limit of 3
wages
to
points, or 10 percent inflation. This rate will be applied are each employee's pay
exempt from the
maximum of $20,000. Employee groups that
up to a
is
standard will qualify for real wage insurance only if their average pay increase
7 percent or less.
The cost of this program-which we estimate at $2.5 billion for fiscal 1980of
depends primarily on the degree of participation in the program and the rate
inflaLower compliance by employee groups would raise the expected sense,
inflation.
credit. In this
tion rate, but reduce the number of workers eligible for the self-limiting.
the potential budgetary impact of the insurance program is
to
As its name implies, real wage insurance offers important protection It workers
against the major risks of complying with the President's program.not does not
an effort
offer cash to "buy out" higher pay increases, and it is emphatically
just
inflation easier to live with or to index the tax system. Indeed it isthose
to make
opposite. It provides some protection against inflation specifically to that
the
who have done something to reduce inflation. The Administration urgesopenmembers of the Congress give this important program a sympathetic and
minded hearing and enact it expeditiously.

115
The economic outlook
Our economy entered the new year in a position of strength. Growth in 1978
was both strong and balanced, and the $19 billion tax cut that took effect on
January 1 will help to sustain consumer and business spending during the coming
year. However, growth will slow during the course of this year for two reasons.
First, the effects of the increase in interest rates last year will be felt increasingly
during 1979. Indicators of business capital investment suggest that the high cost
of borrowing may already be having a moderate deterring effect on capital outlays. Moreover, high interest rates have begun in recent months to reduce savings
flows to thrift institutions.
With mortgage interest rates already at record levels, it is likely that the rate
of housing starts will decline moderately this year.
Second, the personal saving rate was low during 1978. In the last three months.
of 1978, Americans saved less than 5 percent of their incomes, compared with a
historical average of around 6 percent. Last year, consumers continued to purchase durable goods in large quantities and to increase their outstanding debts.
They are therefore likely to show greater caution in their borrowing and spending
during 1979.
These factors are likely to slow growth, but I expect the slowdown to be moderate. Real GNP should rise by about 2Y% percent over the four quarters of this
year, well below the 1978 pace, but only a little below the economy's potential.
Labor force growth will remain strong, and most new workers will find jobs.
I recognize that many forecasters anticipate a recession this year. Some commentators predict a recession in 1979 simply because the current economic recovery
will shortly be entering its fifth year and historically the average length of recoveries has been less than five years. But as the President of the Federal Reserve
Bank of New York pointed out recently, recoveries don't die of old age but from
imbalances and excesses. Such problems have not developed on a wide scale during
this recovery. Inventories have been kept lean.
Overbuilding of shopping centers, apartments, and office buildings has been
avoided. Corporate financial statements are in relatively good condition, and
liquidity remains adequate to support continued expansion. Aside from a few
limited examples, capacity is sufficient to meet expected needs. The government is
exerting measured restraint to ensure that excess demand does not emerge. But
restraint is not being applied so severely as to generate an economic downturn. We
cannot fine tune the economy, and we do not intend to try. But current fiscal and
monetary policies are designed to follow a prudent middle course that will permit
continued, moderate growth as we fight inflation.
The most important contribution to maintaining a satisfactory growth rate
this year is the prospect that the rate of inflation will moderate. The combination of
government restraint and widespread cooperation with the President's pay and
price standards should make possible a significant winding down in inflationary
pressures during the course of the year. From the fourth quarter of 1978 to the
final quarter of 1979, consumer prices are forecast to rise by about 71t percent, and
the annual rate of inflation is expected to be below 7 percent in the final quarter of
the year.
Special factors will keep prices rising early in the year. Food prices, particularly
meat prices, will rise significantly. The OPEC oil price increase will also affect
prices, and the delayed effects of the depreciation of the dollar last year will
continue to be felt.
As these factors wane, and as the pay and price standards begin to take hold, the
rate of inflation should slow significantly. In 1980, the effects of policies of restraint
and the pay and price standards should result in a further slowing of the inflation
rate; we expect the rate of consumer price inflation over the 12 months of 1980 to
be below 634 percent.
The long-term economic outlook
This Administration has given top priority to the inflation problem because we
believe that moderating inflation is essential to making progress toward our longerterm economic goals. This year, as a result of the passage of the Full Employment
and Balanced Growth Act of 1978, speical attention has been given to the longerrange concerns of economic policy.
The Humphrey-Hawkins Act requires the Administration to set forth economic
goals for the future. This year's Economic Report of the President contains a
discussion of the economic performance necessary to achieve the 1983 goals of

116
4 percent overall unemployment and 3 percent inflation that were stipulated in
the Humphrey-Hawkins Act.
By any criterion these are very ambitious goals. Achieving them simultaneously
would demand not only a performance by the American economy that is virtually
unprecedented in peacetime history, but also government programs that can deal
effectively with some of our most intransigent problems, particularly inflation and
structural unemployment.
The discussion in the Economic Report begins by evaluating the likelihood that
the nation's output can grow rapidly enough between now and 1983 to achieve the
unemployment goals of the act while still moving toward a balanced Federal
budget. The analysis concludes that maintaining the requisite growth rate of real
GNP and achieving a balanced budget do not appear to be inherently conflicting
aims. Private investment would have to grow very strongly and excced private
saving by an amount equal to roughly 1 percent of GNP. But this is within the
boundaries of historical precedent.
If Federal spending is held under tight control over the next five years, opportunities will develop for tax cuts to help stimulate growth in the private sector within
The
the context of a Federal budget that continues to move toward balance.deterappropriate timing and magnitude of those tax cuts, however, cannot be and to
mined now. Our ability to foresee economic problems over a 5-year period
design appropriate policies to deal with them is extremely limited.
It would be a serious mistake to commit ourselves now to future changes in
fiscal policy that might be entirely inappropriate at the time they occurred. It
would be equally unwise to adopt some mechanical formula that linked Federal
spending to forecasts of GNP or that provided automatic changes in tax lates
with changes in the rate of inflation. Such formulas fail the test of fiscal responsisensible
bility. They also limit the scope of the Congress and the President to adopt likely to
and needed changes in budgetary policies in the future. And they are very share of
result in perverse effects on the economy-for example, fixing in law the
Federal spending in GNP would tend to raise demand when inflation increased and
restrict demand when the economy weakened.
There is simply no substitute for the difficult process of matching our overall
budgetary policies to the economic requirements of the nation as they develop.
The principal obstacle to achieving the goals of the Humphrey-Hawkins Act
will stem from the difficulty of lowering unemployment significantly further while
at level
simultaneously reducing inflation. Although our economy was operating and aprices
somewhat below its potential in 1978, intensified pressures on wage rates seriously
have already appeared. Continuation of inflation at a high rate would
jeopardize the prospects for maintaining a strong economy and so imperil our
ability to achieve the unemployment goals of the Humphiey-Hawkins Act.
The current structure of labor markets makes it especially hard to reach 4
percent unemployment and at the same time reduce inflation substantially. Unemployment varies widely across demographic groups. Ileasures to address the
structural sources of unemployment have been an ingredient of government
economic policies for more than 15 years, but differential unemployment rates
years
among groups in the labor force are greater today than they were ten in the ago.
unUntil these differentials are reduced, substantial further reductions pressures.
employment rate will be very likely to create additional inflationary
The sources of structural unemployment problems have been reviewed frequently. One major factor underlying the widening of unemployment rate differentials has been the fact that groups with relatively high unemployment rates,
such as youths and women, are now a much larger share of the labor force. Teenworkers as
agers and young adults tend to change jobs more frequently than olderparticularly
they try new occupations and search for long-term careers; women,
during their childbearing years, tend to move into and out of the labor market
more frequently than men.
Major structural obstacles also confront many groups of workers-especially,
but not exclusively, minorities. Many potential imbalances in labor supply and
demand disappear as workers move from sectors offering relatively poor employmay be
ment prospects to sectors offering better opportunities. But this process employblocked by the difficulty of acquiring skills, wage rigidities that discourage
ers from hiring less productive workers, and various sorts of discrimination.
These characteristics of the labor market make it very hard to reduce the overall
rate of unemployment substantially below the present level through expansion of
aggregate demand without encountering labor shortages. As the overall unemployment rate declines, demand for skilled, prime-age workers exceeds supply of
those workers, and puts upward pressure on their wages, even though unemployment among minorities, teenagers and women may remain unacceptably high.

117
The inflationary pressures in a tight labor
economy, contributing to general inflation. market carry over into the rest of the
Achievement of substantially lower rates of overall
inflationary environment will therefore hinge on whether unemployment in a nongovernmental policies can
effectively reduce the structural sources of unemployment.
Toward that end, the
Administration is pursuing several strategies. Strong
efforts
being
target public service employment more directly on those most are need. made to
In 1979, the Administration will propose a welfare reform in
include efforts to use public service jobs and training programs program that will
to combat structural unemployment. The special employment programs
established for youths
under the Youth Employment and Demonstration Projects
lation will continue to pay particular attention to the needs Act and other legisof the
In the President's 1980 budget, these youth programs are continued disadvantaged.
and supported
at high levels of funding.
In 1979 and 1980, new resources also will be devoted to promoting
employment
opportunities for the disadvantaged through job opportunities
in the private
sector. The 1978 CETA legislation authorized a special private
sector employment
and training initiative that will finance new job training slots
in private business,
and a $400 million supplemental appropriation has been
included in the 1979
budget for that purpose. In addition, the targeted employment
tax credit, which
was enacted last year, provides businesses a special
tax incentive
advantaged persons, particularly youths between the ages of 18 and to hire dis24.
These programs can reduce the labor market shortages
sures that otherwise would be associated with achieving and inflationary presunemployment. At the present time, however, we cannot lower overall rates of
or even greatly expanding these programs would make be sure that continuing
cent unemployment rate without accelerating inflation. possible an overall 4 perMuch
done to improve existing employment programs and to discoverwork needs to be
to structural problems if the goals of the act are to be realized. new approaches
Conclusion
In summary, our nation faces new and difficult economic realities
that require
adaptations in economic policies. A decade-old inflation persists.
We must make
progress in regaining price stability if our hopes for achieving
sustained economic
growth and prosperity are to be realized. We cannot avoid
the hard
this effort will entail. Budgetary stringency is essential; sacrifices choices that
will have to
be made. Cooperation will be required from private citizens
in every walk of
life to make the anti-inflation program successful.
We also have to realize that the nation's productivity is
as it once did. Our demands for increases in real incomes not growing as rapidly
and
of living will have to take that reality into account, and that in real standards
what the source of our income-wages and salaries, profits, is true no matter
interest, rent, or
government transfer payments. Our national resources must
be husbanded more
carefully. We cannot do everything at once.
Progress canbe made toward reducing inflation
1979 without putting the
economy through the wringer of recession. It can beindone, and it
to lay the foundation for a strong economy. As we are successful mustbe clone,
reasonable growth with lower inflation, we will create the kind in sustaining
climate in which the growth in productivity and living standards of economic
is most likely
to improve.

Senator BENTSEN. We will have 5 minutes on the questioning
by
each member in order that everyone have a chance to ask
his questions of Mr. Schultze and then, of course, we will go around
for a
second round for whomever wants it.
We
will recognize the members in the order in which they
arrived
at the committee meeting.
Mr. Schultze, since I arrived first [laughter], Iwill start
with my
questions.
I note in your annual report that you talk about the GNP
deflator
and its decrease from 8.5 percent in 1978 to 7.5 percent in 1979
hopefully down to 6.5 in 1980, as a result of tightening of pay and
and
price standards.
Does that mean that you are contemplating a tightening
of the
current price and wage standards in 1980?

118
Mr. SCHULTZE. Well, no decision has been made, but my owvn
judgment is that there will very probably be a necessity for this in
1980, although no specific decision has been made to do this.
In order to achieve the purpose that we are after, we not only need
a budget whichSenator BENTSEN. Probably you won't be able to do it without
tightening up those wage and price standards by 1980.
Mr. SCHULTZE. Probably, but, again, it obviously depends on the
circumstances and how we do in 1979.
There is no use in my trying to make a final decision, but I think
that is quite possible.
Senator BENTSET. I commented very early, and you commented at
length, on the problems of productivity. This committee, I think, is
perfectly positioned to undertake an extensive investigation of this
problem. We are not going to get out of this problem, probably, any
faster than the rate at which we went into it.
Part of our job is to look at the significance of those long-term
trends in the country, and the staff is undertaking a study. We would
be delighted to have your contribution to that study, because I know
you share our deep concern over it.
Now, in your discussion of monetary policy, could you elaborate on
question of more restrictive monetary and credit policies?
What do you mean by that? Relative to what? Does this mean
higher interest rates, or do you think they have peaked, or do you see
a dramatic shift in interest rates forthcoming?
Mr. SCHULTZE. Let me make several points with respect to that.
Until very recently, and by very recently I mean in the last year
or so, in the past., as inflation rose and monetary policy was tightened up
to deal with it, the major impact. of monetary policy came not principally because of the impact of higher interest rates or mortgage
rates and people's willingness to buy homes; it came because higher
market rates contrasted with the low rates paid on passbook savings,
and that pulled huge amounts of funds, in effect out of the thrift
institutions, mutual savings banks, savings and loan associations,
and the like, leading to a rationing of funds in the housing industry,
leading to a virtual collapse in the housing industry.
Most of the recessions in the postwar era have come about because
of the impact on housing.
In 1978, the creation or development of money market certificates
made it possible for savings and loan associations and other thrift
institutions to become more competitive in the market as short-term
rates changed.
It was intended to moderate, not eliminate but moderate, the monetary impact on housing, but spread itSenator BENTSEN. We haven't had the disintermediation problem
that we saw in 1973 and 1974.
Mr. SCHULTZE. Right.
I don't want to suggest that there has been no impact. If you look
at the flow of funds into thrift institutions in the last year, they have
been declining, but not as abruptly as in the past.
I think the second point is that you can look toward significant
moderation in interest rates as we get significant moderation in
inflation.

119
The two go together.
I think thatSenator BENTSEN. Do you have any timespans on those?
Mr. SCHULTZE. No, sir.
Let me simply-when I say, "no, sir," let me go on to point
both the administration and the Chairman of the Federal out that
Board, Mr. Miller, share the same objective to provide the Reserve
kind of
firm and careful restraint to try to get us through this transition
period through relatively high periods of growth without overdoing
The specific monetary actions from week to week or month it.
to
month, however, are in the province of the independent
Federal
Reserve Board, and I am not going to predict monthly changes.
It is our forecast, however, that in the early months of 1979,
rates of inflation are not likely to see a lot of moderation because the
of
increases built in there, but as we move into 1979 further, we
should
see the rate of inflation moderate and it is then possible to have
the
possibility of monetary restraint with the possibility of lower nominal
interest rates.
Senator BENTSEN. Don't these interest rates have to take
and take a bite on the plans of young persons thinking of effect
buying
homes, not that they are worried about the amounts of mortgage
or 30 years from now, but they are worried about the amount 25
of
monthly payment, when the interest rate gets up around 10.5,
11, or
12 percent, the monthly rate gets up to a point where many of
them
can't cut it.
Don't you think that is true?
Mr. SCHULTZE. Indeed, Mr. Chairman, there are risks in that.
For example, our own forecast for the economy does include
moderate decline in residential construction during the year-not a
a
collapse, but a moderate decline-to a range of perhaps 14
million
housing starts by the end of the year. We think that is part
of the
constraint needed.
The long-term prospects for housing are good.
The demographics are going in the right direction, but as
the overall restraint, there would be a modest decline in the part of
housing
industry. in 1979, we think
Senator BENTSEN. Mr. Schultze, my 5 minutes weren't long
but I am sure the ones who just arrived think it was too long.enough,
Congressman Reuss, would you please go ahead.
Representative REUSS. Thank you, Mr. Chairman.
Mr. Schultze, unemployment, now at 5.9 percent, will rise
to 6.2
percent in 1979?
Mr. SCHULTZE. That is correct.
Representative REUSS. I read, from a Washington Post
yesterday, about the view of you and your colleagues. The Post story
says:
Schultze and his CEA colleagues say that the

ment goal can be achieved in only one way inHumphrey-Hawkins full employa
With jobs programs designed specifically for blacks, noninflationary environment:
teenagers, women.
In other words, everyone except prime aged, skilled white
males.

That is fine, but why didn't you do that? Why are you sitting
by
and allowing the overall unemployment rate to go up from an
inexcusable 5.9 percent to an outrageous 6.2 percent, when the additional
unemployment will fall largely on blacks, teenagers, and women,
the

120
groups which you say it should be the policy of the Government to
treat directly, so you don't run into inflation.
I agreed with what you said, buy why don't you do what you said?
Mr. SCHULTZE. Congressman Reuss, we are.
We have moved in that direction. Let me note that when this
administration took office there were 330,000 public service jobs and
an unemployment rate of almost 8 percent.
We moved in very quickly with some countercyclical public service
jobs.
Then, over the intervening period, we have moved to substantially
beef up title II, the structural unemployment part, and as the unemployment rate has moved down from 8 percent to about 6 percent, we
have reduced the countercyclical part and increased the structural
part.
We have very substantially increased the funds available for the
youth employment and training program. I think we have virtually
doubled it.
Next, this budget does include not just in the public service area or
the governmental training program area funds-very substantial
amounts compared to what was the case 2 years ago, or 3 years ago.
We have introduced, admittedly on a modest scale, to see how it
will go, two things: A private employment initiative in which, through
the expenditure side of the budget, the Labor Department will be
working with local groups to place the disadvantaged in private firms
and in on-the-job training and work experience and, second, a work
employment tax program.
The funds have been expanded substantially.
There is a limit, however, to how fast we can move with these
various ventures. We have to gain experience; these programs have
not been around for a long time.
We need to do it in a careful, targeted way to get precisely what we
want, not to have it substituted.
I don't think we have all the answers. We clearly don't in order to
get the unemployment rate among the structurally unemployed down
now.
We are moving to try to find what the answers are and experiment
with different ways of doing it.
Representative REUSS. With your overall unemployment rate going
up this year, as projected, from 5.9 percent to 6.2 percent, what do you
figure that will do to the unemployment rate for black teenage women?
Mr. SCHULTZE. I think that will depend in part upon how the private
initiative, particularly some of the private initiative programs, work,
where we have two new programs coming in directed toward those
groups. You are right, about the overall unemployment rate, if it
does edge up to 6.2 percent, we will have more of a problem.
Representative REUSS. Well, if they use up all their budgetary
money, what will be the effiect on the unemployment rate for black
teenage women?
Mr. SCHULTZE. As I said, I can't tell because I don't know how
successful those new programs are going to be in bringing people
who are structurally unemployed in those groups into employment.
If it is very successful, then we should be able to get some shift in
the unemployment in the direction we want.
Representative REUSS. If I had been running this, I would have
found whatever moneys were needed to avoid increases in structural

121
unemployment, and within the budget's projected $29 billion deficit.
For example, the budget includes $2.3 billion for State
sharing. Certainly, we would be much better off taking carerevenue
of the
unemployed than writing blank checks to States.
Or I could have found $2.5 billion in your wage insurance. It is a
better social contract with workers, I suggest, than the proposed wage
insurance.
Or I certainly could have found $3 billion in the defense expenditure
programs, shifting that to the relief of structural unemployment
would have added more to the security of our country than more
weaponry.
Mr. SCHULTZE. But, Congressman Reuss, it isn't only a question
of finding more money. From 1976 to 1980, the budget for CETA
has approximately doubled.
Within that budget, we are moving as fast as we think we can
toward getting the right targeting.
Representative REUss. I will stipulate that CETA is a dud, but
you have more promising programs.
Mr. SCHULTZE. But the way to make sure they are not duds is to
proceed carefully before dumping $5 or $6 billion in them.
The CETA program now runs up about $11 billion a year, I think.
I don't have the figure in my head. We have moved substantially
to try to tighten up every target.
It has been a major effort, but I don't think the way to do it is
say, "Can we find the money?" We can find the money one way to
or
the other, but I don't think that is the answer.
Representative REUSS. I just wanted to record my dissent.
Thank you, Mr. Chairman.
Senator BENTSEN. Senator McGovern.
Senator McGOVERN. In the President's just released Economic
Report, he says, "We will not try to wring inflation out of our
economic system by pursuing policies designed to bring about a recession."
Further down the page he says, "Stop-and-go policies do not work."
Aren't these statements in effect offset by the President's own fiscal
and monetary policies?
In other words, aren't we really going back to the old policy of
raising interest rates and unemployment and slowing growth, policies
that may very well provoke a recession, without really getting at
the
cause of the inflation?
Mr. SCHULTZE. Senator, not at all. We have an economy
recovering from a recession. The rate of growth in 1977 which is
was 5.5
percent.
The rate of growth in 1978 was 4.25 percent. Obviously,
recover, we have to moderate that rate of growth so that we as we
don't
go through the roof and run into inflationary pressure.
What we are seeking is not to cure inflation by turning the economy
into a recession. What we are facing is the simple reality that
an economy recovers, you have to slow down the growth so it when
doesn't
go through the ceiling.
This is what this budget is all about. It does require restraint.
Monetary restraint is required.
I would have you note, for the reasons I indicated earlier
colloquy with the chairman, that I think there have been in the
major

122
Improvements in the way the monetary policy works, so it doesn't
just clobber housing.
We need restraints, but there is no question that we simply can't
blink our eyes at the fact that we have to move from an economy of
recovery to an economy of sustained but much slower growth.
Senator MCGOVERN. You don't see a danger of that leading to a
recession this year?
Mr. SCHULTZE. Of course I see a danger. The danger is that it is
never as easy as rolling off a log to make a transition from a recovery
period to a long-term growth period, but I think that the danger of
having budgetary and monetary policies which kept the economy going
up very steeply would have been much greater.
This can be done, and we can get through. I think we will get
through.
Senator McGOVERN. You stated in your prepared statement, "The
key element in the President's anti-inflation program is a restrained
budgetary policy."
Is that the chief cause of inflation today in the Federal budget?
I presume that means the nonmilitary portion of the budget, since
you are increasing the military budget even faster than the inflationary rate.
Is it fair to say that the nonmilitary portion of the Federal budget
is the key cause of today's inflation?
Mr. SCHULTZE. No; it is not, Senator. That is, in fact, precisely
what we want to avoid-budgetary policies which were not a key
cause of inflation in the last 3 or 4 years and which we want to make
sure don't become a key cause.
In fact, in a given period, that budget hasn't been a cause of inflation, which doesn't mean one can have any old budgetary policies in
the future.
If we don't slow it, it would be.
Senator McGOVERN. So that explains why the key element in the
anti-inflationary policy is restraining the nonmilitary portion of the
budget?
Mr. SCHULTZE. There are two key elements. I don't think the word
"key" should be used as the keystone in an arch.
There are two
Senator McGOVERN. You indicated that a majority of workers
favor staying within the wage-price guidelines if that brings some
relief from inflation.
Don't those same polls show that by an even larger percentage the
people favor wage and price controls?
Mr. SCHULTZE. Let me first make it clear about the polls. The question was not asked specifically in terms of the standards, "Would you
be willing to accept a lower rate of money wage increase if it helped
bring down inflation?"
The answer is yes.
I think you are right. I have seen polls in which people give a
majority for wage and price controls. My own judgment is that if that
happened, exactly what would occur is what occurred in 1971.
It would last about 9 months, maybe a year, and then because there
isn't any set of bureaucrats who can manipulate 5 million price structures, the pressure to dismantle it would be irresistible and it would
be dismantled.

123
So, I think you are right.
Senator McGOVERN. My time is up.
Senator BENTSEN. Congressman Hamilton.
Representative HAMILTON. Thank you, Mr.. Chairman.
I spent the weekend in a couple of public town meetings in my
district in southern Indiana, and one thing that impressed me was
a
number of older people coming in objecting strongly to the President's
proposal to reduce social security benefits.
I know those proposals are fairly modest in size, but they certainly
have these people, at least, mightily stirred up.
What impressed me about them was not so much their anger as
their anxiety, and, really, their fear for the future about what these
proposals may mean.
I am not speaking here of people who are at the bottom
the economic ladder, but higher than that. They really are rung of
deeply
concerned about those proposals, and they argue that the Government
is breaking its contract, and they fear what is ahead in the future
beyond these proposals that the President has made.
Now, what do you say to those people? What are we getting into
with regard to the social security system specifically and other pension
systems as well, and what can we say to these people which will give
them -some major hope for the future?
Mr. SCHULTZE. Congressman Hamilton, several things.
In the first place, there are a number of different thrusts to
President's social security proposals. One of them has to do with the
forming the disability system, which has been growing absolutely reby
leaps and bounds.
Basically, Congress itself-I believe Ways and Means and I think
Finance; I am not sure-examined it carefully last year and made
recommendations on the subject.
One of the major elements in the reform of the disability side is to
try to insure that the disability program does not provide benefits
larger than the prior earnings of the beneficiary, and then where there
are significant social needs at the low-income level, that they be picked
up by the SSI program.
Similarly, in the social security area itself, before we had a much
better developed program for assistance through SSI, through college
scholarships, and the others, we had built into the social security
system a number of welfarelike benefits, which at the time probably
made sense, because we didn't have anything else.
The thrust of most of these reforms is to try to make the social
security system somewhat more an earnings-related, insurance-related
type program and somewhat less a welfare program, because now
we
do have programs to handle this.
For example, a minimum benefit is an exceedingly inefficient way
to provide assistance to those at very low-income levels.
Among other things, what it tends to do is to provide minimum
benefits to Government employees, who retire and have a very
good
pension and get minimums from the social security system.
Representative HAMILTON. Is the President's program the opening
shot of a battle to take away the marginal benefits of the social security
systems? -

124
Mr. SCHULTZE. I don't think you can say that, Congressman
Hamilton.
recall one of the
What this was, was a look at the system. You mayis now, but some
the pressure
problems, and I don't know how much
and local
time ago there was a great pressure on the part of State
system.
government employees to opt out of the
and welfare
Why? Because there were enough minimum abenefits buy for the
good
it wasn't
benefits in that people were afraid
middle-income earner.
who say
Representative HAMILTON. What do you say to the people
in effect between people in the Government and
there is a contract
they were in the
certain benefits which are built into the law, andand now you are
receiving the benefits,
system and anticipated
changing them?
theory in
Mr. SCHULTZE. It seems to me if one argues the contract
the system at all.
that sense, one could never reform
Let me give you an example.
to the soTwo years ago, Congress moved to make a major reform inflation.
problem, because it double counted during of the
called uncoupling
the turn
It would have had disastrous consequences by If one acts on the
Now, Congress has moved to reform that.
century.
been impossicontract theory, you couldn't have done it. It would have
make any move like that.
ble to
terms as a social
So, it seems to me one has to look at this in broad system cannot be
not such that every minute point of the
contract, but
touched.
Representative HAMILTON. Thank you, Mr. Chairman.
had excellent
Senator BENTSEN. I would say, Mr. Schultze, we have deep concern
at all of these meetings, and I think it shows

attendance
on the part of the members to the questions you are addressing.
Senator McClure.
relating to what
Senator McCLURE. Let me go on with the comment social security
Hamilton was concerned about in the
Congressman
field.
get our growth rate up
I believe it is correct to state that if we could it, we could afford the
year and sustain
by just under 1 percent per
rates, and if we
benefits we have promised without raising the tax raise the tax rates
then we will have to
don't get the growth rate up,
new workers,
from 12 to 18 percent, or raise the retirement age to 68 for
or cut benefits in some manner.
it is correct,
I make that comment, and I suspect that you agree that
rate up, we won't have to take the more
that if we could get the growth
Draconian measures with respect to social security. rate of growth in
Mr. SCHULTZE. Senator, over the longer term, the is very important
productivity, particularly if you look down the years,
in terms of financing burdens of social security.
That is exactly right.
to grow almost
If productivity grows very slowly, then prices tendsystem is severe.
as wages and the impact on the social securityare indexed grow
as fast
If productivity grows rapidly, then benefits thattax and the burden
much less rapidly than wages which pay the payroll
on the system is much less.
expressed
So, as a general proposition over the years that is correct,
in terms of productivity.

125
Senator MCCLURE. That leads into what is my greatest concern.

I don't think we will ever get to a balanced budget unless we change
economic directions.
We cannot do what we have been doing in recent years, rushing to
put out the fires of inflation, while the fire of unemployment grows
hotter, and then turning around and running to put out the fire of
unemployment at the expense of allowing the fire of inflation to rage.
There has to be something to break that cycle, and I have not seen
it under recent administrations, Republican or Democrat, and I don't
see it under this one.
In your prepared statement, you have painted a rather grim picture
of productivity.
Over the past 5 years, since 1973, productivity has grown by only
eight-tenths of 1 percent per year. This compares with a long-run
historical average of 2.5 percent growth per year.
That has to increase the rate of inflation. It must reduce our
economic growth. It has got to put a terrible drag on our standard of
living in the long run.
The basic premise upon which we have built various programs,
such as, welfare, social security, railroad retirement, Government
retirement, military retirement, all these things, is average historic
rates of growth. These programs were rational at the time they were
initiated if we stayed within those projections, but now we face the
possibility that these projections will not come to pass.
Unless we can point to increased rates of productivity in the future,
we simply will not achieve the necessary growth to pay for these
programs.
We heard Congressman Reuss a few minutes ago talking about the
three-tenths of 1 percent in the rate of unemployment as being a
totally unacceptable course, and I suspect as unemployment edges up,
as I expect it will, there will be more and more concern expressed about
unemployment and less and less, relatively, about inflation.
Then we get into the 1980 Presidential election year with the economy
relatively sluggish, with the recession late this year or early next year.
Unemployment will rise. The administration, seeking the political
base it must have, will then rush to put out the fires of unemployment
by reflating the economy very rapidly.
Mr. Schultze, the thing that troubles me about your statement and
the President's budget is that there are a lot of short-term, quickfixes in it, but no proposals for long-term productivity growth.
We have got to take some measures to increase productivity. I
would certainly appreciate your comments.
Mr. SCHULTZE. In the first place, Senator, not merely 1978, but the
longer term growth obviously poses all kinds of problems for our
economy.
Second, there are no magic buttons to push to get productivity up.
There are a number of elements required and you can't put numbers
on them. One is investment. You may recall that in the last session
the tax cut which the Congress enacted had about $7 billion of cuts
directed in one way or the other toward investment-related

requirements.

The administration would actually have had about the same proportion. We would have preferred to come in different ways, but at
any rate, it was about $7.5 billion.
46-126

0 - 79 - 9

126
Investment has, by the way, begun to grow again at a fairly good
clip.
It was about 9 percent in real terms in 1977, and about 8 percent,
I think, in 1978.
That is important; it is hopeful, but it takes time.
Research and development is important. Again, in the last two
budgets for the first time, adjusted for inflation, Federal support
for research has turned around and has begun to increase. That is
important.
We can't put a number on it.
I think it is important in a way that I am convinced is correct,
although I can't measure it. All over the world the rate of investment and the rate of productivity growth has fallen off in the 1970's.
I think one of the reasons for this is that in 1973, 1974, and 1975,
not just the United States but the world as a whole, went through
a major trial, double-digit inflation, and the worst recession since
the Great Depression, all at once.
Confidence in the future was struck a really hard blow. It has
recovered some, but not fully. Growing productivity means doing
things differently.
It means taking more risks.
One of the major elements to get there is an economic policy that
tends to promise less stop and go and more stable, sustained growth,
trying to get your hands around inflation and gradually bring it
down.
Bringing more stability into the system will be very helpful in the
interim; until productivity does grow, our ambitions have to be more
limited than what they could have been in terms of what wages can
do and in all terms of our economy.
I think some of that is in motion, but no one can predict to you the
exact day, hour, time, or year when it will take over.
Senator BENTSEN. Congressman Brown.
Representative BROWN. Thank you, Mr. Chairman.
Mr. Schultze, I am positioned between microphones. I hope you
can hear me.
I was startled in the President's message to the Congress last
evening to find out that farm sales abroad were at record levels.
I venture to say that there isn't a farmer in Ohio and perhaps
much of anyplace else, and I guess they are on their way to town to
tell us, who would share that comment of the President's.
The only thing I could figure out to justify it-I didn't want to attack
the statement as untrue-was that he is dealing with inflated prices
and, of course, all administrations, when they prepare the glowing
reports of how well the economy is doing, pull the inflation into it.
For instance, I think that you tend to do what others have done.
I think you show spending falling as a percentage of GNP from 22.6
percent in the year 1978 to 20.7 percent in 1982.
The other side of that is, of course, that the taxes on individuals
are rising to 19.7 percent of GNP in 1978 and 21.6 percent of GNP in
1982.
So, in effect, what is happening is that we are getting eaten up by
inflation at both ends. I had a colloquy with Mr. Miller of the Federal
Reserve Board about how $15 billion more has been paid into the
Federal Treasury because businesses around the country still pay

127
more in taxes because their profits are overstated because the replacement cost of their equipment is underdepreciated because of inflation.
That is about a $30 billion overstatement in taxes and about $15
billion overpayment of taxes and, of course, that means that that is
money that you do not have in your till. To replace your equipment,
you go out and borrow, and that exacerbates the investment problem
that Senator McClure has been discussing.
Would it be possible for us ever to have all these figures presented
in such a way that we didn't try to make the best of a bad situation,
that we would report it more clearly?
I have to make a McKinley Day speech tonight-this is his birthday [laughter]-and, of course, no one wants to go back to the era of
McKinley, but I would point out to you that the real GNP in President McKinley's days in office was growing at about 6 percent, and
the real per capita income was growing at 4.5 percent.
Ours is growing at a lesser rate, and our per capita income is growing at about 2 percent. We really aren't as well off now as in those
clays when the Federal budget was one-thousandth of what it is now.
Maybe we are doing something that is not right, and I would like
to discuss that with you in the half-minute remaining [laughter] or
let you discuss it with me.
Is there any way that we can get really effective cuts in what the
Federal Government is spending rather than talk about the cosmetics
of an inflated dollar?
Mr. SCHULTZE. I am not sure what you mean by the cosmetics
of the inflated dollar.
When spending goes down, the inflation is in the denominator and
in the numerator.
Representative BROWN. But taxes go up. You are not saving anybody anything. You are actually taking more from them.
Mr. SCHULTZE. We had coming into effect in January of this year a
$29 billion tax cut addressed to that problem.
Representative BROWN. Say how much it was again.
Mr. SCHULTZE. $29 billion.
Representative BROWN. What about social security increases?
Mr. SCHULTZE. I want to come to that. If one looks at tax rates,
you are quite right, the average effective tax rate does tend to climb
as inflation pushes people into higher brackets.
Consistently Congress, every year or so, or at 2- or 3-year intervals,
tends to reduce that.
Representative BROWN. Why don't we do it by formula?
Mr. SCHULTZE. Let me go on for a moment. The share of taxes on
personal income has not risen over time. It rises and then is cut.
Where the share has been rising is in social security taxes, to pay for
the increased benefits.
Representative BROWN. And State and local taxes, which are mandated by the Federal Government, because of the Federal programs
the Government presents them as matching programs and says, "If
you don't spend this money, you don't get the goodies out of Uncle
Sam."
Isn't that true?
Mr. SCHULTZE. Except if one takes away the growth-what the
Federal Government has provided is considerably more than what

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the States are asked to pay. In many cases, the Federal cost share is 80
percent, 90 percent, and in some cases 100 percent.
Let me go to the mechanical formula. There are problems with that.
In the first place you give up the automatic flexibility of the tax
system.
As time goes on, it is desirable, necessary and appropriate to reduce
Federal taxes to take account of the impact of inflation, but to put
it into a mechanical formula means that the Congress is setting fiscal
policy into the future rather than being able to adjust taxes when that
is needed and by the amount needed to deal with the economy.
Next, if one wants to look down the road in providing, for example,
more investment incentives, it seems to me Congress should look at
the taxes and maybe give a greater proportional share of cuts to that
sector.
Representative BROWN. We seem not to have done too well in
either one of those. We seem not to have done too well by retaining
that flexibility.
My time is up, but let me conclude with this comment: We have
what we call uncontrollables in spending to the point where the budget
is supposedly impossible to cut.
Now, if Congress provides that taxes automatically increase
through inflation and spending is supposedly uncontrollable, then it
seems to me that people who spend the money have the best of both
worlds.
Congress supposedly can't cut the expenditures, and the taxes pay
for the expenditures.
I would like to see us try something automatic, either in spending
or in the taxing so that the automatic part could work on the side of
the individual taxpayer rather than on the side of the person who
spends the money and collects it.
Senator BENTSEN. Mr. Schultze, the member's time has expired.
Your time has not expired and you may have equal time to respond.
Do you want to comment, Mr. Schultze?
Mr. SCHULTZE. Several quick points, if I might, Mr. Chairman.
First, let's go back to the period of 1960 to 1965.
In that period, or between that period and 1979, the share of total
Federal taxes in GNP has gone up 1.6 percentage points from 18.3 to
19.9.
During that same period, the share taken by social security taxes
has gone up by 2.9 percent, and all other taxes have come down. If
one remembers, Congress has tended to cut income taxes, and properly
so, as growth and inflation pushes individuals into higher brackets,
but the large growvth in social security benefits has grown more than
proportionately with our economy.
Second, the Congressman from Ohio raises a good question about,
how we deal with our taxes in a period in which changes in the economy tend to change the tax rate. But the dangers of trying to get a
mechanical formula seem to me to be very great.
For example, there are two bills now before Congress that would
fix the share of Federal spending and fix tax reductions by law for a
number of years into the future.
Let's look at the one which fixes expenditures as a percentage of
GNP. Therefore, that would make it possible to cut taxes automatically.

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In 1980, that particular proposal would fix the Federal spending
share at 21 percent of GNP. It would be locked into law that Federal
spending in 1980, and, again, in 1981, would be what the Congressional
Budget Office forecasts for GNP times a percentage.
Now, we happened to look at the range of economic forecasts among
the major economic forecasting institutions for 1980, and the range is
so large-these are the major ones-that if you applied 21 percent
to the top forecast and 21 percent to the bottom forecast as a measure
of Federal spending, the difference is $18 billion.
So, when you try to lock in Federal spending as a fraction of GNP,
the Congress would have taken all its discretion over spending and
turned it over to whoever the technician is who is estimating GNP.
It is a judgment about forecasts, not about spending. I think it is
very dangerous. The way to handle that is with the good sense,
debate, and the dialog between the administration, the Congress,
and the public rather than trying to lock it into a formula.
Senator BENTSEN. Mr. Schultze, we come back again to the question
of productivity.
There are many things that have contributed to the decline in
productivity. You are talking about investment to modernize the
manufacturing capacity of the country. Normally, others who have
testified before us talk about three possibilities, taxwise, and those are
corporate tax reduction, investment tax credit, or accelerated depreciation.
Talking about modernizing the industrial capacity of the country,
where do you think you would get the most, from which of those
three?
Mr. SCHULTZE. I am not sure. I would say, choosing among them,
virtually all the economic studies, for what they are worth, indicate
that tax cuts are directly related to changes in investment.
Senator BENTSEN. That was Bill Miller's testimony before this
committee, too, and before the Finance Committee.
Are there other questions?
Let's go down the list.
Congressman Reuss.
Representative REUSS. First of all, I would like to congratulate the
Council on an extraordinarily good report, particularly in the many
pages it has on Humphrey-Hawkins and its international aspects.
Having said that, in your prepared statement, you say, and I quote:
"We cannot fine tune the economy, and we do not intend to try."
Well, I think you have got to fine tune the economy, and you should
intend to try in this day of international dollars, with all its sinking
problems, and the course we need to steer between inflation and
unemployment, which you rightly, I think, concede, is unamenahip
to traditional monetary and macro means.
Mr. SCHULTZE. Let me see if I can undo the quibble, Congressman
Reuss, because I think we don't really disagree.
If you mean that in setting fiscal policy, we ought to look for a
reasoned objective that we want the economy to perform, and try to
aim our fiscal policy toward it, that is what we ought to do, and that.
is what we have done. I don't call that fine tuning.
What is fine tuning is, every quarter, looking at the statistics, if
things are a little worse than you thought, you go ahead and try to

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boost the economy and so forth. The fine tuning I don't like is when
you try to change your mind, or however you want, every quarter.
Representative REUSS. If you define fine tuning as constant
oscillation, then we must all approve of that.
I would add to the area and content of good fine tuning, that which
we all like, the relationship between fiscal and monetary policy.
Turning to another quibble in your prepared statement, where you
are relatively happily tuned about the future, you say, "Overbuilding
of shopping centers, apartments, and office buildings has been avoided."
Well, I would say that the overbuilding of apartments has been
avoided. It has been one of the most colossal successes in history.
[Laughter.] There haven't been any apartments built, and that has
been one of the problems. So I wouldn't want the word to get out
among the troops in the executive branch that avoiding apartment
building should be a prime object of international policy.
I am sure you didn't mean it that way, and that is why I called it
a sort of a quibble. [Pause.] As between fiscal and monetary policy,
in view of the needs expressed by many of my colleagues here this
morning for more capital investment and more research and development, aren't we better off with a quite tight fiscal policy and a monetary policy which is a little less tight than wholly tight, because by
reason of the tight fiscal policy, it doesn't need to be all that tight?
In other words, aren't lower interest rates designed to increase
investment, increase productivity, and, thus, combat inflation in the
long run?
Mr. SCHULTZE. It all depends on "compared to what?"
Fiscal policy has become significantly more tight. The monetary
policy that would have been required had fiscal policy not have done
that would have been substantially greater. In that sense, you are
quite right. I think one has to look at it in terms of real interest rates.
My own judgment, and this is one of the reasons why pushing down
the rate of inflation rate, is because it then makes possible the kind
of interest rates that gets in the direction you want.
I am not sure how feasible that will be until we get the rate of inflation down. There is obviously a mix between the two. I think the
mix is in fairly good balance. Nothing in this world is perfect, but I
think it is in balance.
Representative REUSS. You say in your prepared statement that
the tax cut that took effect on January 1 will help to sustain consumer
spending. You say, "and business," but I leave that out.
That is part of the game plan, is it, to sustain consumer spending?
If so, it runs counter to the gospel according to the committee
chairman, that what we need to do in this country is to have a little
less exuberant consumer spending and a little more exuberant investment spending.
So, why do we want to increase consumer spending?
Mr. SCHULTZE. Again, in all things, there has to be some sort of
balance. I don't want to speak for the chairman. He can speak for
himself. But I presume that when one speaks about investment incentives and the need for investment, one doesn't probably mean
that you ought to let individual income tax rates climb for the next
10 years, and put all potential tax credit into investment. There is a
balance.

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I note this in last year's tax proposal, where there was a larger proportion relegated to investment tax credit than is normally the case.
One has to tip the balance, but not completely go overboard.
Representative REUSS. Then you approved that portion of the tax
cut with respect to consumers?
Mr. SCHULTZE. In(lividlual tax cuts?
Yes. Any cut is an increase of money and purchasing power in
consumers' pockets, but that has an impact on the economy. You
have to look at it both ways.
Representative REUSS. Thank you.
Senator BENTSEN. Senator McGovern.
Senator McGOVERN. Just one question.
Mr. Schultze, the reason I asked you earlier about your statement
that the key element in the President's policies is the budget restraints
that I have been concerned about what seems to me to be a developing
situation where we are beginning to assume that if we just control
the Federal budget, inflation is going to disappear, it is almost as
though that were the only cause of inflation.
We begin to identify people who are concerned about inflation and
those who aren't almost entirely on the basis of how large a Federal
budget they want, particularly when it relates to nonmilitary
government.
I am wondering, as a professional economist, if you would talk for
a couple of minutes about what you see as the basic cause of this
inflation that has afflicted the country over a considerable period of
time.
Mr. SCHULTZE. I would be glad to, Senator. I am trying to think
how to get it into 3 minutes.
Maybe I can do it very briefly.
We have had 10 to 12 years of high inflation. It has averaged 6%
percent. Essentially, it came, I think, from three kinds of things. We
had two major episodes in which we got a real inflationary kick.
In the 1960's-it depends when you want to start it-in 1966, 1967,
1968, and perhaps 1969, when we financed the Vietnam war with no
tax increase, and had a good old fashioned boom on resources and a
jump in inflation.
Then, again, in 1973-74, we had a little bit of overheating, but also
really got hit by crop shortages all over the world, driving up farm
prices and by OPEC, quadrupling the price of oil. That really hit us.
We had two major inflationary episodes, both of which, particularly
the first one, were part of the Government overheating the economy.
So we slammed on the brakes, and inflation didn't recede very well.
So whatever starts it, and it can be from overheating, or outside events
like food, like in 1973 and 1974, the traditional medicine of slamming
on the brakes, while it has some effect, does not stop it.
You have prices chasing wages and wages chasing prices, and expectations. When nothing is overheating the economy, as in 1976,
1977, and 1978, you still get the inflation going. So what you want to
(1o is prevent the initiating set of factors-don't overheat the economy.
If we did that in 1979 and 1980, we would get it.
Second, we need price standards to help unwind this momentum.
You will note in my prepared statement, and I thought I took great
pains to point out this is a balanced approach. I stated:

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Fiscal and monetary restraint alone could not reduce inflation while still
preserving the economic gains we have made during this recovery. The President's
anti-inflation program, therefore, combines firm restraint over aggregate demand
with a voluntary program of pay and price standards designed to brake the
inherited momentum of the price-wage spiral. Both elements of the program are
essential. The pay and price standards could not work in an overneated economyand so restraint is needed. Restraint alone could not brake the stubborn momentum of the price-wage spiral, unless applied in extreme measure over a long period,
at humge cost to the economy. And so the wage and price standards are needed.

We don't get overheating, and the main thing is to brake the
momentum that keeps you going even when you don't have excess
demand.
That is more than 2 minutes.
Senator McGOVERN. My time is up.
Senator BENTSEN. Congressman Hamilton.
Representative HAMILTON. One of the more popular games in town
now is drafting "balance the budget" amendments.
I think the President spoke out against that the other day. Why
don't you put on the record for us here what is wrong with those
amendments, even those that include some flexibility for national
emergency exceptions and all that?
Mr. SCHULTZE. There are a number of things I think are wrong with
it. I was careful over the weekend to make some calculations that I
probably cannot find now. But let me simply note the obvious point,
that it makes very good sense to move toward and to balance the
budget as the economy moves toward high unemployment.
It is absurd, and I will use the word again, absurd to try to balance
the budget in an economy that for a combination of reasons is moving
into a recession.
Let's take 1975, and I hope I can remember these numbers, and I
will correct them for the record, that if in 1975, we had had an amendment, and didn't have an emergency proviso, initially, we would have
had to reduce the budget spending by $45 billion, or raise taxes by $45
billion as we moved into the early phases of that recession. But, that
wouldn't have been enough.
Even though that would have balanced the budget on the first
round, it would have driven the economy down further, and we would
have had to have had further cuts, amounting, I think, to some $70
billion, with an unemployment rate of 11 to 12 percent, instead of the
8 to 9 percent we actually got.
Balancing the budget is very important under conditions in which
you are trying to combat inflation. Balancing it in the middle of a
recession is another story.
Every State, I think, has in its constitution a budget balancing
provision, but that hasn't prevented them from running modest deficits, at least, under some circumstances.
If you look at other nations which have balancing provisions, what
do they do? The great game becomes, "Why do you classify as investment what you could classify as operating?"
Then you get emergencies, and the emergencies get easier and
easier to declare. In my own judgment, there is no substitute for an
attempt at reasoned use of fiscal and budgetary policy to meet the
needs of the Nation.
We haven't always done very well at it, but we cannot get around
having done it badly in the past by trying to work some formula into

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law, or even worse, in the Constitution-quite apart from the problems of a constitutional convention. Once you get it started, Lord
knows what you would get out of that.
Representative HAMILTON. In exchange with other members, I got
the impression that you had less confidence in CETA as a program
dealing with the structural sources of unemployment, and, perhaps,
more confidence in other measures, such as those you mention in your
prepared statement; namely, private sector employment, training initiatives, and the $400 million provided in the budget targeted to
employment tax credit-is that right?
Is your thinking with regard to how to get at those structural sources
of unemployment shifting more in that direction and away from
CETA?
Mr. SCHULTZE. I don't think it is so much away from CETA at all.
I think what we have are very substantial resources invested in
CETA now.
Representative HAMILTON. You still consider CETA an important
effective partMr. SCHULTZE. Yes. I suppose what I am trying to say in a crude
form is that if one wants to reduce structural unemployment, CETA
is vital, but we cannot say that we should double the amount.
I think CETA is a very important part of this. Improvements are
being made. More improvements will have to be made, but I would
also like to give a try at the private sector part. CETA is a very
important part of this, but it isn't the only part.
Representative HAMILTON. Thank you, Mr. Chairman.
Senator BENTSEN. Senator McClure.
Senator MCCLURE. Thank you, Mr. Chairman.
Let me digress for a moment.
It seems to me your last answer betrays the myopia that has occurred with CETA for the past several years, because CETA can be
a private sector program as well. There is an amendment in the law
which I got the committee to make to that very effect.
The fact that it is not has resulted from the mind fix of the program
sponsors over the years without an attempt even to look outside of
the public sector effects of CETA as it was originally written.
I just hope you go back and try to get some of the administration
thinking on CETA focused on the private sector.
Mr. SCHULTZE. May I respond?
I accept the rebuke. You are quite right. One of the elements of the
private sector program is within CETA, and I don't want to leave the
impression that one cannot use CETA in that direction.
You are quite right, Senator.
Senator MCCLURE. I appreciate that. It is there, it isn't being
used, and I think it could be used.
Mr. Schultze, I know every administration tries to paint a picture rosier than it is, and an administration that has been in just 2
years is going to point to all the good things that have happened within
the last 2 years and all the bad things that have happened, that either
happened before that, or their roots before that, so that is not new to
this administration, and it isn't peculiar to the State of Georgia, but
I think it is part of the political process.
But if I read your figures and the analysis of the budget correctly
and what you project for the future, it doesn't fit with the reality of

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what we see in our economy. What we see in our economy does not
fit with what President Carter said in the state of the Union message,
when he said that incomes were rising.
That really covers up the true situation. The Government's own
figures on real inflation adjustments, spendable earnings after taxes,
show that workers on the average have 3 percent less than last year,
and are no better off than in 1965.
We have slipped back to 1965 earnings, and what is more, we are
still slipping. By the projections I see, in the budget analysis and in
your own statements, Federal spending in real terms will grow at 3.7
percent a year, but taxes in real terms will be up more than 7 percent
per year.
It would seem to me that it is obvious that the real spendable
income of the average American will continue to decline in real terms.
That is simply by way of saying that if the reductions in the expenditures were greater than are proposed, we might be able to lower taxes
and increase real spendable earnings.
Mr. ScHULTZE. Again, let me note several things.
First, the series you were using to describe earnings, is real weekly
earnings. There has been a steady downward trend in the number of
hours worked per week in this economy, about a half a percent a year.
That is partly because of longer vacations, partly because of more
part-time workers are in the economy. You have to be very careful
in using that series.
Real income per capita has been rising, but since productivity growth
has slowed down, much slower than in the past.
If one looks in the long-term future, into 1981, 1982, and 1983, and
calculates the ratio of taxes to GNP or taxes to income, that ratio will
rise, and as the President has indicated any number of times, one of
his objectives is to slow and hold the rate of growth in Federal spending to reduce the share of Federal spending in GNP so that as appropriate, depending on the economic circumstances, you can continue
to reduce taxes.
The other thing I have complained about, if you will, this morning,
is that I don't think that ought to be done by a mechanical formula,
but the strategy is clearly there.
Senator MCCLURE. In other words, you hope we can change that
by enactments of Congress and the initiatives of the administration
in the future, but it requires future action which is not programed?
Mr. SCHULTZE. Right, because of the inflation problem we are
facing now, we need to bring that under control.
Senator MCCLURE. Isn't the real objection to indexing tax rates
is that it is easier to cut taxes than it is to increase them, and if we
index the rates now, we might have to in the future increase some in
order to reduce others?
Mr. SCHULTZE. Increase others, or face an inflationary burst and
need to hold the economy down, one or the other or both.
Senator MCCLURE. The Congress could exercise discretion without
an index system, except that they are playing not with money, or
taxes, already levied, and, therefore, being able to reduce them, but
they would also have to inflict pain at the same time.
Mr. SCHULTZE. First, it takes time, and, second, it is much more
difficult, and as I say, you have ipn effect given away some of the automatic stabilizing features of the system.

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Senator MCCLURE. One final question, if I may, Mr. Chairman.
Senator Bentsen had earlier outlined some possible alternatives that
might stimulate investment productivity.
One of the things that was not covered in his list of three things was
a method by which we might encourage savings in order to encourage
the formation of capital which would then be more freely and readily
available for investment.
We have the most highly consumptive society in the world. One of
the reasons we have that highly consumptive society is that our taxing
and spending system, and particularly the taxing system, encourage
spending. They reward spending and debt, and penalize saving and
investment.
Would it be a useful thing to make the tax system either reversed,
or more neutral in the individual's choice of whether he should save
money or spend it?
Mr. SCHULTZE. Senator McClure, my own judgment would be that
as you look down the years at the opportunities in reducing taxes
and at the need to increase investment, one should pay most attention, certainly initially, toward incentives to stimulate investment.
I believe the savings are there if the investment demands were there.
Ultimately, as you go down the road, I don't know, but it seems to
me that the investmentSenator MCCLURE. I assume your conclusion is that the high
interest rates everyday are inflation-related?
Mr. SCHULTZE. Principally, that is correct.
Senator MCCLURE. They are a measure of inflation or the expectation of inflation, rather than any imbalance between supply and
demand in investment capital?
Mr. SCHULTZE. I think essentially, and I might want to quibble
around the edges of that, but it is principally inflation, correct.
Senator BENTSEN. Congressman Brown.
Representative BROWN. Thank you, Mr. Chairman.
Mr. Schultze, I want to go back to an area of agreement on the
question that Congressman Hamilton asked you.
In your prepared statement you have the sentence:
As the overall unemployment rate declines, demand for skilled,
workers exceeds supply of those workers, and puts upward pressureprime-age
on
wages, even though unemployment among minorities, teenagers and women their
may
remain unacceptability high.

That seems to me a pretty good argument for increases in training
in the private sector that would enhance the skills of minorities,
teenagers and women in productive jobs in the private sector.
The major exceptions to the CETA intention of providing jobs in
the public sector seem to me to be title VII and the targeted jobs program, which has a low budget in 1979 compared to the whole CETA
budget in 1979.
When you said earlier that you want to make modifications into
the CETA programs, do you read into that that you intend to move
more into the private sector for job creation? Because it would seem
to deal with both of these problems.
Mr. SCHULTZE. I understand that. We now have just underway two
important programs in the private sector, one on the tax side and one
of the expenditure side, and I think we have to see how those work out

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before we move ahead, but it seems in the long run we do have to
have private placement of the disadvantaged.
Let me note significant parts
Representative BROWN. When you say, "placement," you mean
training as well?
Mr. SCHULTZE. What I meant is that you look to the private sector
to absord the structural unemployment.
Let me also note, even though I cannot give numbers, the important
part of the youth moneys in CETA do go toward experience and training programs in which the private sector is closely related.
I cannot give you a breakdown on that, but part of the money in
that program is in that general direction.
Representative BROWN. I had the occasion the other day to talk
to a young man who had been trained in the CETA program as a
fireman, and, unfortunately, they ran out of positions before they
hired him.
He asked me where he would go to get a fireman's job. He was
trained for a public job, and unless he went to a private firm that had
a need for a fireman, the opportunities were limited.
Let me be somewhat more contentious. I agree with you that we
need to look to investment, and it seems to me that investment comes
from increased savings, and I have a bill in, and I think Senator
McClure has a similar bill in the Senate, to encourage, by a tax credit,
the increase in savings by private Americans.
It would move us toward the individual savings rates of the Germans, which is three times as high as ours on an individual basis, or
the Japanese, which is something like five times ours.
You talk a good game, but when we talk about cutting taxes, and
social.security taxes, and the administration is opposed to rolling that
back, and the administration is opposed to a general cut in income
taxes, at least as proposed by some of those on our side of the aisle.
In the depreciation area that I discussed with you, there is legislation
put in by Representative Stockman to do something about that problem. I understand that administration opposes that. The instant writeoff of pollution control equipment; to reduce that, and also to compensate for health and safety spending, I am told the administration
opposed that.
Senator Javits had a proposal last year to cut corporate tax rates
by 40 percent. The administration opposes that. Representative
Steiger and Representative Archer proposed a cut in capital gains
taxes and that was opposed by the administration. Also, you abandoned your support of reducing that tax on dividends.
I am concerned about what the formula is that the administration
will support, because that seems to me to cover a rather broad range,
depreciation, capital gains, personal income taxes, savings, and so
forth.
What is the area that the administration is going to support that will
encourage savings and investment and reward rather than tax the
money that goes into that.

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The talk is good, but the results don't seem to be terribly impressive.
Mr. SCHULTZE. Let's expand on this.
The administration proposed last year a deeper cut in corporate
taxes than the Congress would accept.
The administration proposed a reduction in the capital gains tax
structure and the Congress turned that down.
The administration proposed last year an investment-related package which was larger than it ever was in terms of the split in the tax
cut. In the immediate year ahead, we are facing the problem of the
strained budget, and bringing inflation under control. As I indicated,
over the years, as will clearly be the case, we should move toward
further tax reductions. There are any number of options out of which
one can pick the ones between the administration and the Congress
after we debate the ones that we think are the most effective for increasing investment.
The mere fact of increasing the whole range of things, if you added
up the budgetary costs of the whole range of things, the costs are
incredible. As we go down the pike in future years, there will be others.
This year is not the time for it, but there will be a time.
Representative BROWN. Someday, but not now?
Mr. SCHULTZE. That is correct, just as we said on expenditures.
Senator BENTSEN. Senator Javits.
Senator JAVITS. Thank you.
Mr. Chairman, I apologize for being so late, but I had to go to
New York to join in a tribute to my political colleague, Nelson
Rockefeller. But I did rush back to have a word with you, Mr. Schultze.
I understand you had an interesting exchange with Senator McClure
on productivity, Which you know has been a concern of mine.
I am interested in a study made by the New York Stock Exchange
entitled "Reaching a Higher Standard of Living," because it exposes
a thesis on which I would like you to comment, but knowing me as
you do, you will appreciate my saying that I really don't require your
comment off the top of your head.
I think this requires study and thought, and if you agree, please
tell me, and we will wait until you can think it out.
The theory is this: The administration said when it published the
Economic Report, that if productivity remains in the cellar, as it is now
in the United States, it is likely that the Nation's standard of living is
likely to improve only very slowly for some years.
Now, the real thesis of the stock exchange study is that not only
will productivity not improve, it will deteriorate, notwithstanding
that we may remain flat and stagnant. That is the theme.
That is what I would like the comment on. I think it is important.
I will put this study in, Mr. Chairman. It is quite extensive, but I
really think it is quite worthwhile.
Senator BENTSEN. I have a copy of it, and I quite agree.
Senator JAVITS. May I put it in the record?
Senator BENTSEN. Yes.
(The study follows:]

138

REACHING
A HIGHER STANDARD
OF LIVING

THENew York Stock

Exchange
OFFICE OF ECONOMIC RESEARCH

139
Table of Contents
REACHING A HIGHER STANDARD OF LIVING
Page
Preface......................................................................
i
Summary and Conclusions . ...................................................
1
Productivity and Economic Growth ..............
............................
6
Sources of the Productivity Slowdown ............
............................... 14
Effects of Productivity on the Inflation Process ...................................
21
Policies to Promote a Higher Standard of Living .................................. 28
APPENDIX l:

Growth in Output per Employee-Hour in Selected Industries,
1971-76 ......................................................

APPENDIX II:

Shares of Output Growth, 1947-1977
Employment and Unemployment Estimates, 1978-1990 .....

APPENDIX III: Sources of Growth in Real Gross Product ......
APPENDIX IV: Sources of Inflation in Recent Years .......

37
.......

38

.................. 39
...................... 40

BIBLIOGRAPHY.............................................................

41

TABLES
1. Man-hours, Productivity and Output .
.........................................
2. Productivity in Manufacturing, 1960-1976 ........
............................
3. Sources of Productivity Growth, 1948-1977 .......
...........................
4. Factor and Labor Productivity, 1948-1977 ........
............................
5. Changes in Wages, Productivity, Unit Labor Costs
and Consumer Prices, 1955-1977 ..........
................................

10
11
16
19
24

CHARTS
1. Productivity Growth ...........................................
2. Effects of Declining Productivity on Economic Growth
Unemployment, and Inflation . ...........................................
3. Changes in Wages, Productivity, and Unit Labor Costs ........................
4. Changes in Unit Labor Costs and Inflation . ..................................
5. Sources of Output ...........................................
6. Growth in Output, Productivity, and Manhours, 1947-1977 ......................
7. Effects of GNP Growth Rates on 1990 Incomes ...............................
8. Factors Contributing to the Decline in
Productivity Growth, 1973-77 vs. 1948-66 .................................
e Copyright New York Stock Exchange, Inc. 1979

2
3
3
4
8
9
12
15

"The whole of this report or any portion thereof may be reproduced, without change, however, and
provided that New York Stock Exchange, Inc. is expressly given credit for authorship thereof."

140
PREFACE
Why has the New York Stock Exchange undertaken a study of the economic forces that
have powered America's standard of living? It is because we share in the national concern
over the lackluster performance of our economy. Closer to home, both equity investments
and the securities industry do best when real economic growth is strong and inflation is under
control.
We hope that our analysis contributes to a better understanding of the reasons for inflation
and below-trend economic growth during the seventies, and that our suggestions prove
useful in the formulation of policies to get our economy onto a low-inflation, higher-growth
track.
For a decade, the real buying power of wages has remained virtually flat -apart from
cyclical ups and downs-despite large increases in money wages. Higher wages have
simply been gobbled up by higher prices. According to the U.S. Bureau of Labor Statistics,
private nonagricultural workers' pre-tax earnings averaged $190 per week in 1977, compared with just over $100 in 1967. But real earnings, after adjusting for inflation, were only
$2.50 per week higher than in 1967-an insignificant ¼of 1% average annual gain inbuying
power over the decade.
Even inperiodsof recessionthere has been little relief from severeprice inflation. Itused to
be assumed that inflation and recession were mutually exclusive but, in recent years, that
has changed. We have seen in 1969-1970 and 1974-1975, for example, how inflation can
persist when unemployment is rising and the economy stalls.
A decade of inflation has undermined most Americans' traditional confidence in the basic
strength of our economy. Available explanations do not satisfactorily describe the causes of
the acceleration of inflation in the face of decelerating real growth-or why living standards
have not improved in recent years.
Substantial improvement in real wages and the living standards they support is impossible
'without substantial gains in productivity. The formula is simple. Wage increases not supported by productivity gains are translated into higher prices which leave the wage earner
back where he started. Thus, a study of the basic economic forces that raise living standards
is necessarily a study of productivity. If we fail to improve productivity, our economy may be
further bedevilled by inflation, sluggish or nonexistent real growth, and a loss of competitiveness in international markets.
Unfortunately, the long-entrenched Keynesian economics has left productivity out of
economic analysis for several generations. Keynes was concerned with creating jobs. In the
midst of the Great Depression, nonproductive make-work jobs, even digging holes and filling
them up again, could be justified as better than none. Today, however, the challenge is to find
ways to place job seekers in jobs which provide an adequate supply of goods and services,
produced as efficiently as possible. Productivity has come of age.

141
To enlist the broad cooperation required to lift productivity growth, it is necessary to dispel
the widely held notion that equates productivity with faster assembly lines and greater
human exertion. One need not look too far back in economic history to appreciate the fact
that productivity gains have come about largely from more modern plant and equipment,
more efficient production processes, and better management. The historic increases in both
leisure time and purchasing power of workers are testaments to the benefits of productivity.
We believe that our study can contribute toward a solution to the riddle of persistent
inflation. We have developed a theory of how declining productivity gains can send inflation
spiraling upward despite slow economic growth and how accelerating productivity gains can
help unwind inflation. Naturally, this is not meant to imply that productivity gains alone can,
eliminate inflation. Indeed, only if monetary and fiscal policies are effective can productivityI
help in conquering inflation.
Since productivity improvements depend heavily on utilizing more modern plant and
equipment and incorporating new technology into new productive facilities, a major remedy
for sluggish productivity gains should be obvious: an upsurge in capital formation to finance
new plant and equipment and technological improvements. Suggestions for stimulating
capital formation and other ways of improving productivity are discussed in the closing
chapter of this study.
The study was completed under the supervision of Dr. William C. Freund, Senior Vice
President and Chief Economist of the Exchange. New estimates by Professor John W.
Kendrick of George Washington University of the factors underlying the productivity slowdown in recent years appear for the first time in this study. We deeply appreciate his
contribution. We also gratefully acknowledge the important contributions of Ira Gelb and Mel
Colchamiro, NYSE staff economists; the helpful overall suggestions of Dr. Edward F Denison of the Brookings Institution; of Dr. Lawrence R. Klein of the University of Pennsylvania:
and the guidance on selected parts by Dr. Albert Rees of the National Bureau of Economic
Research and Professor Richard E. Quandt of Princeton University. We also acknowledge
the considerable assistance of a number of prominent business economists. Of course, the
Exchange assumes full responsibility for any errors or omissions.

William M. Batten, Chairman
New York Stock Exchange

-i-

46-126 0

- 79 -

10

142
SUMMARY AND CONCLUSIONS
"When I use a word it means just what I choose It to mean-neither more nor less" (Humpty Dumpty
to Alice in "Through the Looking Glass")

Unfortunately, the true meaning of productivity and productivity advances is sometimes
misunderstood. Too often those terms conjure up images of sweatshops and speeded-up
assembly lines. The truth of the matter is that greater physical effort is but a tiny part of what
makes productivity increase. Productivity increases when:
People are better trained, educated and motivated;
People have better working environments;
People are in better health;
People have more efficient machinery and equipment to work with;
People develop new products and technology;
People shift from working in less efficient industries to working in more efficient industries;
* People manage more effectively.

*
*
*
*
*
*

In short, productivity increases primarily when people work smarter and more efficiently.
Productivity growth is important to all Americans because it is a key factor in determining
improvements in living standards. It fuels economic expansion, provides for vigorous longrun growth in jobs, and, in a way little understood, restrains inflation.
Productivity gains have dropped nearly in half during the past decade, contributing both to
an escalation of inflation and a slower rate of economic growth.
The decline in productivity is a long-run problem which cannot be overcome by short-run
solutions. Current inflation took time to wind up and it will take time to decelerate. Productivity
can play a key role in that process, as this study shows.
Productivity and Economic Growth
There are but two sources of long-run real economic growth, labor input and productivity:
Labor input (man-hours)
+ Productivity
= Real Economic Growth

-1-

143
A realistic goal for the decade of the 1980s isa real economic growth rate of 4% per year; any
higher rate would fuel inflation. But a 4% growth rate can be achieved only if productivity
grows 3% per year, since man-hours will increase no more than 1% per year:
If man-hours grow
Productivity must grow

1%
3

To achieve desired growth of

4%

If the 4% annual growth rate is achieved by the end of the 1980s:
* 16 million additional jobs can be created.
* Real per capita income will grow by 48% and reach $10,500 (1977 dollars).
* Average family income will rise by 32% and reach $27,000 (1977 dollars).
In short, a 4% real growth rate inthe 1980s will raise America's living standards substantially.
Unfortunately, productivity growth has declined to only 1.8% per year in the last decade, or
about half of what it was in the two decades earlier.
CHART 1
PRODUCTIVITY GROWTH
(Average Annual Percent Increases)

3.3%

19471967

19671977

The decline in productivity has contributed to slower real economic growth, higher un-2-

144
employment and more inflation, as can be seen below.
CHART 2

Productivity and Inflation
Though prudent monetary and fiscal policy remain critical weapons against inflation and
cannot be supplanted by alternative policies, productivity growth remains a strong influence
on the rate of price increases. Productivity gains offset wage increases and thereby help
check unit labor cost rises.....
CHART 3

-3.

145
... and unit labor cost increases are a key factor in determining inflation.
CHART 4

Moreover, as this New York Stock Exchange study shows, productivity gains often have
unrecognized "multiplier" effects on inflation and, as a result, are a more potent weapon
against inflation than is generally assumed:
* Declining productivity growth can accelerate inflation over time.
* Rising productivity growth can help unwind inflation over time.
For example, a 1% increase in productivity growth can produce a decrease of several
percentage points in the rate of inflation over time.
Sources of the Productivity Slowdown
New data prepared by Professor John W. Kendrick indicating the sources of the recent
slowdown in productivity gains appear for the first time in this study. The primary factors are:
* A slowdown in capital spending for
- research and development programs
- new plant and equipment.
* Increased negative impact of government regulation.
* Increased impediments to capital and labor mobility.
* Slower output growth.
-4.

146
Policies to Promote a Higher Standard of Living
It is essential to reverse this slowdown if we are to come close to achieving the key national
objectives of:
* Promoting a higher standard of living.
* Creating a sufficient number of jobs.
* Restraining price inflation.
The following set of economic goals would help achieve these objectives:
* Increase annual real growth in GNP to 4%. To achieve this will require
* Raising annual productivity growth to 3%. This, in turn, depends primarily on
* Increasing the GNP share of business investment by at least 2 percentage points-from
10% to 12%.
These goals can be achieved if labor, management and government all give urgent priority
to increasifgpr9odct~ty growth. To this end, the following policies should be considered:
Develop a national commitment to productivity improvement.
Adopt measures to encourage saving and risk-taking.
Implement programs to increase business capital spending.
Create incentives to spur research and development.
Relax unnecessary government regulation and other restrictive practices which add to
business costs and inflation.
* Improve education and training; put greater emphasis on on-the-job training.
* Establish policies to better match job vacancies and job seekers.
* Promote economic stability.

*
*
*
*
*

A coordinated national effort to boost productivity growth to at least 3% per annum would
go a long way toward unwinding inflation, raising living standards, and creating jobs. It would
also make American goods more competitive internationally and help strengthen the dollar.
These are objectives in which every American has a stake.

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147
PRODUCTIVITY AND ECONOMIC GROWTH
Introduction
"I believe In materialism. I believe In all the proceeds of a healthy
materialism-good cooking, dry houses, dry feet, sewers, drain pipes, hot
water, baths, electric lights, automobiles, good roads, bright streets, long
vacations, new Ideas, fast horses, swift conversation, theatres, operas,
orchestras, bands-I believe In them all for everybody. The man who dies
without knowing these things may be as exquisite as a saint, and as rich as a
poet; but It Is In spite of, not because of, his deprivation."'

Francis Hackett wrote these words in the beginning of this century. At the time, the United
States was already embarked on the greatest advance in material well-being that the world
had ever seen. Advances since World War II have been particularly dramatic. For example:
* Real per capita income almost doubled between 1947 and 1977.2
* The number of U.S. job holders increased by 59% between 1947 and 1977, to a total of
-over 90 million.
* The average American's life expectancy has increased by five years since 1950.
* The percentage of U.S. families with incomes below the poverty level was almost halved
between 1959 and 1976, declining from 18% to under 10%.
* The percentage of U.S. households with at least one room air conditioner more than
tripled, from 17% in 1960 to 55% in 1977.
* 98% of U.S. households have television sets today, compared with only 9% in 1950;
79% have color TV., compared with 4% a decade ago.
If the U.S. is to continue to benefit from the proceeds of materialism, then our economy
must grow. We do not mean to imply that economic growth has no undesirable side effects.
One has been a decline inthe quality of the environment. The Environmental Quality Indexdeveloped by the National Wildlife Federation - indicates that the overall quality of the
environment worsened by some 10% between 1969 and 1977. Yet, paradoxically, future
economic growth is necessary if we are to have sufficient economic resources to eliminate
the effects of past pollution while maintaining our high living standard.

1 Francis Hacken. Ireland, chedby Paul . Samueison. Economics, tenth edition, 1976. page 759
2 Real per capita income (personal income in 1977 dollars. divided by population) rose from $3,740 In 1947 to $7.053 In 1977.

-6-

148
The Meaning of Productivity
Productivity has been the overwhelming force behind advances in our material well-being.
Essentially, productivity measures how much is produced, on average, per hour worked; it
relates the amount of output-in terms of goods and services-to the number of hours of
labor input. But speeding up the assembly-line is not the only way to promote productivity. In
fact, if people become bored, or tired, or dissatisfied with working conditions, a faster
assembly-line may promote inefficiency and reduce, rather than increase, their output. Many
other factors are involved. Productivity increases when:
People
People
People
People
People
People
tries;
* People
*
*
*
*
*
*

are better trained, educated and motivated;
have better working environments;
are in better health;
have more efficient machinery and equipment to work with;
develop new products and technology;
shift from working in less efficient industries to working in more efficient indusmanage more effectively.

In short, productivity increases not only when people work harder-but when they work
smarter and more efficiently. People produce more when they have better tools, better
production techniques and are better-organized and managed.
Sources of Output
Simply put, man-hours worked, and the degree of efficiency with which they are combined
with other productive factors, determine the volume of output. Many factors affect the
number of man-hours including, for example, population size and characteristics, labor force
participation rates, labor-leisure preferences, and a host of social factors. Technology,
education levels, labor market efficiencies and the quantity and quality of production facilities
all help determine productivity levels and growth.
The schematic diagram below, prepared by the Federal Reserve Bank of St. Louis, depicts
the key factors determining labor input (man-hours) and productivity. As the diagram shows,
the interaction of labor input and productivity of that labor are the ultimate sources of growth.

-7-

149
CHART 5

Determination of Potential Output

Rif
SOIAtL~

1111ti1F'R
I L1

j

Do Stt-Be;2,S,;

~LOY4E!
C~tlil

i==1-'::;"" i11''

j4 ,.',5
4Ad

A-,'i? ium ADJUSTI
A

Source: Roger W. Spencer,
"Population, theLabor Force,and Potential Output: trpfOcations
forthe St. Louis Mod~el."
Federal
Reserve Bank of St. Louis Revew.w
February 1971,page18.

The following simple equation summarizes the factors that determine
the total output of
the economy and provides a framework for estimating the relative
importance of the two
basic components of growth-man-hours and productivity:
;
~~~Total Output = Man-hours x
Average output Per Man-hour (Productivity)
Man-hours are determined by the level of employment, the length of the
average workweek
and the average number of weeks worked each year.
The crucial role that productivity has played inthe growth of our economy
since the end of
World War II can be seen by comparing the trends in the Labor Department
indexes of real
output, hours worked and productivity. Between 1947 and 1977, real output
increased at an
-8-

150
CHART 6

GROWTH IN OUTPUT, PRODUCTIVITY AND MANHOURS
(1947=100)

INDEX

300

GROWTH IN
OUTPUT
(Reol GNP]

275
250
225
200-

150

SECTOR
BUSINESS
PRIVATE

GROWTH IN
MANHOURS

-

125
100

GROWTH IN
PRODUCTIVITY

-~

175

X
i

55

-|
0*
60

_
65

70

75

77

SOURCE: Bureau of Labor Statistics: New York Stock Exchange
SOURCE: Bureau of Labor Statistics; New York Stock Exchange

3
average annual rate of 3.5%. Over the same period productivity grew 2.8% per year, while
man-hours advanced by only 0.7% per year.
Wide disparities in rates of productivity growth exist among industries. While an industryby-industry analysis oflproductivity is beyond the scope of the present study, the chart
presented in Appendix I illustrates some significant differences.

Recent Trends In Productivity and Output
Through the late 1960s, productivity in the United States accounted for almost 8/10 of
4
each percentage point of output growth while man-hours accounted for but 2/10. More
afactors
3 t should benoted that the Labor Departmert output per men-hour measure used heremeasures the contribution ot
of production (including labor. capital and natural resources) In raising output per-hour worked.
4 These estimates are very close to those of Dr. Edward Denison. His study of the sources of growth In the U.S. economy
indicates that total factor productivity as used here has accounted for approxlmately V. of the growth In national Income
between the years 1929.1969.
See Edward F.Denison, Accounting for United States Economic Growth 1929-1989, The Brookingstnstitutlon. 1974, pages
124-149 especially Table 9-5 on page 128. Data in Table 9-5, If regrouped to approximate the overall productivity measure
used here. confirms the Exchange's indings.

151
recently, however, the proportions of output growth attributable to productivity have declined
substantially (see Appendix II).
This shift has occurred because productivity gains have slowed while gains in man-hours
have accelerated. The following table shows how the output slowdown during 1967-1977 is
directly related to the drop in productivity gains; the increase in man-hours merely prevented
a more precipitous decline in output.
TABLE 1
Man-hours, Productivity and Output
(Private Business Sector)5
Man-hours
Productivity
Output.
-Average Annual Percent Increases1947-1967
.1947-1957
1957-1967
1967-1977

0.4%
0.2
0.6
1.2

+
+
+
+

3.3%
3.3
3.3
1.8

.

=
=
=
=

3.7%
3.5
3.9
3.0

Source: Bureau of Labor Statistics.

U.S. productivity growth has lagged behind that of other industrialized countries. The next
table shows that output per man-hour in manufacturing increased mrore slowly in the United
States than in any of the 11 other major industrialized nations during 1960-1976. In part, this
reflects the fact that other countries' productivity levels remain well below U.S. levels, so
there is greater room for improvement. Nevertheless, the fact remains that U.S. productivity
gains have fallen sharply since the 1960s.6 Productivity growth in six countries accelerated
after 1966, while the 45% decline in the U.S. was far greater than in any of the other
countries. It would be one thing if the poor U.S. track record were just part of a world-wide
slowdown. It is quite another when we lag seriously behind the rest of the world.
5 Changes In man-hours plus changes in productivity equal changes In output.
More precisely, man-hours multiplied by productivity equals output. Little accuracy Is sacrificed by adding
rates of change
here, because of the small magnitude of ihe percent changes.
6 A full discussion of the sources of this decline begins on page 14.

-10-

152
TABLE 2
Productivity In Manufacturing, 1960-76
(Average Annual Percent Change)

% Change
1966-76 vs.
1960-66

1960-76

1960-66

1966-76

United States
United Kingdom
Canada
Switzerland
France
Sweden
Italy

2.9%
3.3
3.8
4.3
5.7
5.7
5.8

4.0%
3.7
4.3
2.9
5.5
6.5
6.7

2.2%
3.1
3.5
5.1
5.8
5.2
5.3

-45%
-16
-19
+76
+ 5
-20
-21

Germany

5.9

6.0

5.8

- 3

Netherlands
Belgiumr
Denmark
Japan

6.7
6.8
7.0
8.9

5.6
5.0
5.4
8.8

7.4
8.1
8.0
8.9

+32
+62
+48
+ 1

Country

'1960-1975.
Note: Data for 1976 are preliminary estimates.
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Economic Growth, Productivity and Jobs In the 1980s
The prospect for continuing sluggish productivity gains does not augur well for U.S.
economic growth in the 1980s.
Output grew rapidly during 1967-1977 only because man-hours increased at an extraordinary pace. After increasing 0.4% per year during 1947-1967, man-hour increases accelerated to 1.2% per year during 1967-1977. if man-hours had grown only as fast as in the
1947-1967 period, output would have been 6% lower than it actually was. Between 1980 and
1990, growth in total man-hours is unlikely to exceed 1%per year for two reasons. First, the
number of new entrants into the labor force is expected to decrease; second, the slow
long-run downward trend in the length of the average workweek is likely to continue.' Given
the impending slowdown in additions to man-hours, productivity gains will have to exceed
7 Average workweek. totat private nonagricultural sector:
1967 - 38.0 hours
1947 - 40.3 hours
1977 - 36.1
1957- 38.8
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153
those of the past 10 yearsmerelyto equal the sluggish outputgrowth ofthepast decade. If
output is to regain the 4%annual 1957-1967 rate of increase, then productivity must increase
much more quickly.8 The arithmetic is as follows:
If man-hours are
expected to
increase by

+

+
+

1%
1%

then productivity
will have to
increase by
2%
3%

=

for output to
increase by

=
=

3%
4%

A 1% annual change in output may not seem like very much; but, over a period of years, it
means a significant difference in living standards. Had real GNP growth continued at 4%per
year during 1968-1977, for example, real GNP would have risen to $2,120 million (in 1977
dollars)-12% and $233 billion higher than the actual 1977 level. Per capita income would
have been almost $9,800 (in 1977 dollars) in 1977, or roughly $1,100 more for every man,
woman and child in America.
A4% real growth rateinthefuturewould also mean substantial increases inreal per capita
and household incomes. Real per capita income (in 1977 dollars) would rise from $7,050 in
1977 to $10,460 by 1990, a jump of 48%. Real household income (in1977 dollars) would rise
from $20,470 in 1977 to $27,000 in 1990, a gain of 32%.
CHART 7
HOW GNP GROWTH RATES IN THE 1980'S WILL
AFFECT 1990 INCOMES
Per Capita Income*

Average Family Income'

If GNP Growth Rate Is:

If GNP Growth Rate Is:

4%

2%

$8,130

3%

$9,230

4%

I

2%

$10,470

$21,000

* 1977 Dollars

-12-

-

3x

$23,820

$27,000

154
*

.

.

*

These numbers tell us how Americans can benefit from additions to the output of goods
and services-both in terms of job opportunities and Francis Hackett's "healthy materialism"
-if productivity improves and real growth in the 1980s is strong. But if productivity growth
continues to lag, what will be the impact on the quality of life in America?
* Long-run additions to the output of goods and services will remain sluggish.
* Inflation will be fueled.
* Job creation will slow, making it more difficult for those who have traditionally been hard
hit by economic recessions and slowdowns - teenagers, women, minorities - to
participate successfully in the work force. It is an unfortunate fact of economic life that
these workers are the first to be fired and the last to be rehired.
* Fewer new job opportunities and a low growth rate would make alleviation of social
problems more difficult. With less new output to be distributed, each economic group
would have to strive harder to better its position. Tensions between competing economic
groups would be aggravated as each group's expectations could be realized only at the
expense of other groups.
* By inflating costs, sluggish productivity will make U.S. goods less competitive in world
markets, adversely affecting the nation's trade balance and the international value of the
dollar. Foreign travel and foreign goods will be much more expensive, further cranking
the upward spiral of domestic inflation.
In short, when gains in productivity and output growth decline-or worse, disappear-the
quality of American life suffers. The impact ranges from individual economic hardship to
heightened social tensions. As each group fights to maintain its piece of the economic pie,
the latent tensions in society surface. Thus, a slow or no-growth economy tends to foster a
more divisive and contentious society.
If we are to improve, rather than diminish, the over-all quality of life in America, the nation
must pledge its collective will to the goal of balanced, non-inflationary economic growth.
in
8 A 4% growth rate fueled by a 3% rise in productivity and a 1% rise in man-hours can produce a substantial increase in jobs
and productivity gains are, after
the coming decade if aggregate demand is strong enough to accommodate them. Man-hours
following
all, supply variables and define whatmay be, not will be, attained. The extent oi the increase Is demonstrated by the
relatlonship:
Change In Workweek
Change In Man-hours - %
Change in Employment - %
%
the private
Assuming a 0.3% annual dedine in the length of the average workweek, In line with the 1947-1977 experience in
nonagricultural sector. the change in employment can be estimated as tollows:
%A Empi. = %a man-hours - %A workweek
%A Empi. = 1% - (-0.3%)
%A Empi. = 1.3%
an
Thus, employment can increase by 1.3% per year on average and could mean 16 mitnionaddtional jobs by 1990-or
This
in Appendix 11.)
average unemployment rate of 5.0% over the decade of the 1980s. (Year-by-year changes are shown
1978-1984 and 0.9% per year 1985.1990).
assumes the BLS projected Increases in the labor force (1.3% per year

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155
SOURCES OF THE PRODUCTIVITY SLOWDOWN
(The material in this section draws from a detailed paper specially prepared
for this
study by Professor John W. Kendrick, of George Washington University, which
is
available on requests)
The rate of productivity growth has slowed perceptibly over the past decade,
especially in
the last five years. Professor John W.Kendrick has developed data tracing the
sources of this
slowdown.10 These data cover three periods: 1948-1966, 1966-1973, and 1973-1977.
The
data for 1973-1977 appear for the first time in this study.
Professor Kendrick's data indicate that over-all productivity growth slowed
from an average annual rate of 2.7% during 1948-1966 to 1.6% during 1966-1973 and to
0.7% during
1973-19.77. This deQline-from 2.7% to 0.7%-was caused primarily by slowdowns
in the
rate of technological progress, reduced capital and labor mobility, and
by declines in
economic growth associated with the 1974-1975 recession. These and other
factors are
summarized in the chart on page 15 and the table on page 19-.
It should be noted that the data analyzed by Professor Kendrick represent
total factor
productivity; that is, the efficiency of labor and capital inputs. The way these
inputs are
combined provides the link between factor productivity and the more-familiar labor
productivity concept. This appears at the end of this section.
Sources of the Productivity Slowdown
Technological Progress -The most important source of productivity
growth is the
application of new technology to the production of goods and services. More
than half of the
net productivity growth during 1948-1977 is attributable to technological advances.
Technological progress historically has been fueled by capital outlays for formal
research
and development (R&D) programs. These expenditures had steadily increased
to 3.0% of
GNP by the mid-1 960s, but subsequently declined, to 2.2% of GNP, by 1977.
" As a result,
the growth of the real stock of technological knowledge has decelerated in the
past decade.
The purchase of new capital equipment also significantly affects technological
progress.
Since capital goods produced each year embody the latest technological advances,
capital
9 Address requests to: Or. Wiltiam C. Freund. Office of Economic Research:
New York Stock Exchange. Inc.: I1 Wall Street.
New York, New York 10005.
10 The estimates are confined to the U.S. domestic business economy, which
accounts for about 85% of GNP,since output and
productivity measures are not available for the public and household
sectors.
Professor Kendrick's more detailed table appears in Appendix Ill.
11 Nonetheless, real R&D expenditures (1972 dollars) have risen from
$20 billion in 1960 to 526 billion in 1970 and to $29
billion in 1977.
-14.

156
CHART 8
FACTORS CONTRIBUTING TO THE DECLINE IN
AVERAGE ANNUAL PRODUCTIVITY GROWTH
-1973-1977 vs. 1948-1966
Total annual decline:
1
2
-2.2 percentage points'

in 1948-1966 toO .7% in 1973-1977. This reflects
12 The actual decine in total factor produCtivitywas 2.0% per year-from 2.7%
gain due to accelerated increases In tabor
the netting of the dedines shown above against a modest 0.2 percentage point
quality plus 'other" factors.
-15-

157
TABLE 3
Sources of Productivity Growth 1948-1977
(U.S. Domestic Business Economy)

1948-1966 1966-1973 197 3-19 77p
(a)
(b)
(c)
(Percentage Point Contribution
to Growth Rate)
Technological Progress
1.4%
+ Changes in Labor Quality
0.6
+ Changes in Quality
of Land
0.0
+ Capital and Labor
* Mobility
0.8
+ Changes in Output
Growth
0.4
+ Net Government Impact
0.0
+ Other N.E.C.
-0.5

1.1%
0.4

0.8%
0.7

2.7%

-0.5%
+0.12.

-0.2

-0.1

-0.2

0.7

0.3

-0.1

-0.5

0.2
-0.1
-0.6

-0.3
-0.3
-0.4

-0.2
-0.1
-0.1

-0.7
-0.3

1.6%

0.7%

p = preliminary
N.E.C. = Not Elsewhere Classified.
Source: Professor John W. Kendrick, George Washington University.

-16-

46-126 0 - 79 - 11

-0.3%
-0.2

-0.1

Average Annual Rate of Growth
= Total Factor Productivity

Change Between Periods
1966-1973
1973-1977
vs
vs
1948-1966
1948-1966
(a)- (b)
(a) - (C)
(Percentage Point Contribution
to Change in Growth Rate)

+0.1

Change in
Average Annual Rate of Growth
-1.
1

-2.0

158
spending tends to spread cost-reducing technology throughout the economy, reflected in a
lowering of the average age of capital goods employed inthe U.S. economy. Between 1948
aid1 966, the average age of the capital stock decreased by about three years. However,
during 1966-1973, the decline slowed to one year and between 1973 and 1977 there was
virtually no change.
Informal inventive and innovative activity, including a myriad of small technological improvements devised by plant managers and workers, also help improve total technological
knowledge. Professor Kendrick's data indicate no significant falloff in this area.
The cumulative changes in the various forms of technical progress-highlighted by the
slowdown in R&D spending and capital formation - resulted in a very significant 0.5
percentage point decline in the average annual rate of productivity growth during 1973-1977,
relative to 1948-1966. In other words, slower technological progress accounted for approximately 25% of the slowdown in productivity growth.
Changes in Labor Quality -This major category was the only one to increase its
contribution to productivity growth in 1973-1977 (0.7 percentage points per year) versus
1948-1966 (0.6 points per year), as can be seen in table 3 on page 16. Three factors education and training; health and safety; and the age-sex composition of the labor forcedetermine such changes in labor force quality.
Education and training is by far the most important determinant of labor force quality. In
fact, Professor Kendrick's data indicate that education and training accounted for all of the
upgrading of labor quality during both 1948-1966 and 1973-1977.
The average health and safety of workers has continued to improve slightly, resulting in
reductions in time lost due to illness and accident, and increases in potential working life.
These improvements have annually contributed a constant 0.1 percentage point to productivity growth over the full 1948-1977 period.
Changes in the age-sex composition of the labor force became a significant negative
factor by the mid-1960s, when the proportion of youth in the labor force increased (reflecting
the baby boom after World War II), and accelerating numbers of women began entering the
labor force. Since these groups have traditionally been less experienced and less well
trained, their increased representation in the labor force temporarily reduced the over-all
efficiency of labor, offsetting increased productivity in other areas. Thus, changes in the
age-sex composition of the labor force are estimated to have reduced productivity by 0.4
percentage points during 1966-1973, compared with only 0.1 percentage point during
1948-1966. By 1973-1977, the earlier entrants to the labor force had gained experience and
training on the job while the influx of additional teenagers slowed. Thus, the age-sex
composition in the latter period is virtually neutral with respect to productivity and is no longer
a significant factor explaining its decline.

-17-

159
Labor and Capital Mobility-Productivity is affected by how quickly and
efficiently labor
and capital are reallocated among industries and geographic areas in response
to continually changing supply and demand conditions. Inefficient allocations usually
result from
restrictive practices of firms and unions, government regulations, lack of knowledge
of where
opportunities may exist, and the sheer costs of movement.
Productivity improved significantly during 1948-1966, when less productive
farm labor
shifted to more productive non-farm jobs. However, farm-to-urban labor shifts
have become
a less significant source of productivity gains as the over-all proportion of
farm labor in the
economy has declined. With only 5%of the work force remaining in agriculture,
productivity
gains from a further shift are virtually exhausted.
There have also been relative shifts of capital (including land) from uses
with belowaverage rates of return to more productive uses. A recent study, using real
capital estimates
for over 50 industry groups, found that relative shifts added 0.4 percentage
points to growth
during 1948-1966, and somewhat more after 1966.'3 However, Professor
Kendrick estimates that this source actually had a negative impact on productivity
after 1973. In total,
capital and labor mobility account for 25% of the over-all decline in
productivity gains
between the 1948-1966 and 1973-1977 periods.
Slowed Output Growth - The recession of 1974-1975 sharply depressed
output,
significantly contributing to the decline of productivity gains. Productivity
growth also declined because of the loss of economies of scale as capacity utilization rates
dropped. On an
annual average basis, these factors slowed productivity by 0.3 percentage
points during
1973-1977, compared with a gain of 0.4 percentage points during
1948-1966. Over-all,
output-related factors accounted for more than one-third of the decline in
productivity gains
during 1973-1977.
Changes in Land Quality-Since the mid-1960s, productivity growth
has decelerated in
agriculture, while productivity actually declined in mining. The decline was
due in part to
capital expenditures for safety and other regulations. It also reflected some
decline in the
average quality of natural resources. These factors led to an average annual
0.2 percentage
point reduction in productivity during 1973-1977 relative to 1948-1966.
Net Government Impact-The proliferation of government rules and
regulations has
increased business costs and more than offset the positive contribution
to productivity from
such governmental infrastructure expenditures as roads. Incrementally, capital
expenditures
for compliance with environmental and occupational safety and health
regulations reduced
productivity growth by 0.3 percentage points during 1973-1977. Because any
improvements
in the natural and working environments associated with this spending cannot
be measured,
these expenditures necessarily lower measured productivity.
13 See Frank M. Goliop and Dale W. Jorgenson. U.S. Productivity
Growth by Industry, 1947-1973, In New Directions In
Productivity Measurement. (University of Chicago Press for ihe
National Bureau of Economic Research, In press).
-18-

160
The Role of Capital In Labor Productivity
As noted earlier, Professor Kendrick's data explained the sources of total factor productivity, that is, the efficiency of both capital and labor inputs. This measure of productivity can be
related to the more customary measurement-output per man-hour-by examining the role
capital plays in raising the productivity of labor inputs.
The usual measure of productivity - output per man-hour - measures more than the
actual performance of workers. It also reflects changes in all the various factors which help
make labor more productive. Although capital works side-by-side with labor to raise output
per man-hour, the role of capital is not identified in the customary Bureau of Labor Statistics
productivity data.
In general, the more capital associated with each man-hour of labor input (the so-called
capital/labor ratio), the greater output will be. A man using a steam shovel can dig and
displace more dirt per hour than if he used an ordinary garden spade and still more than it he
used only his hands.
Thus, to assess adequately the role of capital in raising output per man-hour we must have
some notion of the degree to which capital and labor are combined in the productive
processes. Professor Kendrick calls changes in this combination "capital/labor substitution"
or the "rate of substitution of capital for labor." A higher rate means more capital associated
with each hour of labor input and vice-versa. Professor Kendrick has estimated that capital
substitution improved labor productivity by 0.8 percentage points during 1948-1966. During

1966-1973, however, growth of the capital/labor ratio declined as the result of the bulge in
man-hours associated with the post-World War II baby boom, boosting labor productivity by
only 0.5 percentage points. As the increase in man-hours subsided, capital substitution
increased labor productivity by 0.7 percentage points during 1973-1977 .14
The two basic factors which contribute to labor productivity-the efficiency of labor and
capital and the mix of labor and capital inputs-are summarized below.
TABLE 4
1948-1966

1966-1973

1973-1977

(Average Annual Percent Change)

Factor Productivity (Efficiency
2.7%

1. 6%

0.7%

0.8

0.5

0.7

3.5%

of Labor and Capital)

2.1%

1.4%

Capital/Labor Substitution
(Mix of Capital to Labor Inputs)

Output Per Man-hour (Labor
Productivity

14 The Improvement Inthe capitalftabor substitution ratio in 1973-1977 raflects greater efficiency per unit of capItal. In absolute
terms, the amount of capital per person in the labor torce declined between 1974-75 and 1977.

-19-

161
*

*

*

*

*

Clearly, capital plays a crucial role in raising labor productivity.
Through R&D spending it
provides the wellspring for technological progress; capital
spending for new plant and
equipment spreads cost-reducing technology throughout
the economy and in combination
with labor inputs, makes labor more productive.
The data also show that many of the factors which fueled
productivity growth inthe pastthe shift of less productive farm labor to more productive
non-farm jobs, the high degree of
capital and labor mobility, the higher quality of land and
the less unfavorable net impact of
government regulation on business-cannot be expected
to provide the push for higher
rates of productivity growth in the coming decade.
Future gains inproductivity will have to come from continued
improvement in the age-sex
composition of the labor force, in the quality of labor and,
above all, from capital spending for
research and development programs and for new plant and
equipment. Naturally not much
can be done to influence the age-sex composition of
the labor force. But in areas of labor
quality and, especially, capital spending among others,
policymakers can indeed have a
powerful constructive impact on productivity and American
living standards.

-20-

162
EFFECTS OF PRODUCTIVITY ON THE INFLATION PROCESS
Some Fundamentals of Inflation
America's continuing problem with inflation reflects a disparity between ambitious social
goals and relatively limited economic resources. We have sought to achieve many desirable
objectives, including high levels of employment, a high degree of family security, an abundance of social services, and real economic growth. But even a country as richly endowed as
the United States cannot stretch its economic resources to meet all desirable goals. Ultimately, inflationary pressures develop, and real benefits begin to evaporate.
Choices must be made and priorities set. The achievement of larger social purposes
requires higher tax revenues in one form or another. Either society decides to tax itself or the
hidden tax of inflation serves to limit -competing claims. Once inflation gets started, it feeds on
itself, and the upward spiral is difficult to stop.
Economics texts generally distinguish between "demand-pull" and "cost-push" inflation..
Demand-pull refers to price rises resulting from demands which strain available supplies,
while cost-push inflation results from rigidities in the markets for both labor and products
which allow wages and prices to be pushed up even in an economy operating below full
employment. However, categorizing the causes of inflation is in many ways artificial, since
15
demand-pull and cost-push often interact and reinforce each other.
Although it is impossible to define a single cause of, or a single remedy for, inflation,
productivity gains can be a powerful tool in reducing inflation, no matter what its cause.
However, productivity growth cannot supplant responsible monetary and fiscal policies.
Prudent government spending and taxing policies contribute importantly to price stabilization. Judicious monetary policies can hold down cost-push inflation by avoiding the excessive increases in the money supply required to finance the push inwages and prices. Inother
words, cost-push inflation can proceed only so long as expansion of the money supply
permits it. Often, however, monetary authorities fear that a tighter money policy would
jeopardize the short-term maintenance of high employment. The problem here is that
monetary policy that validates the cost-push process can set the stage for longer-run
economic instability and inflation.
The presence of cost-push factors sometimes leads to calls for wage and price controls. To
the extent that inflation results from claims on resources that are not adequately dealt with by
monetary and fiscal policies, controls treat symptoms rather than causes. To the extent that a
productivity slowdown fuels inflation, controls again do not come to grips with causes. A
program of wage and price restraint will have a chance for success only if accompanied by
prudent fiscal and monetary policies and by vigorous efforts to increase productivity growth.
15 For a discussion of the interaction of these two sources of Inflation over the past decade, see AppeniSx IV
-21-

163
Unfortunately, productivity has been largely neglected as a vehicle for
reducing inflation.
Productivity is an important element in the cost-push equation since
it serves as a direct
offset against wage-induced price rises. Two major reasons seem to
be responsible for the
neglect of productivity:
* The conventional analysis of productivity's role in holding down unit
labor costs seems,
at first blush, to offer little promise of significantly reducing inflation.
If, for example,
productivity were to rise by one percentage point, the initial impact on
unit labor costs
would be a decrease of only one percentage point, hardly an exciting
prospect.
* Gains in productivity come relatively slowly and over a period of time.
They provide no
quick fix for controlling inflation.

How Productivity Fights Inflation
In the arsenal of weapons against inflation, gains in productivity are
more potent than is
generally assumed. The primary role that gains in productivity play is
well understood: An
increase in productivity brings an increase in aggregate supply, which
holds down unit labor
costs. This, in tum, brings downward pressure on the average price
of goods. But to a
degree not widely recognized, increases in productivity can have
multiplier" effects on
moderating inflation. A one-unit increase in the longer-run growth
of productivity can
produce a more-than-one-unit decrease in the rate of inflation over a
period of time.
This magnified effect of productivity gains is due to the workings of the
so-called "wageprice spiral." An increase in wage-rates can push up prices; and the increase
in prices can, in
turn, operate to push up costs and, as a result, prices. The increase
in prices once again
operates to push up wage-rates which act to push up prices again
-and
so the spiral
continues. But whenever an increase in productivity growth occurs,
it will act as a morethan-one-time brake on the spiral.
Let us assume that the increase in productivity growth occurs at a point
where wages are
acting to push up prices. On the first round, the increase in productivity
growth will moderate
the wage-induced rise in prices.. On the second round, by holding
down the initial priceincrease, the earlier productivity gain can moderate subsequent wage
increases; likewise,
the resulting price increase would be more moderate-and so on through
each round of the
spiral.
To understand more fully the role of productivity in the inflation process,
one must first look
at a few details of wage negotiations.16
. -22-

164
The Wage Bargain
It is widely acknowledged that wage increases are generally composed of two main parts:
* An increase to compensate labor for past inflation. Indeed, with some two-thirds of
negotiated wage contracts that cover 1,000 or more workers tied to cost-of-living
clauses, the adjustment to past inflation tends to be built in. Moreover, contracts
frequently also reflect anticipated inflation over the contract life.
* An adjustment for labor's entit!!ement to perceived past productivity gains. Workers
expect their real incomes to rise and their real purchasing power to improve. Since
long-run improvements in real wage rates can only come from rising productivity, this
element of the wage contract generally reflects labor's and management's perceptions
about average long-run productivity gains.
One observer of the economic scene recently commented on these two components of
current wage settlements: ". . . strong unions habitually settle for nothing less than 3%
Another observed:
(productivity offset) plus the rate of inflation .1. 7""
"These [large] unions all have contracts similar to the one pioneered by the auto workers in
1970-3% annual wage increase plus essentially full adjustment for increases in the cost
of living. When increases in the cost of fringe benefits are included, these contracts
produce compensation cost increases in real terms of 3% or slightly more per year. When
these contracts were first negotiated, it was believed that real wage increases of about 3%
were in line with the economy's ability to provide higher real wages through productivity
growth. In fact, however, the 3% figure was overly optimistic ... since 1970 productivity
18
has been only 1.4% per year."
The institutionalization of the long-outdated 3% productivity standard was recently remarked upon by Barry Bosworth, Director of the U.S. Council on Wage and Price Stability. He
noted that:
". . . many labor contracts currently call for cost of living plus a productivity improvement.
The only trouble is that this formula dates from the world of the 1950s and 1960s, when we
had 3 percent annual productivity increases. This economy hasn't had a 3 percent annual
19
productivity growth in a decade."

in union
16 Naturaily. not all wage increases are set through formal collective bargaining. Nonetheless. agreements reached
negotiations tend to have powerful spillover effects and set patterns for the entire labor market.
Co., July 28, 1978.
17 Sam Nakagama. 'Economic Perspectives," Kidder, Peabody &
18 Morgan Guaranty Survey. October 1978, pages 5-6.
1978. page
19 A Conversation with the Honorable Barry Bosworth, American Enterprise Institute for Pubic Policy Research,
29.

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165
Wage Increases and Productivity
Productivity gains are a direct offset to wage increases. If we assume in one case no
productivity gain and in the second a 3% productivity increase, the difference in unit labor
costs is 3%.
Case 1

Case 2

8%

8%

0%
8%

Wages rise
Productivity increases
Unit labor costs will rise

3%
5%

Since labor costs are a dominant component of total business costs, it follows that in Case 1,
inflation will be roughly 8%, and in Case 2, about 5%,20
The following table shows that the relevant statistics bear out these illustrations and that:
* As discussed earlier, productivity improvements played a vital role in containing unit
labor costs between 1955 and 1967. Thereafter, as productivity gains slackened, unit
labor costs began spiraling upward.
* The rise in labor costs has gone hand-in-hand with inflation. While inflation has not
always coincided exactly with rising unit labor costs, the two statistics have tracked each
other quite closely.
Table 5
Changes In Wages, Productivity, and Unit Labor Costs
In Non-Farm Business and Consumer Prices, 1955.1977
Compensation
output Per
Unit
Consumer
Per Hour
minus Hour Worked equals
Labor
Price Inde.
Worked
1Prodctfvi-l.
Costs
(Inflation)
-------- --------------- Annual Percent
.
Changes -------------------------------1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977

So.:

3.7%
5.9
4.4
3.5
3.7
3.4

5.9
6.5
6.6
7.5
9.9
8.3
us s.m

4d%
2.2
3.7
2.8
35
3.3
1.9
-0.2
2.9
1.5
1.9
1.9

-0.4%
3.7
0.7
0.7
02
0.2
3.9
6.7
35
60
7.9
6.7

-0.4
3.6
0.8
1.0
1.2
1.7
2.9
5.4
4.3
62
9.1
6.5

, d Lo ant orLrw S1.trn

20 For illustrative purposes, throughout this section we have equated Increases in unit labor costs
with Inflation, fully
recognizing that (1) If non-labor costs rise faster than labor costs, price nses will be greater than indicated,
and vice-versa:
and, (2) In some cases, only part of the increase In unit labor costs may be passed on to customers.

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166
Accelerating Inflation
A slowdown in the productivity growth rate during one period will ignite an inflation
speedup not only in that period but in succeeding periods - even after the decline in
productivity growth is haltedl This relationship can best be illustrated by means of an
example.
Assume that in Period 1 workers anticipate no inflation because there was no inflation in
the preceding year. 21 Labor seeks a wage increase of 3%, solely to match the perceived
long-run average increase in productivity. In other words, workers expect their real incomes
to rise and their purchasing power and standard of living to improve. If productivity actually
rises by 3% in Period 1, the year will be inflation free.
Period 1
Assumed inflation
Expected growth in real income
Wage increase
Productivity gain
Actual inflation (unit labor costs)

0%
3%
3%
3%
0%

Next, assume that productivity gains slacken in Period 2, from 3% per annum to 11/2%-an
assumption which conforms to the reality of recent years. The wage-price spiral is quickly
activated:
Period 2
Assumed inflation
Expected growth in real income
Wage increase
Productivity gain
Actual inflation (unit labor costs)

0%
3%
3%
1112%
1V2%

Workers anticipated that purchasing power would grow at the same 3% rate as in Period 1.
But because productivity dropped off, unit labor costs went up and so did-prices. Hence,
inflation enters the picture at a rate of 11/2%. In effect, wages increase by 3%, half of which is
consumed by inflation, leaving only a 1/2% increase in real income. Labor is disappointed
and readies new wage demands aimed at overcoming the real-income deficit.
Predictably, in Period 3, wage demands go up to 41/2%. (The assumption is reinforced by
the large number of labor contracts which have cost-of-living escalators built-in.)
21 Actually. the process could start from any base level of Inflation.
25-

167
Period 3
Assumed inflation
Expected growth in real income
Wage increase
Productivity gain
Actual inflation (unit labor costs)

11/2%

3%
41/2%
11/2%

3%

Obviously, the windup of inflation is under way and will continue, as shown below, until
something occurs to lower labor's wage demands or to raise productivity.
Period
4

5

6

7

3%
3
6%

41/2%
3

71/2%

71/2%

6%
3
9%

101/2%

Productivity gain

11/2%

11/2%

1V/2%

11/2%

Actual inflation (unit labor costs)

41/2%

6%

71/2%

9%

Assumed inflation
Expected growth in real income
Wage increase

3

In fact, inflation would probably spiral upward more rapidly than these calculations
suggest, since labor almost certainly would begin to anticipate future inflation and try to build
it into wage settlements, thereby further fueling the inflation momentum.
Wind'ing Down Inflation
Naturally, at some point labor will have to pare down its wage demands, say to 1%/2%, in
response to the lower rate of productivity gains. Then, the rate of price increase will level off
and the upward spiral of price rises will be broken. If that occurs in Period 8, the arithmetic
would be as follows:
Period 8
Assumed inflation
Expected growth in real income
Wage demand
Productivity gain

Actual inflation (unit labor costs)

9%
11/2%
101/2%

1i12%

9%
-26-

168
Inflation will decline below 9% only if productivity gains accelerate, say, back up to 3%,22
Assume this happens and that, at least for a time, labor demands only a 11/2% gain in real
wages (to match the previous plateau in productivity gains). The result is that inflation begins
to unwind.
Period
9

9%

Assumed inflation
Expected growth in real income
Wage increase

10

71/2%

11

6%

11/2%

11/2%

11/2%

101/2%

9%

71/2%

3%

3%

3%

71/2%

6%

41/2%

Productivity gain

Actual inflation (unit labor costs)

Now the process has been reversed, with the rise in productivity causing inflation to
decelerate from 71/2% to 6% to 41/2%. Inflation will continue to wind down so long as the rate of
productivity gain continues to exceed labor's expected growth in real income. When those
two factors come into balance-say, 3% productivity growth and 3% expected growth in real
income, inflation will stabilize at a constant rate until one of the key variables changes again.
A key question is the length of the adjustment periods; that is, how long does it take labor to
adjust its wage demands to changes in productivity? Is labor able to argue for wage
increases based on historic productivity changes or will labor base its real wage demands on
relatively recent productivity performance? Whatever the answer, whatever the length of the
adjustment period, productivity plays a key role in this entire process.
At this point in time, increased productivity can serve to help unwind a decade-long
process of inflation. Whatever the specific causes-fiscal and monetary mismanagement,
soaring commodity prices, the quadrupling of oil prices, dollar devaluations, excess demands, rising unit labor costs-the ftct of the matter is that we are in a stage of the inflation
process where both costs and wages are leaping upward. Increased productivity in these
circumstances is essential to cool inflation while maintaining the nation's commitment to high
levels of employment.

22 Inflation would also dedine ii labor agrees to accept something less than assumed inflation plus a realistic allowance for
producivity growth.

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169

10

POLICIES TO PROMOTE A HIGHER STANDARD OF LIVING
Accelerated productivity growth is essential if we are to come closer to achieving three of
our nation's most urgent economic objectives:
* To promote real economic growth and, thereby, a higher national standard of living.
* To create a sufficient number of jobs for all those able and willing to work.
* To restrain price inflation.
Unfortunately, there is no quick way to achieve all three goals simultaneously. In the
short-run, rapid growth and full employment may generate inflation-and controlling inflation
may limit job creation and growth. In the longer-run, all three objectives can be reconciled
through high productivity gains. Thus, a major national commitment to spur productivity
would seem to be very much in order.
A Set of Economic Goals
To establish appropriate priorities for the 1980's it would be desirable to identify a series of
consistent national economic goals aimed at speeding growth and job creation while restraining inflation:
* Increase real annual growth in GNP to 4%. To achieve this will require
* Raising annual productivity growth to 3%O. inturn, depends primarily on
This,
* Increasing the GNP share of business investment by at least 2 percentage
points over the 10% longer-term trend.
The goals suggested are consistent and realistic. They can be achieved through the
promotion of private incentives and the loosening of competitive forces.
A 4% real annual rate of growth is the highest attainable without adding to inflation. But a
4% growth rate can be achieved only if we manage to raise productivity by 3% annuallydouble the recent anemic 1/2% rate. The arithmetic is straightforward. Man-hours worked
are expected to increase 1% per year at most. For GNP to grow by 4%, therefore, an annual
3% productivity gain is required. If these goals are met by 1990, average family income will
rise 32%, to $27,000 (1977 dollars); real per capita income will increase 48%, to $10,000
(1977 dollars); and 16 million new jobs will be created.
The task of doubling the recent trend rate of productivity gain is not an easy one-but
neither is it impossible. However, it would require critical contributions in the areas of
business capital investment; research and development; education and training; and easing
restrictive regulations and practices.
Increases in productivity growth rates cannot be achieved overnight. Considerable time
necessarily elapses between the implementation of economic policies - management
decisions to step up capital investments and facilities planning -and the completion of
expansion and modernization projects.
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170
The importance of lifting the GNP share of business investment at least 2 percentage
points is underscored by the Department of Commerce's findings. In a 1975 study commissioned by the President's Council of Economic Advisors, the Department concluded that
business capital investment would have to rise from the 10%level of GNP maintained during
the preceding 15 years to 12%, if capital requirements are to be met. 23 This substantial 2
percentage point gain will be needed merely to increase capital per worker at the same rate
as in the previous decade, in the face of the anticipated costs of energy, environmental and
safety programs. Increasing capital per worker at a faster rate than in the previous decade
would require a still greater increase in the proportion of business capital investment to GNP.
As Federal Reserve System Chairman G. William Miller remarked:
"The Japanese economy spends over 20 percent of GNP on capital investment; West
Germany 15 percent. It certainly would be appropriate for us to seek a 12 percent
level." 24

A 2 percentage point shift in output away from consumption expenditures to investment
outlays will require a fully coordinated public and private program to redirect priorities toward
greater capital formation. Above all, this would require a tax climate that encourages
research and development, innovation and risk investment.
Policy Options
As our study demonstrates, many factors contribute to productivity. Thus, there are no set
formulas for achieving improvements. Some suggestions for policies which might be considered for inclusion in a productivity program are offered below. They are intended to provide a
basis for discussion and analysis in formulating a coordinated prograrn to spur productivity
growth.
Some suggestions are as follows:
* Implement policies to increase business capital spending.
* Adopt measures to encourage savings and risk taking.
* Create incentives to spur research and development.
* Develop a national commitment to productivity improvement.
* Relax unnecessary government regulation and other restrictive practices
which add to business costs and inflation.
* Improve education and training.
* Establish policies to better match job vacancies and job seekers.
* Promote economic stability.

23 Nonresidential fixed investment averaged 9.6% of GNP In 1975-1978. and 9.8% of GNP in 1960-1975.
24 Speech before the American Productivity Center's Productivity Conference. October 3. 1978. page 8.

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171
Each of these policy options is discussed below:
Increase Business Capital Spending
Capital investment is the chief conduit for technological progress. Capital must be invested in new plant and equipment if output is to increase. Capital must be invested to move
new ideas from the drawing board to the production line, and to make more efficient
processes marketable.
A high degree of uncertainty about future returns on investment has reinforced business
caution about committing funds for the future. This reluctance to invest has raised the
minimum or "hurdle" rate of return required of new investment projects.
Many specific factors can be cited for the persistent lag in capital investment.
* Chief among these is the uncertainty created by inflation, which all too often sends costs
spiraling upward faster than prices, thereby lowering profit margins. This conclusion is
confirmed in a number of recent studies of rates of return after adjustment for inflation.
The pernicious effects of inflation are compounded by the fact that as capital expenditures stagnate and productivity slows, further cost pressures arise which erode profits
and, in turn, discourage investment and give another turn to the inflation cycle.
* Inflation also discourages capital investment by creating illusory profits in the form of
phantom inventory gains and inadequate depreciation charges based on original rather
than replacement costs. But when seemingly satisfactory profits are adjusted for inflation, they shrink in size. To compound the problem, corporations are taxed on book
profits rather than on real profits after adjusting for price inflation. Depressed "real
profits" discourage capital spending.
* The uncertain energy outlook has discouraged new investments. Higher energy costs
have raised investment requirements to finance more energy efficient facilities and
equipment.
* Proliferating governmental restrictions, regulations and reporting requirements have
added to both costs and uncertainties.
* Over-all, supplies of new equity capital have been inadequate to support the financing
requirements of needed modernization and expansion programs.
National policies to encourage business capital spending would seem to be an essential
component of any responsible effort to spur productivity growth. Of extreme importance are
measures to eliminate taxes on the illusory profits created by inflation. Toward that end,
consideration should be given to basing depreciation allowances on replacement rather than
original costs. Other policies which would encourage business capital Investment include
further liberalization of corporate income tax rates and the investment tax credit, and easing
regulatory policies which depress corporate profits and retained earnings.
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172
Encourage Saving and Risk Taking
Ultimately, capital investment is limited by the amount of saving that the economy generates. It is not likely that the economy can achieve a sustained 4% real growth rate if steps are
not taken to raise the rate of saving. And sufficient additional savings to meet the investment
needs of a high-growth economy cannot be generated without greater encouragement to
personal saving, which has accounted for some two-thirds of net private savings over the
postwar period.
However, a larger pool of personal savings is not by itself a sufficient condition to stimulate
the business investment required to achieve high productivity and economic growth rates.
The extreme difficulty of raising equity capital has serious implications for increasing

productivity gains in the future. Without an adequate equity base corporations will be
hard-pressed to raise the long-term funds required to translate expansion and moderni-

zation plans into operating facilities.
To provide the equity base necessary to support a high level of business capital spending,
policies to stimulate saving must be fashioned in a manner which would encourage risk
taking. It will be necessary, for example, to modify or eliminate tax laws which unduly
discourage investment in equities. Among the prime candidates are discriminatory doubletaxation of corporate income distributed as dividends (vis-a-vis single taxation of bond
interest) and taxation of phantom capital gains resulting solely from general price inflation.
Capital gains taxes have particularly discouraged risk-taking: Although the recent rate
changes are a step in the right direction, long-term gains are still taxed without regard to
whether they are real or simply due to inflation.
The treatment of losses should be more realistic. Even now, net losses deductible against
ordinary income are limited to $3,000 a year; and only one-half of net long-term losses are
deductible. Policy-makers should not be perplexed if investors continue to seek refuge in
such tax havens as tax-exempt bonds.
Elimination of the double-taxation of corporate income (first under the corporate income
tax and, second, when it is paid out as dividends) deserves careful consideration. The
specifics of these and other components of a capital formation package can be debated; but
25
the over-all need for investment tax modifications is clear.
Inadequate capital formation and the misallocation of capital resources are among the
principal contributing factors slowing productivity growth and inhibiting living standard improvements. Determination of the best mix of tax policies to achieve growth objectives would
benefit from a major study of the interrelationships among capital flows, tax policies,
risk-investment, and productivity.
25 Proposals to ease tax burdens on saving and investment are often rejected because ot presumed negative effects on
Treasury revenues. However, a recent study by Professor Martin Feldstein and Joel Slemrod (The Lock-in Effect of the
Capital Gains Tax: Some rime-Series Evidence, National Bureau of Economic Research. Working Paper No. 257, 1978)
condudes that Treasury revenues would expand, rather than contract. In response to a lower capital gains tax rate. A lower
rate would induce a great incease in the sales of capital assets. and shiftcapital to those enterprises which are most efficient
and profitable -a net plus for productivity growth.

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173
Spur Research and Development
Greater availability of funds for business capital investment would also spur spending for
research and development, the fountainhead of technological progress. Advances in knowledge gained through R&D are an integral part of the entire modernization/innovation process. New technology stimulates new plant and equipment investment programs.
As President Carter has noted, "Emphasis on longer-term research that could lead to new
products and processes has decreased." This has led to fears that U.S. industry is losing
its
creative edge.
Professor Kendrick recently recommended that R&D be spurred in the following ways:
* Extend the investment tax credit on equipment to cover industrial R&D, as defined by
the Financial Accounting Standards Board or some other body. Better yet, allow a 50%
tax credit on increases in R&D.
* Allow accelerated depreciation or, possibly, a complete write-off in the year that R&D
plant and equipment costs are incurred.
* Provide government grants on a matching basis for industry-wide R&D expenditures.
* Renew Federal support for state technical service centers and, possibly, provide loan
guarantees to "lone-wolf" investors.
* Encourage the Federal Government to pursue a reasonably steady and predictable
policy with respect to investment of public funds in support of R&D. A sharp cutback in
Federal funding was a major reason for the substantial drop in the ratio of R&D
expenditures to GNP-from 3% in the mid-sixties to 2.2% in 1977. Had the higher
percentage been maintained in 1977, an additional $15 billion would have been spent on
R&D.
In addition, a major study of the impact of Federal regulations on the initiation of new
research projects and on R&D spending generally, could provide useful guidelines
for
overhauling Federal policies to spur innovation.
Develop a National Commitment to Productivity Improvement
The President's newly created National Productivity Council, is designed primarily to
improve the productivity of Federal Government agencies. Although it represents a
good
beginning, its limited focus permits it to address only a small part of the productivity problem.
Determined efforts at the national, regional and local levels are needed to develop and
implement programs to encourage greater productivity. One possibility for enlisting active
-32-

46-126 0 - 79 - 12

174
grassroots participation might be to establish productivity councils throughout the country to
assist individual business organizations in setting up their own internal productivity councils.26

The government's contribution to the national effort to raise productivity might include:
* Appointment of a high-level spokesman on economic policies affecting productivity.
* Review of existing and proposed legislation, rules, regulations, and practices at all
levels of government for their impact on productivity.
* Conducting productivity impact studies of proposed Federal actions.
* Conducting research studies on means of promoting productivity; and examining on a
continuing basis, the sources of productivity growth and factors responsible for increasing or slowing productivity, both at macro and micro-economic levels.
* Provision of a corps of experts to consult, on request, on specific productivity problems.
* Promoting the organization of joint labor-management productivity committees to focus
on the particular productivity problems of individual business and directly involve those
closest to the problems.

There is no one "best" way to develop a national commitment to raise productivity growth.
Whatever specific policies may be implemented should be pursued within the framework of a
well-coordinated private and government cooperative effort to integrate broad programs at
the national level with more closely focused regional and community programs. Success will
come only if the program touches individual firms, and plants and work units within plants.
Governmental and Other Restrictions
Environmental and related governmental controls have been important factors in reducing
27
measured productivity growth. That conclusion does not imply that such controls are
undesirable. But costs and benefits must be realistically assessed on a case-by-case basis.
The benefits are better air, cleaner water, fewer accidents. The costs are more inflation,
fewer new jobs, less long-term economic growth. It is estimated that some 10% of all capital
investment today is spent on environmental improvements, diverting substantial funds away
.from productivity-improving investments.
Unrealistic government policies, however well-intended, can stifle innovation, investment,
and risk-taking.
operating efficiency under given
26 "The individual producing organization Is where the action is with regard to improving
advances." Kendrick. Undertechnologies and making the cost-reducing innovations required for continuing productivity
121.
standing Productivity. John Hopkins University Press, 1977. page
plant level, thanks to the efforts of the
Some companies have begun to look more closely at the nature of productivity at the
up over the last few years.
Houston-based American Productivity Center and similar organizations which have sprung
Upon Output Per Unt of tnput,
27 Edward F. Denison. Effects of Selected Changes in the institutional and Human Environment
The Brookings tnstitutlon, 1978.

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175
In his recent anti-inflation message, the President gave particular
attention to the impact of
Federal agency regulations on costs. We commend such a review.
Along these lines, we
suggest that each new Federal rule or regulation be subjected to
a separate analysis of its
productivity impact.
All programs need to be evaluated at the margin. Will the benefits
of new Federal
restrictions and regulations more than offset the added costs of higher
inflation and slower
growth? Clearly formulated productivity impact studies before new
rules and regulations are
adopted could provide the answers.
The blame for restrictive practices which stifle innovation and create
inefficiencies must be
shared by all sectors of our economy-management and labor as well
as government. Some
examples:
* Franchise agreements in the trucking industry still prevent the
transportation of goods
by the shortest route. Competition in trucking remains severely limited
by ICC regulations, despite recent easing of some restrictions.
* Full crew laws on railroads, setting of bogus type by printers,
and other work-related
limitations reduce efficiency and increase costs.
* Local building codes often hamper the introduction of innovative
and cost-reducing
material. Unrealistically low ceilings are set for work performance.
* Tariffs, quotas and other controls on imports of commodities of all
types increase costs to
consumers.
Many other examples can be cited. The objective should be to allow
competitive forces to
operate; to encourage the mobility of resources; to avoid restrictions
on the productive use of
land, labor and capital; and to minimize political impediments to productivity-whether
from
govemment, business or labor.
Business has not been doove restrictive practices which deprive
consumers of the
benefits of greater competition. Too often competition is favored
only in the abstract or for
some other industry. Business sometimes lobbies for protection from
competitive imports,
rather than striving to compete more effectively. Practices which
restrict output, pricing,
innovation and investment should be curbed regardless of who
is responsible for them.
Improve Education and Training and Match Jobs and People
Human capital-The education, skills, and training possessed
by people is our most
important national resource. The existing work force must have adequate
opportunities for
upgrading skills and, consistent with other social goals, potential
new entrants should be
encouraged and assisted to acquire marketable skills and training.
Of course, schools can
teach useful and productive skills only if they have access to the
most modern techniques
and practices. More attention should be paid to on-the-job training
at the workplace as a
means of honing skills.
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176
Opportunities abound for modifying work rules and for redesigning jobs so as to enhance
the quality of working life and to stimulate productivity. A high degree of cooperation between
management and labor will be needed to achieve these goals.
Matching Job Vacancies and People-Economic growth and productivity as well as
individual well-being would benefit from efforts to more closely match the skills of people in
the job market and the requirements for filling vacant jobs. Schools should be more cognizant of the future needs of the job market, and they must keep abreast of, and train students
in, the latest technology. Toward that end, links between the school and the workplace could
be strengthened. Cooperative work/school programs and formal apprenticeship programs
could be expanded so that young workers would be better prepared to meet job requirements.
Programs might be developed to apprise workers in declining industries of new opportunities elsewhere. Retraining should be encouraged and new methods to aid in retraining
older workers should be explored.
It is not uncommon to find workers with specific skills in surplus in one geographic area
while those skills are in short supply elsewhere. Removing both real and psychological
obstacles to the movement of people to jobs and jobs to people, would be an important spur
to productivity. Professor Kendrick determined that decreased labor mobility was one of the
key contributors to the slowdown in productivity growth.
Federal, State and Local Government
Perhaps even more than their business counterparts, government agencies have an
obligation to measure and improve their productivity. With the public sector accounting for
more than 30% of GNP, there is plenty of scope for raising national productivity levels by
improving the efficiency of government operations.
In addition to direct programs for increasing individual output, government can do much to
enhance productivity in the private sector by reducing paper work, simplifying regulations,
and applying strict cost-benefit principles in revising old standards and promulgating new
ones as necessary. . .X28
Stable Economic Growth
Though broader monetary and fiscal policies are beyond the purview of this study, it is
important to recognize that, for maximum effectiveness, specific policies to promote productivity require an environment of relatively steady economic growth.
Recessions typically make sharp inroads into productivity by idling resources and creating
inefficiencies in the use of plant and equipment. Moreover, the uncertainties created by the
business cycle hamper capital investment planning and create insecurity as to the future. To
the extent that economic growth can be steadied and inflation restrained, the environment for
investment and productivity growth will improve.
28 Kendrick. Testimony before Joint Economic Committee, June 3. 1978.
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177

Our main objective in this study has been to highlight the central role productivity plays in
fueling economic growth and in restraining inflation. Appropriate public and private policies
can be developed to spur productivity-and this should be a high-priority national economic
goal. However, a successful national productivity growth policy will also require a high
degree of cooperation among government, management and labor. The effort to maximize
productivity requires a major management commitment to capital investment as well as a
commitment at the individual workplace and throughout the ranks of every business organization.
Only through long-run increases in productivity growth can our economy generate more
jobs, less inflation, and a higher living standard for all Americans. There is no easy path.
America needs a national focus which will properly place accelerated productivity growth
high on our list of national priorities.

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178
APPENDIX I
Growth In Output per Employee-Hour in Selected Industries, 1971-76
712

0

2

-4

6

;

00

_I-II.i
G-0 C0tO
Telolooho04000.1t'00lo0

I

I

f II I I

Ibl
I~~~. 'lb. b

I

ooO
totilog 470
ditoobooto

t 0I n
C o 0 00t .4t .04 4 lfoioll00
oud
Cooon1 01010. 2

oot O
too..,tlo -iot iO O
0 .,

~

t unt
o
ilo
M ot 0 0 00 t 4 op p tt .. Gooit o .o oc .. n oeu
oi

Zn~~~Z

0,o o o oo t sotl_
ol

0 0.0In d
fo o tb
uo

0

I

p
0
2
Rt

tO
o
o
ob oo o p~n tt t t 0 SOds
m

I

I

I
8

6

4

I I_
72~~~~~~~~~~~~~~

70

~t

n
0
i 010 io04 4

.
t ot
m
l
i
P oot . 4 000 0, t o o o ' 070 400. Pko e o o0t,000 .4 04 10
l
07.4: iot.,oltottooloo

Cl., Ooto,0000 otoed~tO

II

I

I

I

~~~~~e
Ilkf Ir s

ID

ii

00

e

6

4

2

6

F

10l

\7

I

Source: Bureau of Labor Statistics. Reproduced from Productivlty Indexes for Selected Industies. 1977 Editon. page 6.
-37-

179
APPENDIX II

1947-1967
1948-1968
1949-1969
Average

SHARES OF OUTPUT GROWTH
(Private Non-Farm Economy)
Productivity
79%
78
73
77

1967-1977
1968-1977
1969-1977
Average

55%
52
59
55

Man-hours
21%
22
27
23
45%
48
41
45

Sources:
Bureau LaborStatstics; NewYork
of
StockExchange.
NOTE: see page9.

Estimates of Potential Employment and Unemployment,
1978-1990
Civilian
Civilian
Unemployment
Labor Forcet Employmentt Unemployment
Rate
.................... millions ....
...
percent
June 1978 (Actual)
100.6
94.8
5.8
5.8%
1979
101.9
96.1
5.8
5.7
1980
103.2
97.3
5.9
5.7
1981
104.5
98.6
5.9
5.6
1982
105.9
99.8
6.1
5.8
1983
107.3
101.1
6.2
5.8
1984
108.7
102.5
6.2
5.7
1985
109.7
103.8
5.9
5.4
1986
110.6
105.1
5.5
5.0
1987
111.6
106.5
5.1
4.6
1988
112.6
107.9
4.7
4.2
1989
113.7
109.3
4.4
3.9
1990
114.7
110.7
4.0
3.5
Avg. 1978-1990

108.1

102.6

5.5

5.1%

Avg. 1980-1990

109.3

103.9

5.4

5.0%

Source:Bureauof Labor Stabstics NYSE.
tAsumptions: (I) Civilian labor force growth:
1978.1984 = 1.3% peryear: 1985-1990 0.9%
per year(seepage 13)
(2) Civilian
employment
growth:
1978-1990 = 1.3%Per year (see page 13).

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180
APPENDIX III
SOURCES OF GROWTH IN REAL GROSS PRODUCT
U.S. Domestic Business Economy
(Selected Subperlods 1948-1977)

Real Gross Product

1966-1973
1948-1966
(Average Annual Rates of Change)
3.5%1/
3.9%

7
19 3-19

77

p

2.0%

Factor Input-Total
Labor
Capital

1.2
0.4
2.7

1.9
1.4
2.9

1.3
0.6
2.6

Real Product Per Unit of Labor

3.5

2.1

1.4

Capital/Labor substitution

0.8

0.5

0.7

Total Factor Productivity

2.7

1.6

0.7

1.1
0.75
0.25
0.1

0.9
0.7
0.2

Sources of Total Factor Productivity Growth:
(Percbfitage Point Contribution)
1.4
0.85
0.3
0.25

Advances in Knowledge
R&D Stock
Informal
Rate of Diffusion

0.6
0.6
0.1
-0.1

Changes in Labor Quality
Education & Training
Health
Age/Sex Composition

0.4
0.7
0.1
-0.4

0.7
0.7
0.1
-0.1

-0.1

-0.2

Resource reallocations
Labor
Capital

0.8
0.4
0.4

0.7
0.2
0.5

0.3
0.1
0.2

Volume Changes
Economies of Scale
Intensity of Demand

0.4
0.4
-

0.2
0.3
-0.1

-0.3
0.2
-0.5

Net Government Impact
Services to Business
Regulations

0.1
-0.1

-0.1
0.1
-0.2

-0.3
0.1
-0.4

Actual/Potential Efficiency,
and n.e.c.

-0.5

-0.6

-0.4

-

Changes in Quality of Land

p = preliminary; n.e.c. = not elsewhere classified.
Source: John W. Kendrick, George Washington University. based in part on estimates by Edward F Denison, Accounting for
United States Economic Growth, 1948-1969 (Brookings, 1974) and an article in the January 1978 Survey of Current
Business.

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181
APPENDIX IV
THE INTERACTION OF DEMAND-PULL
AND COST-PUSH INFLATION IN RECENT YEARS
Recent economic history demonstrates the intricate interrelation between demand-pull
and cost-push inflation.
The current "inflation era" was given major initial impetus by the surge in government
spending associated with the buildup of the Vietnam War and the Great Society programs of
the 1960s. This spending buildup occurred at a time when the economy was already
operating at close to full employment. The results were large Federal deficits and a classic
case of demand-pull inflation.
But as government expenditures escalated and demand pressures grew, price increases
began to accelerate-from 2% in 1965, to 3% in 1966 and 1967, and to 41/2% in 1968.
By
1969, wage demands reflected these price rises, as well as the customary demands for
additional wage increases to improve living standards. Cost-push inflation was underway.
The 1969-1970 recession coupled a decline in the level of output with continued price
escalation as labor sought wage increases to keep up with and even get ahead of mounting
inflation. In August 1971, the President instituted Phase I of wage and price controls. 29
1973 was a watershed year inthe history of inflation in the U.S. Commodity and food prices
soared, interest rates went through the roof, and the oil embargo began. Together with
the
effects of two separate dollar devaluations and declining U.S. productivity, 1973 saw prices
jump by 8%. With so many shocks to the system, inflationary expectations intensified. The
term "double-digit inflation" entered the lexicon.
Despite the worst recession since World War II, prices rose by 12% in 1974 and by another
10% in 1975. These continuing price rises were fueled primarily by the combination of actual
declines in the level of productivity for six consecutive quarters and persistently high
increases in compensation per man-hour which exceeded 9% in 1974 and reached nearly
10% in 1975.
Rebounding productivity gains offset some of the rise in unit labor costs in 1976, but 1977
productivity slowdowns sparked further sharp rises in unit laborcosts and prices. As this was
happening, the unemployment rate began to fall toward a level which many economists
would consider close to full employment. Thus, demand-pull factors strengthened and
reinforced the inputs of cust-push inflation.
The push-pull of inflation has continued into 1978. Near double-digit compensation
increases, coupled with declining productivity gains, have pushed prices up at still faster
rates, with little relief in sight. At the same time, some tightness has developed in the skilled
and experienced labor force and production bottlenecks have begun to appear.
This history illustrates the interaction between demand-pull and cost-push forces. Prices
29 By 1971. unit cost pressures had actually begun to ease (as it turned out. temporarily)
as robust productivity gains offset
persistent wage demands. Price rises dipped below 3°% per annum in the third
quarter of 1971. Thus, as Phase I of
wage-price controls was instituted increases in productivityhad already begun to
slow the upward spiral of prices In 1972.
inflation ran at only a bit over 3%, due more to continued strong productivity gains than
to Phase 11 the control program. The
of
1971-1972 experience strongly suggests the potential of productivity gains as a
policy instrument for curbing inflation.

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182
have risen at times in response to peak demands. In turn, wages have increased as labor as
sought not only to maintain, but to increase, purchasing power. Over-all, unit labor costs and
prices have spiraled upward without full-employment output.
Demand-pull and cost-push inflation, therefore, carnot be separated into two neat boxes.
Because they constantly interact with and fuel each other, an array of economic policies is
essential to control them.

BIBLIOGRAPHY
Joint Economic Committee (studies prepared for
the), U.S. Economic Growth from 1976 to 1986:
Prospects, Problems, and Patterns, U.S. Government Printing Office, November 1976.
John W. Kendrick, Understanding Productivity,
The John Hopkins Press, 1977.
Mel CoIchamiro and Karen Kelly, "UnemployRonald E. Kutscher, Jerome A. Mark, and John
ment at the End of 1971," The Conference
R. Norsworthy, "The Productivity Slowdown and
Board Record, May 1971.
the Outlook to 1985," Monthly Labor Review,
Commerce, U.S. Department of, International
May 1977.
Economic Indicators, June 1978.
Labor, U.S. Department of, Employment and
Earnings, July 1978.
Commerce, U.S. Department of, Population Estimates and Projections, Series P-25 No. 607, Labor, U.S. Department of, Bureau of Labor
August 1975. "Projections of the Number of
Statistics, Productivity Indexes for Selected InHouseholds and Families: 1975-1990."
dustries, 1977 Edition, 1977.
Manufacturers Hanover Trust, Economic ReCommerce, U.S. Department of, "Projections of
the Population of the United States: 1977 to port, May 1978.
2050," Population Estimates and Projections,
Morgan Guaranty Trust Company, The Morgan
Series P-25, No. 704, July 1977.
Guaranty Survey, October 1978.
Campbell R. McConnell, Economics, Seventh
Council of Economic Advisors, Economic ReEdition, McGraw-Hill, 1978.
port of The President, 1976, 1977, 1978.
Janice D. Murphey, "Wage Developments DurEdward F. Denison, Accounting for United
ing 1977," Monthly Labor Review, April 1978.
States Economic Growth 1929-1969, The
Sam Nakagama, Economic Perspectives, KidBrookings Institution, 1974.
der Peabody & Co., July 28, 1978.
Edward F. Denison, Effects of Selected
Arthur M. Okun and George L. Perry, Eds., CurChanges in the Institutional and Human Enviing Chronic Inflation, The Brookings Institution,
ronment Upon Output Per Unit of Input, The
1978.
Brookings Institution, 1978.
Paul A. Samuelson, Economics, Tenth Edition,
1976.
Otto Eckstein and Nikki Shields, The Role of
Productivity in Controlling Inflation, Study Paper Albert T.Sommers, "Prospects for Inflation in the
of The National Commission on Productivity and
United States," Conference Board Record,
Work Quality, December 1974.
June 1974.
Roger W. Spencer, "Population, the Labor
Martin Feldstein and Joel Slemrod, The Lock-in
Force, and Potential Output: Implications for the
Effect of the Capital Gains Tax: Some lmeSt. Louis Model," Federal Reserve Bank of St.
Series Evidence, National Bureau of Economic
Louis Review, February 1971.
Research, Working Paper No. 257, 1978.
41 -

Peter K. Clark, Capital Formation and the Recent Productivity Slowdown, paper presented to
the American Economic Association and the
American Finance Association, December 30,
1977.

183
Senator JAVITS. It says on page 22-do you happen to have a
copy?
Mr. SCHULTZE. Not with me. I have just been handed one.

Senator JAVITS. I think it would be useful if you read it with me.
On page 22, in the middle of the page, about the third sentence,
italicized:
But to a degree not widely recognized, increases in productivity can have
'multiplier" effects on moderating inflation.

Then you need to move on to the basic points, and I am skipping
a lot of the material before you.
Page 27, at the very bottom of the page, reads:
At this point in time, increased productivity can serve to help unwind a decadelong process of inflation. Whatever the specific causes-fiscal and monetary
mismanagement, soaring commodity prices, the quadrupling of oil prices, dollar
devaluations, excess demands, rising unit labor costs-the fact of the matter
is
that we are in a stage of the inflation process where both costs
leaping upward. Increased productivity in these circumstances and wages are
is essential to
cool inflation by maintaining the Nation's commitment to high levels
of
employment.

The fundamental thesis, and I don't want to trouble you to read
any more, because I think you get my point, is that the study claims
that wage increases cause prices to move up, and then wages move up
in sequence. Once that process has started is when we begin stagnant
productivity, and it multiplies.
You don't stop the process when productivity begins to increase.
You may moderate the inflation process, but in order to really reverse
the trend, it takes a period of time to work itself out.
I would hope, and I see my time is up, but I would hope, Mr.
Schultze, that either now, or whenever you wish, you would analyze
that, because I think that study is critical to policy changes here in
Congress and to policy choices of the Government.
Mr. SCHULTZE. I would be glad to give it more careful analysis
for the record, Senator.
Let me note that increasing the rate of productivity growth does
have more than an immediate impact on the rate of inflation precisely
for the reasons indicated. Other things which moderate inflation also
have second and third round impacts.
Growing productivity has an additional impact in that it raises
real living standards as well as simply reducing the rate of inflation,
so I don't disagree with that basic thrust, but I would like to look at
it more carefully.
Senator

JAVITS.

Thank you.

May I have permission that the hearing record remain open for
whatever Mr. Schultze produces for us?
Senator BENTSEN. I think it would be very helpful to us.

184
[The following information was subsequently supplied for t0he
record:]
The rate of increase in prices would be moderated in two ways by a more rapid
increase of productivity. Most directly, higher productivity would lower the
rate of inflation because it would moderate in the rise in unit costs of production.
The New York Stock Exchange paper, as well as various sections of this year's
Economic Report make this point. To the extent that higher productivity lowers
inflation, there will be beneficial secondary effects as inflationary expectations
are reduced and wage and other income demands are moderated.
The NYSE paper presents an example of one way in which this could happen.
In their example, expectations of increases in real income do not change with the
assumed improvement in productivity. As they recognize, real income expectations would eventually adjust upward, but in the interim, a significant antiinflation benefit would accrue.
Almost anything we can do to lower inflationary expectations will help to brake
the momentum of inflation and ease the process of deceleration in future periods.
Our present need is to create an environment in which price and wage increases
could reasonably be expected to moderate, and to set standards of behavior
that are consistent with a modest but significant braking of the momentum of
inflation. Chapter 2 of this year's Economic Report sets out in detail the administration's near term policies to achieve this objective.

Senator BENTSEN. Mr. Schultze, one congent comment.
I was reading an article by Mr. Costello, of the EPA, talking about
the Clean Air Act, and I am a member of the Committee on Environment and Public Works, and when he was asked the question of the
cost of accomplishing these things, he said the question of cost is
not germane, because the law does .not provide for any consideration
of the cost.
Well, that is a little outrageous, and I am not blaming him. I am
blaming us. But in trying to do something about the regulatory costs,
and let me say very clearly that many, many regulations are meritorious, they are needed, and we want to accomplish some of these
objectives, but many of the regulations are not the most economical
way of accomplishing the objective.
I have introduced legislation, and Congressman Brown joined
me in that. We are trying to find a way to establish a regulatory
budget for agencies on how much they can spend. Some of us think it
is time we place limitations on how much they can spend.
What do you think about the possibilities of devising a regulatory
budget?
Mr. SCHULTZE. I was trying to find that section, Senator. You
will be pleased to note that we discuss that subject, not greatly, but
with some care, in one of the chapters of the Economic Report.
It is a subj ect that is hard to comment on, except at length.
First, it is true that in the regulatory area, we do not have a sense
of overall priorities. We are trying to improve this in looking at the
economic content, costs, as well as benefits of individual content. We
are taking the first step of trying to put this in perspective.
The President has set up a regulatory council, which will for the
first time set a regulatory calendar and give us an overall grasp of
what the impact of the regulations are likely to be. That is the first
step.

185
Through that process, we will look at the overall effect on different
sectors of the economy. It is, as I said, a first step. It is a process that
is going to have to be worked through very, very carefully, because
while you are exactly right in one sense, that we have no analogous
process as set by the budget, if we begin to think through what it
would mean to (lo so, then you begin to realize that while it is a process
that we surely ought to begin, it is a process that we will have to
approach with great care and caution, not just because of the substance
of it, because you begin to think through the relations of the executive
and the Congress on the budget as well as through regulations, and
they are not analogous at all.
At this stage, I am not giving any answers, except to say that the
basic thrust of what you are saying is right. We have taken a basic
step, or a little more than that. It is a step in that direction. It is
something we will have to develop as we go.
Senator BENTSEN. We want to find a way to achieve the social
gains at nominal cost, and you state that in your report, and we are in
full concurrence, but you have to find some kind of a limitation that
will work automatically, or it just won't be done.
Hopefully, we will work together to develop some kind of a regulatory budget to accomplish that.
Thank you very much, Mr. Schultze.
The committee stands recessed.
[Whereupon, at 12 noon, the committee recessed, to reconvene at
10 a.m., Tuesday, January 30, 1979.]

THE 1979 ECONOMIC REPORT OF THE PRESIDENT
TUESDAY, JANUARY

30, 1979

CONGRESS OF THE UNITED STATES,
JOINT ECONOMIC COMMITTEE,

Washington, D.C.
The committee met, pursuant to recess, at 10 a.m., in room 1202,
Dirksen Senate Office Building, Hon. Lloyd Bentsen (chairman of the
committee) presiding.
Present: Senators Bentsen, Proxmire, McGovern, Javits, McClure,
and Jepsen; and Representatives Reuss, Mitchell, Brown, and
Heckler.
Also present: John R. Stark, executive director; Louis C.
II, assistant director-director, SSEC; Richard F. Kaufman, Krauthoff
assistant
director-general counsel; John M. Albertine, William R. Buechner,
Thomas F. Dernburg, L. Douglas Lee, Deborah Norelli Matz, and
Paul B. Manchester,, professional staff members; Mark
administrative assistant; Katie MacArthur, press assistant;Borfhelt,
Charles
H. Bradford, minority counsel; and Stephen J. Entin and Mark R.
Policinski, minority professional staff members.
OPENING STATEMENT OF SENATOR BENTSEN, CHAIRMAN

Senator BENTSEN. This hearing will come to order.
We are pleased to welcome the very distinguished Chairman of
Federal Reserve, Bon. G. William Miller, to this morning's sessiontht,
o-1
the Joint Economic Committee's annual hearings.
Mr. Miller, I think you would agree that two currently
characteristics of the economy are tight money and highdominant
rates of
interest.
The basic question I have for you today, Mr. Miller, is when this
combination of high interest and tight money is finally going to
on the housing industry? I recognize, of course, that the housingimpact
industry has been insulated from tight money problems by the new variable
interest certificates available at savings institutions.
I know that since the last crunch we had in 1973 and 1974 when
housing starts went down to, as I recall, something less than 700,000
housing starts, that we have had quite a change in the way that the
savings have flowed into savings institutions. Bundles of mortgages
are now being put together and variable interest rates have come iuto
use.
The variable interest certificates may merely mask a larger,
problem since they do not actually increase the overall supply of deeper
credit.
Funds that in the past would have been drained away from the housing
market are simply diverted from capital spending.
Mr. Miller, we look forward to your testimony.
(187)

188
STATEMENT OF HON. G. WILLIAM MILLER, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. MILLER. Thank you very much, Mr. Chairman.
With your permission, I think it might be useful merely to submit
my prepared statement for the record so I can address the issues that
are of more direct interest to members of the committee. I can respond
now to the questions you have asked about housing and the mix of
policy, if that would be satisfatory.
Senator BENTSEN. Mr. Miller, you have something in particular on
structural unemployment, do you not?
Mr. MILLER. Yes, I also have a paper and some comments to make
on structural unemployment and programs that might be addressed to
it. With your permission, if we discuss that today, I can submit the
paper for the record.
Senator BENTSEN. That will be fine.
Mr. MILLER. Mr. Chairman, the questions you have raised about
housing, capital spending, and capital productivity, are critical, of
course.
In implementing monetary policy over the past year, while moving
toward restraint in order to lower the level of economic activity and
thus bring about conditions for wringing out inflation, one of our
objectives has been to create that restraint and that dampening of
economic activity on a balanced basis. The authorization for thrift
institutions to issue 6-month certificates at rates equal to the rates
which would apply on 6-month Treasury bills has permitted the
housing industry to compete for funds, as you point out. Overall
availability of credit has been restrained but the competition for that
credit has been more balanced this time than it was in the last economic
cycle.
At the end of 1972 the housing starts were running at a 2.5 million
annual rate. Because of the massive disintermediation at that timedue to the limitation on interest rates that could be paid by thrifts
while higher interest rates prevailed in money market instrumentshousing dropped precipitously, so that, by the last quarter of 1974 it
reached a level equal to an annual rate of about 900,000 starts.
That was not a recession in housing, but truly a depression, that
depression led to considerable hardship and unemployment. Many
firms who were engaged in homebuilding were unable to survive, and
the result was considerable distress and an aftermath of costs to the
housing industry that we still are suffering from. Once you dismantle an
industry, particularly a highly cyclical industry, and because of the
tremendous penalties that take place in down cycles, starting it up
again obviously increases overall costs.
It was for that reason that the regulatory agencies felt that, in this
economic cycle, as the economy was restrained, we should allow the
housing market to have a fair opportunity to compete for funds. That
of course, is what has happened, and housing has been maintained.
To the extent that that increased competition for funds has meant
that credit was less available in other sectors, there has been more
restraint in other sectors. But, nonetheless, the overall result has been
one of considerable balance. We have implemented monetary policy
not only to seek balance, but in a smooth way, so as not to create
shocks and dislocations that would send the economy into a tailspin.

189
The mix of policies that you mentioned is critical. There is no doubt
that the changes of policy in the last year are very promising.
One change has been the redirection of fiscal policy. A year ago, the
contemplated financial plan for the Nation involved a Federal deficit
of $60 billion in fiscal year 1979. Congress and the President, in the
face of accelerating inflation, elected to change that direction and to
apply more austerity to fiscal policy. They reduced that. proposed
deficit to $38 billion, a very commendable redirection of policy. The
continuation of that trend from higher deficits toward balance-we
will have a deficit of less than $30 billion in fiscal year 1980-is movement in the right direction. That policy shift has created conditions
where we can expect a better mix of fiscal and monetary policy in the
period ahead. Continued reduction in Federal spending stimulus would
take the pressure off of monetary policy and allow us to proceed
through this period with lower economic activity, but without the
distortions or the amplitude in cycles that we have experienced in
the past; this is encouraging.
Monetary policy, by imposing a posture of restraint, has been
successful in beginning to reduce the growth of the monetary aggregates. As seen in the charts that have been attached to my prepared
statement, the growth of those aggregates is now beginning to fall
within the longer term ranges that the Federal Reserve has felt
appropriate to the degree of restraint needed in the economy.
Mr. Chairman, you may like to proceed in a different order. At the
appropriate time, I would like to make a few comments about structural unemployment, but perhaps at this point you would like to
stick with questions on fiscal and monetary policy.
Senator BENTSEN. I am sorry, I just can't hear you.
Mr. MILLER. I am sorry. Is this better?
Senator BENTSEN. That is better.
Mr. MILLER. I apologize; I hope that I have not been as unintelligible as usual.
Senator PROXMIRE. We heard most of it. We are glad *ve did.
Mr. MILLER. I should have had the microphone up closer.
I was saying that we can continue with fiscal and monetary issues
at this point, and discuss the unemployment situation at some other
point in the proceeding, if you prefer.
Senator BENTSEN. That will be fine, Mr. Miller.
Senator JAVITS. Mr. Miller, may I suggest, some of us may not be
here so I think maybe, if I may respectfully suggest, you ought to
get your whole message across then we can ask questions on everything.
Senator BENTSEN. Let me inquire of the members, is that all right
with the rest of you?.
Senator PROXMIRE. Fine.
Representative MITCHELL. Sure, fine.
Senator BENTSEN. All right. Then go ahead.
Mr. MILLER. Let me make a few comments about structural unemployment then.
In the overall management of our economy, we have generally and
historically followed a policy of dealing with its macrocharacteristics.
This macro policy can, of course, contribute to resolving unemployment issues to the extent that unemployment comes about from cyclical conditions. But monetary or fiscal policy alone cannot deal with

46-126 0 - 79 - 13

190
the more pervasive problems. of structural unemployment which results from conditions other than the cyclical nature of the economy.
If we are to deal with structural unemployment, it seems likely that
we must find targeted programs to address the problem rather than
rely upon macropolicies.
Tlie benefit of targeted programs is not only in reduction of unemployment. There is an additional payoff to the economy in the form
of reducing social hardship and, in the long run, from increasing
productivity, which is so essential if we are going to break the cycle
of wages and prices chasing each other during this period of high
inflation.
The approach that undoubtedly needs to be taken is to find targeted
programs that do address, explicitly, the problem of the quality of the
work force. Targeted programs that only temporarily park those who
are not fully participating in the economy are only palliatives, whereas,
what we need to do first is to address the fundamental issue of the
quality of the work force or the work training of individuals.
Second, we need to be sure that we are preparing people in the skills
that are needed in the economy and not teaching skills that are obsolete or not in demand. Otherwise, we will create the disappointment
of unfulfilled expectations.
Third, we need to couple these actions with an effective program of
placement. We not only have to upgrade the skills of individuals and
upgrade them in areas where they are needed, but also see that people
flow into permanent jobs.
My experience in business involved a number of these programs;
I think most of you are aware of these activities. I might point out
that there are some fundamental causes for and characteristics of hardto-employ Americans, and we need to look more at these causes in
order to be sure that our programs address realities and that we are
making progress.
One of the problems is that we have changed from a rural economy
and a rural society into an urban one. Young people also have lacked
exposure to the world of work; they are not familiar with what it is
that working adults actually do. For both these reasons, we have had
a very difficult time linking up the knowledge and experience of young
people with the real world of work and with opportunities for work.
The linkage has been very weak, indeed.
So we need to be sure that we expose youngsters, when they are still
in school-very early-to the potential careers that exist. They will
then begin to make the choices in life that motivate them to self-help
and to preparation for careers.
One such possibility has been experimented with in the private sector, and that is programs that relate particular businesses to particular
schools, often referred to as "adoptive school programs." If carried
out on a much wider scale, this program has the potential for exposing
large numbers of young people to the world of work, so that they can
see the new skills that they are not familiar with-computers, certain
professional services-and areas that are expanding and are more
likely to offer opportunities for them.
We also have the problem of the boredom that hits many youngsters
todav in their school years. As they become less motivated to carry
out their studies, we also need, I think, greater and greater numbers

191
of work study programs, again so that they can be given exposure to
the real world of work at an early age.
More recently, there have been some developments in Federal programs that are worth pursuing. One has been in CETA title VII, the
Comprehensive Employment and Training Act program that deals
with private sector opportunities for the economically disadvantaged.
Here, one of the critical ingredients has been the development of the
concept of local, private industry councils that involve the local business in the community, the local educators, and local labor leaders
where the job opportunities exist. Many of the jobs that are available
for young people exist in smaller enterprises. Some of the larger training programs have been difficult to implement in smaller companies.
These new programs to create private sector opportunities, rather
than public sector opportunities, are very encouraging. The last Congress approved this concept and did authorize funds for carrying on
the program, but appropriations were not approved. One of the urgent
needs this year is for Congress to proceed to act on the supplemental
request for $400 million to carry out this program.
It is also important that we look at the hard-to-employ, not just
the young people, but in the context of all of the impediments to
obtaining jobs.
The tendency, at times when the economy is weak, is to provide
public service jobs as a solution. That is very helpful in terms of the
immediate alleviation of economic hardship, but in the long termas far as the possibility of permanent employment and progressionit is important that efforts in the private sector, and linkages from
school to work or from public employment experience to private
employment, be strengthened.
One of the organizations that has been working on this for some
time, as you know, is the National Alliance of Business, which is
organized to help in private sector initiatives. But there has also
been considerable work done by the National Manpower Institute,
which has been creating experimental education work councils around
the country to speed up this process of linking up the needs of young
people with job opportunities.
Another program that has been pursued more recently, approved
by the Congress, is the employment tax credit. Initially, there were
some limitations, but the program was broadened in the last Congress.
We do not know what extent this effort will be effective, but I certainly would commend your actions which create self-implementing
systems; employers are reimbursed and thereby encouraged to find
jobs for those who are hard to employ. By meeting the qualifications
for tax credits, their burden of training and of introducing these
youngsters or adults with low skills into the work force is eased.
Because the problem of structural unemployment exists so heavily
among the young and particularly among young blacks in urban
areas, I think we ought to reconsider the issue of the minimum wage
and its effect upon opening up opportunities for young people.
A couple of years ago Congress narrowly defeated a proposal for
a youth differential in the minimum wage that would have set a
lower minimum for initial period of work experience as an incentive
for employers to hire young people who need experience before they
can contribute fully to an enterprise.

192
I hope this is not legislation whose time has passed; it may be

to consomething that should be reconsidered. The problem is going Teenage
tinue to be with us. The numbers, however, are manageable.
rate
unemployment is one of our most serious problems; the overall rate
is about 16 percent. But that
of unemployment among teenagers
problem
of unemployment could be substantially reduced and the
could provide job opportunities for
could be significantly solved if we
I believe
some 500,000 young people. That is a manageable number.and work,
programs between school
if we can combine more linkage
sector,
and more skill training and job opportunities in the private
for emplovers to reduce the barriers to
with more economic incentive
potential
job experience-and if we can expose young people earlier to
can be made.
careers-substantial progress
I would like to elaborate on these general comments by submitting
a paper to you, Mr. Chairman.
Senator BENTSEN. That will be fine.
Does that complete your prepared testimony at this time?
Mr. MILLER. Yes; indeed, sir.
en[The prepared statement of Mr. Miller, together with a paper
titled "Programs To Reduce Structural Unemployment," follows:]
PREPARED STATEMENT OF HON. G.

WILLIAM MILLER

I appreciate the
Mr. Chairman, members of the Joint Economic Committee,
Board in your annual
opportunity to participate on behalf of the Federal Reserve an important juncture
hearings on the state of the economy. We find ourselves at
and persistence are
in our Nation's economic progress, a time when patience
begin to achieve
needed until the nation's anti-inflationary economic policies
significant results.
completed its
The current expansion in economic activity has now almost
The rate of
fourth year-an impressive performance by historical standards.
employment gains
economic growth moderated somewhat in the past year, yet
associated in the past
were exceptionally large, and major imbalances generallyThere were, however, a
with a maturing business expansion (lid not materialize.
rate of inflation, already
number of disturbing developments. In particular, the
of the dollar declined
far too high, accelerated further, the foreign exchange value debt rose sharply.
substantially prior to November, and the level of consumer and housing activity
Outlays for business fixed investment grew strongly in 1978,
spending, buttressed by
remained at a high level through the year-end. Consumer provide support for the
further large increases in consumer credit, continued to
during the year;
expansion. Total employment rose by more than 3 million persons
rate declined
although the labor force also increased rapidly, the unemployment
about Y percentage point to just under 6 per cent at year-end.
2
reduced the
The further expansion in economic activity last year appreciably increasingly
were in
margin of unutilized resources in the economy. Skilled workers
closer to peaks
short supply, and industrial capacity utilization rates moved
moderation in economic
reached in recent cycles. In these circumstances, the rapid rate of expansion
growth last year was a desirable development since a more
serious inflationin aggregate demand could well have exacerbated our already
ary problems.
the rate of inflation
The general level of prices rose sharply in 1978, with
cent in 1977. While the
accelerating to about 8% per cent compared with 6% per
of significant distormoderation in the pace of economic expansion and the lack
further expantions in major sectors of the economy augur well for the economy's of the economy
sion in the months immediately ahead, the longer-run performance inflation.
rate of
will depend critically on our success in bringing down the
is also a major
Containment of inflationary pressures in our domestic economy markets while
prerequisite for strengthening the dollar in foreign exchange
billion, on an interreducing our trade deficit. In 1978 the deficit was about $35
major foreign currennational accounts basis, and the value of the dollar against
November 1 when
cies fell 17 percent over the first 10 months of the year. Since
were initiated,
new domestic monetary policy actions and dollar support measures

193
the dollar has risen about 7 percent. The vigorous implementation of the support
program through cooperative exchange market intervention has been successful.
The expansion of Federal Reserve swap arrangements and the marshalling of other
resources have proved very useful in correcting the excessive decline of the dollar.
However, the longer-run strength of the dollar will depend on reducing our domestic inflation, increasing our exports, and curbing our oil imports.
Another worrisome aspect of our economy's performance has been our lagging
rate of productivity growth. The poor performance of productivity has retarded the
rise in living standards and aggravated the inflation problem. There are many
causes of this retarded growth, some of which hopefully reflect temporary developments, but tax policies that pay insufficient attention to investment incentives and government over-regulation must rank high among the contributing
factors.
In domestic financial markets, conditions have tightened considerably over the
past year. Since the beginning of 1978, short-term interest rates have increased 3
to 4 percentage points; mortgage rates about 1% percentage points; and bond
yields about 1 percentage point. Despite higher interest rates, funds for creditworthy borrowers have remained in ample supply. The total volume of net funds
raised in credit markets was lower in the second half of 1978 than in the first half,
but total credit flows remained large as borrowing by households in the form of
mortgages and installment credit continued to expand at a rapid rate.
The acceleration of inflation over the past year has required major adjustments
in economic policies. In the fiscal policy sphere there has been a dramatic movement toward tighter control over government spending and a related
in
current and prospective Federal deficits. The deficit specified for fiscalreductionthe
1979 in
First Concurrent Budget Resolution was $60 billion, but this was cut to $39 billion
in the Second Resolution. This very impressive reduction was a result of highly
commendable actions by the President and the Congress that cut contemplated
expenditures and moderated proposed tax reductions incorporated in the original
financial plan for the year. More recently, President Carter has announced a
budget for fiscal 1980 that would reduce the yearly deficit further-to $29 billion,
by far the lowest level in 6 years. There seems to be widespread support for this,
initiative, and the prospects favor a further move toward budgetary balance in
fiscal 1981 and actual balance by fiscal 1982, if not before.
A second policy initiative in the fight against inflation was the Administration s
introduction on October 24 of a broad-based program calling for voluntary moderation in wage and price actions, the establishment of specific standards for wage
and price increases, and the offer of various incentives for compliance. Past
experience has suggested that incomes policies are of limited effectiveness in
reducing the underlying rate of inflation. Yet, an incomes policy can play an important role in circumstances where more basic economic policies are being redirected in a vigorous way toward the containment of inflation. I am confident that
most business and labor leaders will abide by the spirit of an incomes policy if they
perceive that the Administration, the Congress, and the Federal Reserve are truly
determined to bring inflation under control.
Monetary policy also moved toward increased restraint in the past year as the
Federal Reserve sought to foster financial conditions that would contribute to a
reduction of inflationary pressures while supporting continued moderate economic
growth. Accelerating inflationary pressures were accompanied by rising demands
for money and a tendency for the monetary aggregates to expand at rates that
were widely viewed as excessive. In the circumstances open market operations
became progressively less accommodative in the provision of reserves and the
Federal funds rate rose from around 6Y2 per cent in early January to about 10 per
cent recently. The discount rate was increased in a number of steps by 3Y2 percentage points during 1978, to 9Y per cent. These anti-inflation moves featured
2
actions taken on November 1 in conjunction with the dollar-support program:
the System announced a one percentage point increase in the discount rate, imposed a two percentage point supplementary reserve requirement on largedenomination time deposits, and further tightened reserve availability through
its open market operations.
Growth in the narrowly defined money stock, M-1, slowed sharply in the final
quarter of 1978. The cumulative impact of rising short-term interest rates has
undoubtedly helped to restrain the growth of money. But recently, the public
has shown a tendency to economize more than might have been expected on their
holdings of cash balances. Persisting high levels of short-term rates and the availability of alternative transactions-type accounts, such as the new savings accounts
with an automatic transfer feature, have probably caused many depositors to shift

46-126

0 - 79

-

14

194
the broader
sizable amounts of funds out of demand deposits. Expansion inreflecting notmeasonly
ures of money, M-2 and M-3, also moderated late in the year,
the sluggish performance of their M-1 component but also the weakness in time
and savings accounts subject to fixed-rate ceilings.
Rising yields on competing market instruments tended to make such accounts
time deposits
increasingly less attractive as the year progressed. In contrast, have continued
paying interest rates competitive with those on market instruments
to attract sizable inflows of funds to banks and nonbank thrift institutions.
by
The tightening of financial conditions has been accompanied and erosion of
consumer
liquidity positions in various sectors of the economy. Mortgage consumer debt
debt burdens rose sharply in 1978 and the ratio of mortgage and
repayments to disposable income reached a record high. Borrowing by nonfinancial
corporations was concentrated heavily in short- and intermediate-term liabilities.
especially bank loans and commercial paper, and the ratio of short- to long-term
have
business debt is now only slightly below the 1974 peak. Commercial banksuse of
reduced their holdings of U.S. Government securities and increased their repurinterest-sensitive liabilities such as large-denomination CD's and securityamount
a record
chase agreements. Savings and loan associations have borrowed individuals, busifrom Federal Home Loan Banks. The reduced liquidity of many
ness concerns, and financial institutions is likely to exert a moderating influence
on credit-financed expenditures.
It should be emphasized that the much needed firming in credit market conditions has not been accompanied by the severe strains and distortions associated
with past periods of ci edit restraint. Current interest rate levels may be inhibiting
some potential borrowers, which is the objective of credit restraint, but creditThe
worthy borrowers continue to find funds available at prevailing rate levels.share
housing market in particular has continued to attract a relatively abundant was
of financing, though at rising interest rates. A key factor in this development have
that
the introduction in June 1978 of new 6-month money market certificatesmarket inenabled depository institutions to attract funds by paying prevailing
the
terest rates. In addition, housing has been supported by the lending activities of and
Home Loan Banks, the emergence of new mortgage-related securities,
Federal
the improvement of secondary markets for mortgages. The net increase in mortgage
debt in the fourth quarter of 1978 was only a little below the record increase in the
fourth quarter of 1977.
Mr. Chairman, you have asked me to assess the economic outlook. The major
threat to the economy is inflation and the concomitant expectations that dominate
the setting of prices and wages. Thus, any weakening in our anti-inflationary resolve could seriously damage our domestic economy and have adverse implications for the external value of the dollar.

195
Policies of fiscal and monetary restraint-together with the cooperation of
business and labor in the Administration's wage-price program-can achieve a
a gradual reduction in the rate of inflation, with progress becoming evident during
1979. While growth of output and employment is expected to slow this year, a
recession is unlikely in the absence of outside disturbances to the economy. A
moderate rate of economic growth is likely to avoid financial and economic dislocations, such as overinvestment in business inventories, which in turn could
foster a recession later. The economy is already quite close to full employment and
any new surge in demand must be prevented since it would only be translated into
more inflationary pressures.
Spending by consumers, a mainstay of our economic expansion since the spring
of 1975, will probably continue to grow but at a reduced pace in light of the
increased consumer debt burdens noted earlier. Expenditures on new plant and
equipment by businessmen seem likely to be well maintained and they may even
increase more than is currently anticipated if visible progress is perceived in the
fight against inflation. In the housing area, some decline from the current high
level of activity seems probable as financial restraints exert a retarding influence
on both builders and homebuyers. Nonetheless, the severely depressed conditions
that have periodically affected this sector of the economy will most likely be
avoided. Adequate financing will continue to be available thanks to the wide
range of government support programs and the access of home-lending institutions
to market sources of funds such as the new 6-month certificates. Prospects for
our trade balance in 1979 also seem to be brightening.
In your letter inviting me to these hearings, Senator Bentsen, you have asked
for comments on the appropriate mix of fiscal and monetary policies. In the area
of monetary policy, the restraint that has been put in place is achieving welcome
results in the form of a reduced rate of monetary expansion. As may be seen
from charts 6 to 8, the monetary aggregates have generally moved into the ranges
set by the Federal Open Market Committee. The Federal Reserve is determined
to achieve a rate of monetary growth that is consistent with the objective of
fostering a decline in the rate of inflation while encouraging moderate economic
expansion. The Federal Reserve's task will be eased immensely if fiscal policy
remains on the course outlined by the President. Large budget deficits tend to
put upward pressure on interest rates as Government demands compete with
private demands for funds. It is therefore essential for the Congress to resist
programs that lead to increased expenditures. A reduced Federal deficit, including
borrowings by off-budget agencies, would ease pressures on interest rates and
allow the Federal Reserve to achieve its monetary growth objectives at lower
interest rates than otherwise. A reduced budgetary deficit would also foster a
financial environment that encourages greater business investment and would
improve the prospects for a period of sustained economic growth and a moderating rate of inflation.

196
Chart I

Change from previous period,
annual rate, per cent

- 5

Per cent

_

8

-7

6

5

Change from previous period,
annual rate, per cent

_

nfl

10

5

0

1974

1975

1976

197
Chart 2

DMPONENTS OF FINAL SALES
972 Dollars

Trough, 197501=100

Residential Construction
160

140

120

100

198
Chart 3

Annual rate, millions of units

PRIVATE HOUSING STARTS
Total

2.5

2.0

1.5

1.0

I

I

I

I

Change from previous period,
annual rate, percent

I)EPOSIT GROWTH AT
'HRIFT INSTITUTIONS

_

_

15A\/\ _

X

/

20

10
5

I

I

I

I

OUTSTANDING COMMITMENTS AT
SAVINGS AND LOAN ASSOCIATIONS
35
30
25
20
15

1 974

1977

1 978

. 199
Chan 4

EXCHANGE VALUE OF THE U.S. DOLLARF*

March 1973=100

104

96

92

88

84

96

92

88

84

I Sept 78
* Index of weighted average 1 G10 countrIes Plus SwItzerand
Weights ore1972-76 g9ob.l trade of each of the 10 countrtd-

80
a79

200
Ch.rt 5

U.S. MERCHANDISE TRADE
AND CURRENT ACCOUNT BALANCE

201

Recently Established M-1 Growth Ranges and Actual M-1

202
Chart 7

Recently Established M-2 Growth Ranges and Actual M-2

Billions of dollars
945
,

930
91

03'78-03'79,
-915

-o'

-s'evwx

870
- 9

- ,,s'ezsx
-v

900

9%

02 '78-Q2 '79
--

885

j870

855

810

885
795

01 '78-01 '79

-

- 1%

870

-885
9%~~~~~~~~~8

-6~
,,G%%
-870

--

04 77-04 '78I
-~~~~~

--

1~~~~~~~8
4825

81(

1977

1 797

203
Charma

Recently Established M-3 Growth Ranges And Actual M-3

Billions of dollars
_ 1640
10% - 1610

03 78-03 '79
,"

1 580

1520
1490
10%

- -

-fS

If,,"

_ 1550

-2152
I~e78-02'78

-

]s';sss
1490

--

1370
-

-

01 78-01 '79
-- -

--

]14
I15
1550

~~~"10%

1340

"'710%

~~~~~~152

1520

~~~~~~~14

10%

04 '77-04 '78

1979

204
PROGRAMS To REDUCE STRUCTURAL UNEMPLOYMENT

been
Conventional aggregate demand management policies historically have have
generally
the major instruments for reducing unemployment. The policies associated with
been most successful in situations where unemployment has beenhowever, is not a
cyclical contractions in economic activity. Some unemployment,
consequence of deficient aggregate demand, but rather is a reflection of persistent
structural impediments in the labor market. In such cases, traditional monetary
unemployment rates
and fiscal policy actions alone can not achieve desirably lowFor this reason, our
without generating unacceptably high rates of inflation.
arsenal of weapons to combat structural unemployment should include training
programs as well as selective Federal policies to promote the creation of jobs.
Aside from their other benefits, such programs can enahance long run prowith
ductivity growth and ease the inflationiary pressures often associated when periods
jobless
of high employment. As the economy approaches full employment,
are relatively low,
rates for certain categories of workers (particularly skilled) remain unacceptably
unemployment rates for several groups within the labor force
on
high. A scarcity of skilled workers puts upward pressure the wages and prices,
prime benefits of
and can inhibit economic efficiency and growth. One of
structural employment programs is that they increase the supply of workers
upgrading-at
available both for entry level jobs and-through the process ofhigher levels of
higher skilled positions. The net result is increased efficiency,
output and income, and further advances in employment.
go
The social rewards of creatively-designed structural employment programs
these
beyond near-term readily measurable economic variables. To the extent that stock
our Nation's
programs contain a training component, they directly increase for young peopleof human capital. But, perhaps more important-particularly world of work and
are the benefits associated with the positive exposure to the
the reduced dependency of participants on the government's income support
systems.
PROGRAM PRINCIPLES

improve the
Policies to reduce structural unemployment should be designed to skills needed
of the work force, facilitate the flow of information about my view, the
quality
in a growing economv and provide for effective job placement. In to ameliorate
following principles should be embodied in programs intended
structural unemployment.
growing
Emphasis should be placed on preparation for and direct placement inthe bulk
the years the private sector has generally provided
industries.-Over
of the net increase in payroll employment; reflecting this, structural labor market
empolicies should be aimed at identifying and meeting needs of private sector
found in smaller
Moreover, many job openings in the private sector are a decidedly local
plovers.
businesses. Thus, structural labor market policies should have
emphasis.
local employers,
The design and operation of training programs should include are likely to be
and public officials.-Training and guidance programs
educators,
their needs.
most successful when employers have a direct role in specifying an increased
Indeed, participation by business in such programs often leads to the willingwillingness to hire graduates or provide on-the-job training. Similarly, to the world
ness of educators to adapt curricula to provide students an exposure employment
of work, and the commitment by community leaders to direct their likely to be
and training funds to meet the needs of the local economy are most
forthcoming when they are direct participants.
More generally, incentives to create jobs for the structurally unemployed should
be provided and disincentives should be eliminated wherever possible.
SPECIFIC PROGRAMS

CETA title VII.-The Administration has recognized the importance of coordinating training programs with private sector needs in its funding authorization for Private Sector Opportunities for the Economically Disadvantaged,
which has been included as Title VII in legislation reauthorizing the Compreis
program
hensive Employment and Training Act. I strongly support this the local which
business
designod to demonstrate the effectiveness of directly involving and operation of
community-particularly small businesses-in the planning
training programs.
Local Private Industry Councils will be created by each CETA prime sponsor,
and, in cooperation with the sponsors, these councils will have the opportunity

205
to direct the use of funds for private sector initiatives.
The activities allowed
by the legislation are sufficiently broad to encourage
innovvation. Employers,
educators, and manpower planners should be able
to
will help meet the demands of private businesses for develop new linkages that
specific work skills by providing coordinated training and direct placement of
the structurally unemployed
in permanent private-sector jobs. The needs of the
unemployed and their future
employers should be better served by such a cooperative
arrangement than by the
traditional approach of large training efforts, which
on the fullest possible knowledge of the needs of local may not have been based
employers. The main thrust
of this program is efficiency through local decision-making,
but a national leadership role-on the part of the Labor Department
Business-is provided to assure technical assistanceand the National Alliance of
of ideas. I strongly urge Congress to act quickly in and to facilitate the sharing
appropriations for this program recommended by granting the $400 million in
the President as part of the
1979 supplemental budget request.
Programs to facilitate the movement of youths from school
into good jobs.-The
transition from school to work is a critical period in
transition which has not had sufficient attention in a youngster's life. Yet it is a
national policymaking. The
nonprofit National Manpower Institute has been promoting
the establishment of
'community education-work councils. There are currently
ing, funded either by the Labor Department or nonprofit over 30 of these operatsponsors. These councils
are comprised of government, education, business,
and
Their purpose is to collaborate with educators on relevant labor representatives.
work-study opportunities, and to help improve placement curricula, to develop
guidance activities for students. This is an important assistance and career
effort that should be
expanded.
In addition to education-work councils, other ways
strengthen the linkages between private sector businesses must be developed to
and secondary schools.
Such programs can afford yougsters the opportunity
the world of work before they make career decisions. to learn first-hand about
One plan that has been successful involves the "adoption" by business of a
school. In this arrangement,
young people are given an opportunity to experience
what adults actually do on
the job. These programs should include hands-on
as much in-plant and in-office involvement as can activities where possible, and
be managed. It is important
that these programs have the full support and cooperation
parents, and educators, and that the work-place experience of business leaders,
be intergrated into
formal classroom activities.
The Youth Employment and Demonstration Projects
Act signed in August
1977 has funded a series of demonstration projects
designed to indicate the feasibility of cooperative efforts by employers, schools, and
community organizations
to provide special career development assistance to
youths. Other experimental
efforts under the Youth-Act umbrella are testing the
value of guaranteed work
opportunities for youths in order to encourage them
to stay
and finish their classroom education. These demonstrationin school or to return
projects should be
evaluated carefully, keeping in mind the goals of
developing mechanisms for
continued cooperation among schools, employers,
and community leaders, and
the emphasis on serving the needs of the private sector.
Eliminating barriers to employment.-Many studies
wage significantly limits employment opportunities indicate that the minimum
for entry level workers,
mainly teenagers. Nevertheless, the House of Representatives
defeated in 1977
(by only one vote) an amendment allowing employers
to pay teenagers 85 per
cent of the Federal minimum wage during the first
six months of employment.
Some such legislation should be reconsidered in light
of the 11% million teenagers
who have been looking for jobs in recent months.
Incentives to create jobs.-In addition to providing useful
skills and career guidance, a comprehensive employment policy should
private-sector jobs for the structurally unemployed. include incentives to create
Congress has recognized this
need by incorporating a targeted employment tax
credit in the Revenue Act of
1978. Under the provisions of the tax code, employers
50 per cent of the first $6,000 in wages paid during the are allowed credits up to
workers who are certified as disadvantaged; the credit first year of employment to
drops to 25 per cent of the
first $6,000 in wages paid during the second year
of wages qualifying for the credit cannot exceed of employment. The total amount
30
unemployment insurance wage base for the year. To per cent of a firm's aggregate
receive the credits, employers
must certify that employees added to payrolls have
family incomes less than
specified amounts. Also, the plan is aimed primarily
at improving job opportunities
for young people aged 18 to 24.

206
is an important setp toward
In my view, this type fo private sector involvement
problem, and Congress should consider
alleviating our structural unemployment to private employers. Other possibilities
enlarging the scope of incentive grants
and payroll tax credits. These
that should be investigated are wage subsidies creating new jobs, thereby imwith
would directly reduce labor costs associatedcosts of hiring and training the strucmediately compensating employers for the grants have been tried in France with
turally unemployed. Payroll tax incentive
participation by private employers.
considerable success as evidenced by broad
however, should be governed by
design of any program of incentive grants,
The
remedies, they should be restricted
certain principles. To be effective as structural
target groups. At the same time, the
to workers being hired from appropriate so as not to place an undue certification
selection critieria should be broad enough
essential that reporting requirements and
burden on employers. Furthermore, it is
should be minimized to increase
other "red tape" associated with the subsidies
their attractiveness to small employers.
efforts should be made to promote
In implementing incentive grants, strong regard, Private Industry Councils,
this
business participation on a broad scale. In now awaiting Congressional appropriaauthorized under Title VII of CETA and
information on existing employment
tions, can be instrumental in disseminating
local business leaders. In addition, the
tax credits and in encouraging support by
vehicle for facilitating placement of the
Industry Councils can be an effective
employers in the process of certifying
structurally unemployed and for assisting
workers eligible for the credit.
the payment of a tax credit to firms
Another incentive-type proposal involves
areas. Congressional leaders have
that locate or expand in high unemployment depreciation allowances and an inshown increasing awareness that accelerated
spur business investment. In an effort
crease in the investment tax credit would
jobs in hign unemployment areas,
to revitalize our Nation's cities and to create merit of supplementing any general
Congress also should investigate the possible
incentives for business exoansion
policies to stimulate investment with differential
areas. An alternative that could be conand renovation in high-unemployment
for firms in those areas to dissidered is a speed-up in allowable depreciation should study these tax incentives
Congress
courage them from moving or closing.
of job opportunities in the private
as possible methods of promoting the growth concentrations of the structurally
sector, particularly in areas with the greatest
unemployed.

members in the
Senator BENTSEN. The Chair will recognize the questions to 5
and we will limit their
order in which they arrived
many here and each
minutes on the first round because there are so
interest.
wants to deal with his area of
of attendance, which
Mr. Miller, this committee has had this kindhearings and we have
we started these
is excellent attendance, since
this committee than we
had more people applying for membership ontheir deep concern about
that reflects
have had in a long time. I think
of those problems.
the problems facing the economy and the complexity
in your testimony.
That is why we are so interested
and that
of
One of those concerns is the questionthis productively what with
committee,
of
concern is shared by many members eight-tenths of 1 percent, one
productivity dropping last year to some
do you think we
of the lowest of all the industrialized nations. What
product into capital
can do to get a larger segment of ouir nationalincrease that fraction?
formation? What in your view is the best way to
of the investment
Is it accelerated depreciation? Is it liberalization fixed assets on a
business to write off
tax credit? Should we allow
replacement cost basis?
What do you think would be most effective?
that our producMr. MILLER. Mr. Chairman, there is no question to our economic
is a long-term threat
tivity has lagged seriously, which
low rate of productivity gains
progress. It is very alarming to see the the high rates of the first two
recall
in recent years, especially if we
States led the world
decades after World War II in which the United

207
in productivity; this was the basis for real increases
in the standard of living for Americans for a long in real income and
going to be able to continue such gains unless we do time. We are not
solve this problem.
The problem divides into several parts. One part
is
and skills of the work force. For reasons of demographic the experience
and social less
experienced workers have joined the labor force;
but that will show
change, improvement in the next few years, and will
The second major area of concern is investment. Our be encouraging.
relation to our labor force has been dropping steadily.capital stock in
We are falling
behind other nations very seriously.
To answer your question about how we can reemphasize
investment
as an essential component of productivity gains
and expand our
investment until we are once again leaders in technology
tivity, we have to look at two factors: business conditions and productivize investment, and fiscal policies that incentivize that inceninvestment.
To the extent we can create more certainty about
our successand to the extent we can succeed-in bringing
inflation and introducing more economic stability, down the rate of
we
nesses' investments. But it it still important to pursuewill aid busisome of the
ideas that you have just suggested.
In my view, the most important incentive for increasing
business
investment would be faster rates of depreciation.
The reason for
that is as follows: it is the approach with the best
trade off between
costs to the Treasury and benefits in incentivizing
investment. If
we try to create incentives for investment through
higher investment
tax credits, it takes quite a loss in Federal revenue
in
enough of a benefit in the analysis of discounted cash order to create
business investment decisions. That is an expensive flow to change
least a more expensive way than higher depreciation, way to go, at
in
Accelerated depreciation, on the other hand, has my opinion.
a significant
impact on discounted cash flow calculations. For
possible to write off all production machinery andexample, if it were
years, it would mean a much more rapid recapture equipment over 5
means that a business making its calculation on the of capital, which
ment would find investment more favorable. But return on investmeans only a deferral of taxes, so the cost to the faster depreciation
less to get the same result; there would be more Treasury is much
by going to accelerated depreciation, in my view, bang for the buck
than by going the
investment tax credit route.
As far as allowing depreciation on replacement
generally opposed that approach for several reasons. value, I have
One is that it
might work contrary to our objective: it might
be an incentive to
keep old machinery and equipment in operation,
because the older
it is the more would be the depreciation in relation
to its current
replacement costs. Productivity might not be as
important to the
calculation as the increased depreciation using replacement
value;
an obsolete plant would be retained because of
value even though it should be scrapped. But more its depreciation
that, a higher depreciation on existing plants and importantly than
no incentive to modernize. It onlv increases the cash equipment gives
flow to businesses
with a cost to the Treasury and without a direct
linkage to new
investment.
Senator BENTSEN. Mr. Miller, I am going to interrupt
you because
I have 1 minute left of my time.

208
excuse me.
I want to get one more queston in here.
with
again we have seen us trying to stop inflation
Time and time
tight money and high interest rates.
we have tried to bring it
Often it has led us into a recession. Then
mix between fiscal and monetary
out with tax cuts and our policy
in massive deficits, and a
policy gets really badly out of line resulting
but penalizes capital formation.
mix that it encourages consumption
has proposed-it
Now the t-ight budget that the administrationfiscal, easier monetime for a tighter
seems to me-provides an ideal
tary mix.
we going to get the easier
Now, where is the Federal Reserve? Are
money that such a change in the mix implies? we are going to encourif
Aren't we going to need something like that to lay a basis for price
and productivity and try
age capital spending
stability in the future?
far better in my view, and
Mr. MILLER. Mr. Chairman, it would be to be made more toward
for the mix
in the Federal Reserve's view,
in fiscal policies, and toward
austerity in Federal spending, austerity
in monetary policy; that would have
more latitude for moderation
many, many benefits.
spending as the force to
To the extent that we have used Federal greater competition for
stimulate the economy, wve have created
We have thereby put
private capital from the Federal Government.
Federal deficits, and we
ourselves on the treadmill of ever increasingof capital to the private
and cost
have impeded that availability
achieve the kind of growth,
sector which is essential if we are going to
we
stability thatv all seek.
productivity, employment, and price
as it
to see the possibility again developing, direcSo it is encouraging
about and some new
appears to be now, for some new attitudes
policy.
tion in the mix between fiscal and monetary
in no way offer an
hasten to say that that shift in policy can trying to restrain
Let me
the pressure on
excuse for us to let up prematurely
from very high inflationthe forces of inflation. We are still suffering
and it is critical that we stay firm in
ary tendencies in the economy,
toward containment. But
the confluence of fiscal and monetary policy if the economy begins to
we be alert, so that
it is also important that
for encouraging moddrop to too low a level of activity the potential side, rather than from
from the monetary
erate economic growth come
again.
opening up spigot of fiscal policy oncemorning they are organizing the
Senator BENTSEN. M\/lr. Miller, this
to show up so that I remain
Finance Committee and I want to be sure to recognize Congressman
I would like
on it. In the meantime,
Reuss for his questions.
Chairman.
Representative REUSS. Thank you, Mr.
like myself, is conM\liller, I know that the Federal Reserve,
Mr.
of conglomerate takeovers. Conglomerate
cerned about the problem
economic power. There
takeovers can present a problem of excessive economies of scale, no
where there are no
are frequently takeovers
no faltering manageincreased exports, no efficiencies in distribution,
It is pure empire building.
ment to be taken over.
concentration. If a
Second, they present a problem in political districts, for example,
in 218 congressional
conglomerate gets a foothold
good position to be in.
it owns the United States, which is a pretty
MILLER. Oh,
Senator BENTSEN.

Mr.

209
Third, in a time of inflation, conglomerate takeovers may
represent, it seems to me, a misuse of scarce credit resources. well
Conglomerate takeovers don't result in any new plant and equipment,
they simply result in a bidding up of financial pieces of paper.
Fourth, and here the point of the American Express-McGraw-Hill
takeover is symptomatic of what frequently happens, they lend themselves to conflicts of interest. For example, the banks involved in that
takeover offer-which is currently at $40 a share level-Morgan
Guaranty, Chase Manhattan, Manufacturers Hanover,
Bank, First National of Chicago, Continental Illinois-own,Chemical
their
trust accounts, about 12 percent of McGraw-Hill's commoninstock.
Just one of these banks, Morgan Guaranty, stands to make a rather
tidy $26 million profit for the beneficiaries of its trust department
if
the sale at $40 a share goes through. There are, of course, additional
nonfinancial conflicts of interest involved in the matter, too.
My question is really twofold:
First, does the Federal Reserve, in its relationship with the banking
system, have a policy on conglomerate takeovers, at least those
that
don't involve a failing company to be taken over?
Second, has the Federal Reserve given thought to reversing what
it
did last August? Last August, you recall, the Federal Reserve reduced
from 4 percent to zero the reserve requirement on Eurodollar borrowings by U.S. banks. Those Eurodollar borrowings tended to be by
the
very multinational American banks, such as those I just named, which
are also big in the conglomerate takeover financing business.
I realize that the reduction in the reserve requirement from
cent to zero was due to a desire on the Fed's part to help the 4 perdollar
in its balance-of-payments problems, but I question
whether it really was of much help there. I inquire whether very much
it wouldn't
be a good idea to turn off this reserve-free supply of takeover money
which is sloshing around the world, some $500 billion in Eurodollars
alone.
Would you address yourself to those two questions?
Mr. MILLER. Congressman Reuss, let me, perhaps, give you a little
background on the takeover situation.
We had a rash of takeovers in the late 1960's,
which actually resulted in new legislation, becauseasofyou will recall,
which there seemed to be nonproductive activities in the degree to
mergers and
takeovers.
My view, expressed at that time, was one of personal concern about
business activity that did not contribute to a more efficient economy
and took place either plainly for empire building or perhaps
for
arithmetical considerations-mergers that had more form
than
substance.
We see, for new reasons, a rash of takeovers recently. One reason
is that, because of the economic course of this Nation over the
dozen years and the emergence of rates of inflation that we last
never before seen in peacetime, and because of the effect that have
that
phenomenon has had on the pricing of equity securities, there exists
a very, very peculiar market: It is literally cheaper to buy existing
assets to obtain production capacity than it is to build new ones,
because those assets are often selling well below their book value
and
substantially below their replacement value.

46-126 0 - 79 - 15

210
however,
So the reason this activity comes about is understandable, though
that the economy may not benefit even
I share your concern
one can understand the reason for the phenomenon. been considerable
The Federal Reserve, in the past, when there has
guidance to
merger activity, has occasionally given administrative
they be cautious on nonproductive loans.
banks, suggesting
because it is
We have been reluctant to do that during this cycle
what is nonproductive. Despite the concern you and
so hard to judge
cases where capital is sterile,
I share for this phenomenon, there are management is inadequate in
poorly, where the
where it is working
that somefinding a higher and better use for capital. The challenge certain disyou over unless you do a good job places a It is a very
one may take
cipline on the economy that we don't want to destroy.
hard area to judge.
conditions in the economy
Our preference has been to bring about system, that would reduce
a sense of value to the
that would return
to more normal
the tendency for these takeovers by getting us back as good. I don't
the economics of takeover aren't
conditions where
say that we
know whether we should be doing more or less. I merely where the
been reluctant to try to administer an area
have, so far,
yardsticks are so imprecise.
requirements
Now, as far as the action in August to reduce reserve reserves so
effort there was to lower
on Eurodollar borrowings, our
dollar funds
to
that a higher rate of interest could be paid and,attract
thereby, take some
into our economy
abroad and pull them back
of the liquidity out the of Eurodollar market. and I don't think the
The Eurodollar is a big issue, as you know, in what should be a
action taken on November 1 is the last chapter
the liquidity that
continuing effort for us to understand and deal with it more difficult
make
exists in that market, because that liquidity can
and worldfor us to deal with the inflationary problem, both domestic
wide.
funds may
Now, the extent to which the ability to attract those for financUnited States
have caused more funds to be available in the is of concern to us. Yet,
ing takeovers rather than for productive loans
other. So far, we
against
we are trying to balance the one problemtaken arethe
moderate and have
that we have
have felt that the actions
has contributed
not really created any excess liquidity in the state that
to this phenomenon.
monetary
Evidence now indicates that the growth of the various conditions,
loan demand is falling; and that
aggregates has slowed; that
the balance that
perhaps, are beginning to move a little more toward
you are concerned about.
avoids the kind of activity
a more precise
There is a problem, and I wish I could give you of whether to
with the tough decision
answer. We are always faced
not beneficial to the
add a regulation to correct actions which are to correct such a situupon macropolicies
economy or whether to rely
time.
ation, although they will take a bit more a very responsive answer.
Representative REuSS. Thank you for
indicated that
Senator PROXMIRE. Before Senator Bentsen left, he
would be as they came in. That means that
a recognition of members
Mitchell, SenI am next and then Senator Javits, then Congressman Heckler, and
and Congresswoman
ator Jepsen, Senator McGovern,
Congressman Brown.

211
I say that because it will seem like a strong Democratic bias, because
that is just the way it is.
Representative BROWN. That would be the last thing I would
suspect.
Senator PROXMIRE. I am sure it would be the last thing you would
suspect.
Mr. Miller, all of us are concerned as the chairman of this committee
indicated earlier, with the very, very high interest rates, close to a
record high, punishingly, cruelingly, painfully high, and interest
rates that just don't seem to have the kind of bite they should have,
that they have had in the past.
In the past when the Fed followed a tight money policy, it got
results. The economy slowed down, there was a lot of moaning and
groaning and complaint and criticism but the inflation was retarded.
Now, it seems you are riding your way right up. You talk about
structural unemployment policies. I think that you should be concerned with structural monetary policies, particularly in the light of
what I think was a subsequent criticism by William Griggs of the
Schrader Bank & Trust, who argue the Feds' efforts to slow inflation
have been increasingly ineffectual and that you are losing control of
monetary policy.
Let me just list some of the points that are made here.
One, these are the changes that he points out, one, the easing of
ceilings on what financial institutions can be paid for money. Most
dramatic was the introduction in the summer of 1978 of the 6-month
savings certificates by which banks and thrift institutions could beat
out even the U.S. Treasury for funds, a development that has done the
most to weaken the Fed's grip on monetary policy.
Second, the astonishing growth in trading in interest rate futures
which has gone from zero in late 1970 to a $378 billion industry by
January of 1979.
Third, the movement to floating rate loans by financial institutions.
Because banks now merely pass on the higher costs of funds to borrowers, higher interest rates have lost much of their bite and the problem as far as the banks are concerned.
I would point out in the second quarter or third quarter bank profits
have gone right through the roof.
Fourth, the rapid growth of these sections of the financial markets
lie outside the Fed's jurisdiction. Nonbank institutions are in competition for loan funds that have left the Fed system.
Five, new lending techniques, such as 5-year car loans, graduated
mortgage payments and so on.
Six, proliferation of foreign banks in the United States. This has
been matched by the growth of the U.S. bank activities overseas with
access to funds that the Fed cannot control.
Seven, the housing sector's fast growing attempts to tap national
money markets for sale of mortgaged bank securities. There are two or
three other elements, too, that indicate that monetary policy is much
more difficult now to get a bite on and restrain than it was a few years
ago.
What is your comment on that?
Mr. MILLER. Senator, I would tend to disagree with this analysis
because I think it is too simplistic. There is a rationale that says

212
that our policy will probably result in greater likelihood that inflation
will be controlled in the long term.
The suggestion that policies pursued earlier in this decade were
successful in controlling inflation is false, on the record. aHigh interest
very
rates in 1973-74 were a contributing force toward and the major
worst
recession with high unemployment, high social costs,
since the 1930's depression. And, we didn't
economic downturn
a high
eliminate inflation, we merely brought it down temporarily to
as Federal deficits mushroomed in response to
base of 6 percent. Then,
the
the recession, we started once again on the treadmill, feeding
flames of inflation.
are
The policies that are being pursued now are different. They to
down the economy on a more balanced basis;
intended to slow
avoid the dramatic, draconian effects of high amplitude swings;
us
to slow us down to a more moderate rate of growth; and to permit
period of time.
to continue in that mode for a longer
The effect in the economy is, I think, more successful if you avoid
those sharp swings. The introduction of the 6-month money market
certificates was designed technicallySenator PROXMIRE. Let me just interrupt, Mr. Miller.
Mr. MILLER. Yes.
Senator PROXMIRE. The difficulty is the objective which is to slow
obinflation. That is one of the big objectives, that is the principal
be working.
jective and it doesn't seem to
Here we have very high interest rates, we continue to have prices
rising very sharply, and where are the results?
It is true that the economy is being cushioned. Housing is cushioned.
it is
I just got a question from the staff that I will not ask because
obvious what the answer is.
pretty
How could we cushion capital spending? If you cushion everything you don't have the unfortunate painful effects of retarding
to
inflation by slowing down the economy. You are just not able
have that effect. They are not there, are they?
Mr. MILLER. I just wonder if the comment that we have high interest
rates is realistic.
Senator PROXMIRE. You wouldn't deny they are high, would you?
Mr. MILLER. What does "high" mean? Do we mean nominal
interest rates or do we mean the real interest rates?
this
One of the problems is that we have never experienced in nor
such prolonged high rates of inflation
country, in peacetime,
that
the corresponding and inevitable high nominal rates of interest
go with high inflation.
the
So the pressure is on: interest rates are high, and, therefore, were
But the truth is that real interest rates
situation is dreadful.
higher in the 1930's, when we had a depression.
One of the difficulties in getting the bite you want is the tolerance
reflect both
that the Congress has for making nominal interest rates lower today
rate of return. Real interest rates are
inflation and a real
they are in a
than earlier in this decade. I happen to believe that restraining the
to do the job, because they are
high enough range
down. Inflaeconomy and the growth rate of the economy is coming eradicated in
up over 12 years is not going to be
tion that has built
of
one quarter or two quarters or in 1 year by any sensible degree
restraint.
monetary or fiscal

213
Senator

PROXMIRE. My time is-

Mr. MILLER. It will take years to work inflation out. Inflation has
now become so deeply embedded in our economy that we are going
to have to pull it out by the roots if we are serious about getting rid
of it.

Senator PROXMIRE. My time is up, but the last quarter that we
have indicates that the economy was moving along at what, a real
increase of, a real growth rate that was far above that was anticipated
and certainly that doesn't indicate a slowdown.
Mr. MILLER. I should mention that I don't think it is wise to
concentrate on one quarter; you could say, then, that the third
quarter was lower than you expected.
You have to look at what's happening over a longer period of time.
In the first quarter last year, there was zero percent real growth; in
the second quarter, when there was a catchup and some anticipatory
buying because of inflation, real growth was 8.7 percent, which put
considerable pressure on; the rate came down to 2.6 percent in the
third quarter; and it was at 6.1, tentatively, in the fourth quarter,
which is too high. The average growth rate for the year was a bit
over 4 percent.
So we are at least beginning to get the average rate down; we need
to get it down lower. But I don't think it would aid our cause to
push our economy into a recession, because I am sure that would
pressure everyone to get back onto the treadmill of spending our
way out of the recession and back onto the path of more inflationary
pressure.
Senator PROXMIRE. Senator Javits, you are next.
Senator JAVITS. Thank you, Senator Proxmire.
First, let me welcome you, Mr. Miller, to the committee. You
already went into your presentations here and have shown yourself
to be an authoritative commentator and also director on the modern
scene.
I gathered from the press that you had some differences with the
expectations of the administration on which the President's Economic
Report were built. And that those related to forecasts in the various
critical fields of our gross national product, real increase; interest rates;
unemployment; and so on.
Now, one, is that so; and, two, what are the implications for the
Feds' policy, if it is so?
Mr. MILLER. Senator Javits, I would say that, on net, there is no
serious disagreement between our view and the economic plan submitted by the President. The comment I made the other day was
that I thought the outlook for inflation was somewhat optimistic and
that perhaps inflation wouldn't come down quite that rapidly.
I did not, however, suggest that the real rate of growth of the
economy in that plan was not reasonable, nor that its other forecasts
were not reasonable. I did think-and I still do think-that the degree
to which it anticipates inflation will abate is a little optimistic; I
don't think inflation will come down quite that fast.
Now, there is an interaction between the inflation rate and Federal
revenues that comes down to the bottom line of the Federal deficit
that we are talking about in connection with the budget situation.
If inflation is, in fact, higher than the administration has indicated
in its budget plan, then revenue will be higher. Correspondingly, if

214
inflation is higher, costs will also be higher because of the inflationary
right
impact on costs. On the other hand, if the administration is
or inflation goes even lower, then revenue will be
about inflation
lower but costs will also be lower.
So, one doesn't reach a substantially different figure for the Federal
deficit based on differing inflation estimates.
The problem comes if there is disagreement on unemployment.
unemployment,
Because if, in fact, there is a serious error in estimating situation. Some
have a completely different budget
then you might
rate
commentators-not the Fed-have felt that the unemployment
under the conditions that are likely.
would be higher
expect
one
For every 1 percent increase in unemployment,deficit. can is from
It
$20 billion or so increase in the
something around
risk in
that source that some commentators feel there is a degree of
I don't believe so.
the budget estimates;
more people
Productivity gains have been low, and that means that not likely to
to produce for the same output. So we are
are employed
economic
see really serious increases in unemployment at the level of
projected.
activity
be about the
My view is that unemployment, on the averae, will figure at year
1979 calendar year as in 1978, although the
same in the
end 1979 may be slightly higher.
So I come out, on net, believing that the bottom line of the budget
be
figure-the deficit of $29 billion-is reasonable and should
achievable.
different
I do believe that unemployment will not be significantlysomewhat
budget plan. I do believe that inflation will be
from the
higher.

Senator JAVITS. My time is up, but I would like to make a request
of you, Mr. Miller.
credit and
I am very deeply worried about rising installment upon highly
credit which is based
especially the inflated mortgage
be
would
inflated costs of homes, both new and old. Therefore, the Fed you
thinks
the record with what
good enough to furnish us for
about that and whether or not, with the uncertaintyto respecting
deal with
unemployment, we ought to make some provision in law payments.
of homeowners to keep up with their mortgage
the ability
Mr. MILLER. I will do that.
in
Senator JAVITS. I ask unanimous consent that that be included
the hearing record.
SenatorBENTSEN. Without objection, it will be done.
the
[The following information was subsequently supplied for
record:]

strong during the
The rate of growth in household borrowing has been quite
in business activity-well in excess of the expansion in disposable
current upswing
debt levels and debt
personal income since early 1977. Although total household than in comparable
higher at the end of 1978, relative to income,
repayments were
indications of a serious
periods of earlier postwar business cycles, there are no
in the ability to service this debt.
deterioration
part of the increase in
Recent survey information suggests that a considerable
accounted for
installment debt-at least between 1970 and 1977-was to carry debt.
consumer
families that presumably have greater capacity only in the past
by higher-income
available
Moreover, bank-card credit-which has become widely indebtedness even though
decade-is included in full as a component of consumer cards primarily as a subabout two-fifths of all card users activate their credit

215
stitute for cash or check transactions. Finally, other indicators of debt overload-such as delinquency rates or personal bankruptcies-on balance have shown
little sign of deterioration.
Taking such considerations into account, the Board believes that spending by
consumers probably will continue to grow about in line with income during 1979,
subject to some constraint posed by the larger burden of consumer debt, as noted
in my prepared testimony. This is obviously an area that bears close watching,
particularly if increases in consumer income should unexpectedly falter substantially.
Insofar as the burden of mortgage debt is concerned, home-owners should be
able to meet their mortgage payments promptly, and without undue strain in the
vast majority of cases, given the prospective environment of moderate general
economic growth involving further gains in income and employment. The Board,
accordingly, foresees no compelling need at this time for some kind of comprehensive mortgage payment program as an adjunct to broad economic stabilization
policies.
-

Senator BENTSEN. Mr. Miller, I keep commenting on the deep

interest of these members in these economic issues. And the attendance here shows the depth of sincerity of interest with all these members here in full. attendance and not a TV camera in the house.
[Laughter.]
Mr. MILLER. That says something for the chairman of the committee, no doubt.
Senator BENTSEN. Oh, oh, oh.

Mr. MILLER. Cameras usually come for you, I notice.
Senator BENTSEN. No.

Congressman Mitchell.
Representative MITCHELL. Thank you, Mr. Chairman.
Can you hear me?
Mr. MILLER. Yes, sir.

Representative MITCHELL. It is good to see you again, Mr. Miller.
Just one comment, first, before I get into a series of 15 questions.
The comment deals with your comments on structural unemployment. I visited more than 20 cities last year and in each one of those
cities, I made it a point not to just go to the hotel to speak, I go where
people are. And, frankly, I don't think the people that I talked with
in those 20 cities would believe you nor me nor any member of this
committee nor any Member of Congress when we say that we are
planning to do something about structural unemployment.
They have been lied to, they have been tricked, they have been
misled, they have been promised and the rate of black unemployment
and Hispanic unemployment remains just as high as it has been the
last 5 years.
These people don't believe in us anymore, and I can understand
why. With an administration enunciating a policy which anticipates
an increase in unemployment, I think you understand their cynicism
and their doubt.
You delineated a number of factors relating to structural unemployment and I agree with most of them. However, you failed to add oneand that is the matter of racial discrimination at the hiring gate.
If you can create a million jobs last year and not dent black unemployment at all across the board, then you must look at discrimination as a factor at the hiring gate.
That is my comment. I wanted you and the members of the committe to hear it.
We have passed the Humphrey-Hawkins act; it is now the law of

216
the land. There was a lot of snickering and laughter about it being a
meaningless piece of legislation. I don't think it is meaningless.
The goals of 4 percent unemployment and 3 percent inflation by
1983, I think are accomplishable if the Congress and all the agencies
of Government decide to do their work.
Under the law, you are required to develop aggregate money policies, monetary aggregates to achieve the goals of unemployment and
inflation by 1983.
What policies have you developed? What policies have you started
implementing, in terms of the Federal Reserve system, to achieve
those two goals by 1983?
Mr. MILLER. Congressman Mitchell, next week our Federal Open
Market Committee will meet to address that very question for the
first time. We have, under Humphrey-Hawvkins, a mandate to report
to the Senate and the House Banking Committees on the policies that
we will pursue and their relation to the objectives of employment,
inflation, productivity, and other factors in the Economic Report of
the President.
So we will be going through this exercise for the first time next week,
and on the 20th of February we will be reporting to the Senate Banking
Committee; on the 21st, to the House Banking Committee. By that
time, I will be able to give you an outline of how we hope to respond.
Representative MITCHELL. May I interrupt you, those are the dates
that you will have developed comprehensive monetary aggregate plans
to implement the Humphrey-Hawkins bill?
Mr. MILLER. No, our task is to indicate the monetary plan for the
single year 1979 and how it relates to other objectives.
Representative MITCHELL. I understand.
Mr. MILLER. Next July, we will come before those two committees
to indicate any midcourse correction for 1979 that we believe would
be necessary, and also indicate how we think monetary policy should
then operate into 1980.
We report in segments, as I understand it.
Representative MITCHELL. I have time for one more question, Mr.
Chairman, or is my time up?
Senator BENTSEN. If you haven't been advised, I assume you do.
Representative MITCHELL. I have a minute left then, I understand
this reporting is to be done on a semiannual basis?
Mr. MILLER. Right.
Representative MITCHELL. Twice a year?
Mr. MILLER. Twice a year, yes.

Representative MITCHELL. I think it would be a horrible mistake
to do your comprehensive planning on only an annual basis. I think
an annual review has been one of the problems of the Federal Reserve.
I certainly don't think it to be wise or prudent not to look at the
out years, during which you must achieve the goal.
I will be the first to admit that you cannot develop a plan locked
in concrete, but it certainly seems to me that you can establish the
parameters of a comprehensive plan to cover that time period.
Thank you, Mr. Chairman.
Senator BENTSEN. Thank you, Congressman Mitchell.
Senator Jepsen, we welcome you to this committee. We are delighted
to have you as a new member.

217
You may proceed.
Senator JEPSEN. Thank you, Mr. Chairman.
Mr. Miller, in both the budget and economic report, President
Carter indicates that inflation will be with us for some time to come.
You announced earlier that you felt it may be with us a little longer
and more severely than the President does. One of the effects of
inflation, as we all know, is that it pushes people into higher tax.
brackets, even though there may be no change in their real income.
In the State of Iowa, which I represent, there is a reasonable rate
of productivity; people work hard and have a national and statistical
reputation for being productive. But they also share, along with all
other Americans, the problem that the harder they work, the further
into higher tax brackets they get. Inflation does distort work effort
and business finances, and even leads to real capital losses when
taxes must be paid on money just in inflated capital gains.
I am sure you are aware of the important work done by Prof.
Martin Feldstein of Harvard, in this area. Thus, my question is,
isn't it time for us to finally consider indexing of the tax code in order
to stop inflation from raising taxes year after year in this manner?
Mr. MILLER. Senator Jepsen, I recognize the burden that all of us
bear from the effects on real income from inflation pushing us into
higher tax brackets. It is a painful consequence, but I do not believe
we can solve anything by trying to shelter ourselves by indexing
taxes. I believe we have to suffer that effect as part of the process of
trying to correct and address the fundamentals.
I do not think that indexing taxes would result in lower Federal
spending. I think the likely consequence, instead, is that Federal
deficits would increase. I would think that the need to finance the
Federal Government in such a case would put more pressure on capital
markets, and that the whole process of trying to achieve productivity
gains and to reduce the relative size of the Federal Government,
would be aborted. I think the only way we are going to solve the
problem is through willingness to cut expenditures before we cut the
taxes; if we index taxes, we are going to cut taxes before we cut
expen(litures.

It would be easy to l et automatic indexation produce lower revenues,
but it would still be up to Congress to find ways to cut spending,
and I don't think that the incentive would be there.
Senator JEPSEN. Mr. Miller, I appreciate what you are saying and
I agree, for the most part with cutting expenditures and government
spending, which is one of the root causes, in my lay opinion, for
inflation.

I would not recommend, and I am not recommending that the
indexing should be on a permanent basis.
Back at the ranch and away from our castles here on the Potomac,
young people cannot buy homes. They are finding it increasingly difficult to travel. As many others here have, I have come off a number
of months of very intensive people contact day after day and hear
the story repeated, that those who have saved all their lives now find
themselves in a very frustrating and very serious situation of not being
able to even remain in and keep the home that they have, and that
they have paid for, just because of the increase of the cost of normal
upkeep, utilities, insurance, and all the things connected with inflation.

218
and
So for those people-whereas, we can talk about philosophies the
and the whole thing, we might project and talk about
theories
years to come-their problem is now.
I would suggest that the real reason for President Carter's opposition
he
to indexing is based on his desire to get that extra revenue so that
achieve a balanced budget next year on the backs of the taxpayer.
can
The figures in the 1980 budget make it quite clear that the reduction
from increasin the deficit this year and in the future results primarily the growth of
rather than a reduction in
mng revenues due to inflation,
the
expenditures, which does not quarrel with what you stated toward
about a balanced budget.
end of your last statement
I think it is so serious that we should consider a temporary, at least,
indexing of the tax code.
Thank you, Mr. Chairman.
Senator BENTSEN. Senator McGovern.
Senator McGoVERN. Mr. Miller, this is not the first time-as other
members of the committee have pointed out-that we have been assured that tight money and high interest rates would cure inflation
without putting us into a recession. We heard the same arguments
several times over the last 8 or 10 years.
formula
Where do you obtain your confidence that this time this to work,
that has been tried in the past and found wanting is goingrecession?
a
that it is going to control inflation without putting us into state that I
Mr. MILLER. Senator McGovern, I would hasten to or wring out
don't believe that monetary policy alone can eliminate
in fiscal
inflation. I think it takes a combination of policies; discipline problem
an incomes policy to help bridge us over our
policy is a part;
is helpful; policy of balancing our international accounts is essential,
dibecause of the inflationary impact of a weak dollar; and policies
are also important.
rected toward improving our productivity
up-that I
So, I would be the first to say-to be sure to clear this job. Monealone can do the
do not claim at all that monetary policy
tary policy can contribute to the extent that it is consistent with, and
combined with, these other policies that are so essential.
to
In terms of the effect of monetary policy-in its restraining mode
we do not add demand-pull
bringing down the rate of activity so that
inflation to cost-push inflation and so remove the capacity of our
inflationary
economy to work off and digest and to eliminate theother policies
to which we can use monetary and
forces-the extent
in this mode to slow the economy and not dip into a recession, that
issue is, of course, of concern to all of us.
It is my view that a recession does not contribute to the solution.
Most recessions result in inflationary policies to overcome the distress
of unemployment-which they should-but that results in higher
deficits and we are back on the treadmill.
I
Senator McGovERN. Mr. Miller, if I can just break in there,
you say is true, that monetary policy is part of the
recognize what
colloqucy with
total package. I think I understood you to say in yourhigher inflation
that you were forecasting somewhat
Senator Javits
things do
before it tails off. If that is true-recognizing that these the deficit
that mean that the forecasts on
affect each other-doesn't
also are off and also the forecasts on unemployment?

219
In other words, if you are going to get higher inflation wouldn't
you also forecast a bigger Federal deficit than has been anticipated and
also a somewhat higher unemployment?
Mr. MILLER. Let me come to all those questions.
First, to clear up what I have said to Senator Javits, I am predicting
that inflation will come down, but not by as much down as was
predicted in the budget message. The difference is not which way we
are are going, but by how much.
Senator MCGOVERN. My point, though, is that if you disagree with
the budget projections, the budget message projection on the inflation
rate, doesn't that also throw off the budget projections on the deficit
and on the unemployment figure?
Mr. MILLER. Not in my view, because a slightly higher inflation
rate-that is, down from the present rate, but slightly higher than in
the budget message-means that there will be higher revenues to cover
the higher costs from higher inflation. The tax structure is such that,
if inflation is higher, incomes will be higher and the revenues will be
higher.
You are absolutely correct that if unemployment went higher than
planned, we would have a higher deficit. I was saying that it is my view
that the inflation projection is slightly optimistic, but that the real
level of activity predicted in the economy and the unemployment level
seem to me to be reasonable. That is why I come out as I do in the
mix of policies.
Now, may I go back to the fundamental question you asked: Why
do I have any degree of confidence that we are not headed for a recession as we apply these restraining policies?
Let me point out that, despite the simplistic approach that is often
taken as to business cycles, business expansions don't die of old age,
they die of some illness; they have to get sick first. Although this
economic expansion is 4 years old and will, in March, be entering
its fifth year, it is remarkably healthy. The economy is remarkably
balanced, and many policies have been pursued to keep it balanced.
So, there continues to be a large increase in employment and therefore in personal income and personal expenditures, the state of inventories is extremely lean and in good condition; there are lower
inventory-to-sales ratios than we have seen before. We don't have the
overhand, where plants shutdown so they can adjust their inventories.
Business spending has not gone through a boom period; it has been
moderate. But it is still going to show continued moderate growth.
The Government is a fairly neutral factor, but it is not overextended,
or about to drop. Our net export position is an improving one. The
one factor in the economy that looks like it will be turning dlown is
housing, which will come down from a 2 million level of annual starts
to 1.7 million or so.
So the economy is remarkably balanced and, therefore, that is how
I analyze the prospects of whether we can have a slower rate of growth
without a recession.
What is it that brings the-economy down? Most people have been
predicting it is going to slow down because it is x months old. I am
saying you have to find some other reason than age. That is the reason
I think we have a chance for moderation without it going into recession.
Senator McGOVERN. Thank you, Mr. Chairman, my time is up.

220
Senator BENTSEN. Thank you, Senator McGovern.
Congresswoman Heckler.
Representative HECKLER. Thank you, Mr. Chairman.
It is a pleasure to have you with us again, Mr. Miller. I would like
to say that I am encouraged by your forecast and see the rationale
behind the projections that you have made. Nonetheless, I am also
burdened by the knowledge that when the economy does slow down
nationally-or in other words, if the U.S. economy should develop a
cold-New England would get pneumonia.
I am concerned about what policies the Fed would take under these
circumstances. Now, just recently many economists have been saying
that even a mild slowdown could be traumatic for certain regions of
the country. I believe that Walter Bogley of the Bank of America
made that statement, and with good documentation.
What I am afraid of is that New England, which is your home region
and mine, could very well suffer a disproportionate recession or disproportionate injury economically, which it is least able to bear. At
the same time, I am wondering if the regional structure of the Fed
could possibly permit you to pinpoint relief to disproportionately
burdened sectors of the economy should that occur.
Would it be possible to have a split discount rate, under the correct
circumstances, which would justify its use where a bank could lend
to a small business and then discount the paper at the Federal Reserve Bank of Boston at a preferential rate, if the economy and the
data supported the need for that as a result of disproportionate trauma
in that region?
Mr. MILLER. Congresswoman Heckler, you have put your finger
on one of the problems with which we are struggling. We have a
national economy and national economic tools, and yet many regional
economic differences-not only in New England, but in other areas.
There are parts of the country now that are, if anything, overheated,
which creates a problem for us; and there are areas, New England and
other parts of the Northeast particularly, that are not doing as well
as the rest of the country.
That creates a serious problem for us, because money is fungible,
capital is fungible, and it is very hard to direct it toward a particular
sector. Possibilities exist, however, for doing things to deal with the
regional aspects of our economy.
If we are talking, as Senator Bentsen has about the need to incentivize investment, and accelerated depreciation as a possible tool,
then it is possible to tie accelerated depreciation to regions, so that
investments in areas with higher than average unemployment would
qualify for more rapid depreciation allowances. Such an approach
could speed up investment in areas where it is most needed to create
jobs. That idea has been proposed from time to time to Congress;
it has not caught hold yet, but I think it needs serious examination,
because we do need better tools.
The idea of a split prime rate for small business is not new; it has
been proposed not just for reasons of Federal Reserve policy, but for
good commercial purposes. Many banks have always maintained a
differential between lending to national concerns and lending to local
customers. In many parts of the country today, local businesses are
able to get lower rates than the prime rate quoted for a large credit-

221
worthy customer. When rates go down, local businesses usually get
charged a little more, so it sort of averages out as a way of keeping good
customers.
A number of large banks have begun to use a split rate prime rate
and for good commercial reasons. They feel that if they support small
businesses with lower interest rates now, they will be good and healthy
customers when they grow up. Whether or not we should actually
start to discount some of that paper at the Federal Reserve, I don't
know, Congresswoman Heckler.
At the moment I would prefer to let the industry make those choices,
but I would certainly be willing to reexamine that issue if the economy
behaves differently than we expect. Fortunately New England seems
to be doing a little better since I left.
Representative HECKLER. I doubt it. Then your response is you
would be open to the subject?
Mr.

MILLER. Yes.

Representative HECKLER. But your first response is you would
prefer the Congress legislate the answer concerning the depreciation
policy.

Mr. MILLER. Regional economic issues are quite often better
handled with fiscal policy than with monetary policy because, as I
say, money is so fungible that it will move around, but fiscal policy
can be tied to a region. Government can accelerate spending on high-

way construction in one area, for example. It can, as I say, legislate
better depreciation allowances for a particular region based upon economic data such as higher unemployment for let's say, 3 years. A
region could get a higher rate of depreciation for new investments, or
there could be other similar policies.
Representative HECKLER. Then it would seem that the regionalization of the Federal Reserve would not necessarily be a tool that you
would prefer to use. On the other hand, you have stated that if there
is a business slowdown, that you would prefer to see the monetary
response rather than a fiscal response. So we are caught in a conundrum
here.
Mr. MILLER. We sure are. There is a tremendous degree to which
our banks do participate in understanding and helping regional economies, when it comes to setting monetary policy. But if we expand
the money supply, it doesn't just expand in New England, it flows to
other places.
That is the problem with money. But it isn't inconsistent for the
Federal Reserve banks to help in other programs, such as the one you
suggest of finding a technique for helping smaller enterprises; that is
certainly worth examining.
Representative HECKLER. I am advised my time has expired.
Senator BENTSEN. Congressman Brown.
Representative BROWN. Thank you, Mr. Chairman.
Mr. Miller, I am fascinated by your opening comments with reference to structural unemployment.
I think your concern about structural unemployment is extremely
important because we in the Congress and business people and others
have to recognize that it has become a devastating problem for a good
segment of our society. The structurally unemployed are forgotten
people, in effect, in this effort to balance out the economy and to have

222
a recovery. I agree that we are stabilized at this moment with reference
to the economy, but we sure as heck haven't done much of a job for
the structurally unemployed.
As Congressman Mitchell has pointed out before the committee and
elsewhere, in the public sector that approach has actually been a
failure.
It certainly hasn't effectively cured the structural unemployed problem, and I might also add that the demographics show that in the
very short run, near future structural unemployment xvill be more and
more of a problem for minorities in this country; when you consider
that the black youths in urban centers already face unemployment
rates of above 50 percent, in some cases much higher than that, any
worsening of the plight of young blacks in our society becomes a very
serious problem. It is literally a ticking bomb that could explode on
our society again at any time.
Now, let me say to you that my area of the Nation has been a
leader in the collegiate work-study program, that is a semester off
campus in finding private employment. The vocational education
program which has been developed in Ohio has developed a number of
public specialized secondary schools in the vocational area geographically dispersed so as to meet the needs of localities.
We have also a number of 2- and 4-year technical colleges, also
geographically dispersed and charging low tuitions. These schools
have active local industry advisory committees to recommend what
courses should be taught to meet real existing job needs, and the
program seems to be working out relatively well.
I think that that is the linkup that is extremely important. So I
share your concern that training is given to the structurally unemployed to provide skills that are really needed in the labor market.
Wouldn't it be most efficient if the private sector provided on-the-job
training because the skills then would fit in existing jobs? Isn't there
some way that we could put the job needs and the job training and
the available personnel who have been partially trained together so
that we would not have training in unneeded skills?
Mr. MILLER. Congressman Brown, on-the-job training is one of the
most effective ways to deal with the problem; there is no question
about that. There have been impediments to it, as you well know,
and it has declined somewhat recently from the level that existed
before the CETA legislation.
I think you are absolutely correct, this is something that needs far
more emphasis. There is a probability that a trainee will stay with a
company where he has been getting on-the-job experience; there is a
greater probability of his moving into continuing employment than
there is when he has to be moved from a training institution to the
job. I concur with you.
Representative BROWN. Now, you called for a youth differential
in the minimum wage law, and assuming that this legislation would
not pass the Congress, would you settle for some kind of a training
subsidy to be paid to employers who hire structurally unemployed
persons?
Mr. MILLER. Yes; the new tax credit is certainly a step in the
right direction. The limitation, as I recall, until the 1978 Revenue
Act was passed, was $100,000 in credits for any one firm. Now I
understand it is a much higher figure based upon the degree to which

223
salaries are subject to unemployment insurance. That is a very
encouraging step, because it has somewhat of the same effect as a
differential. But it's too early, I guess, for us to know how that is
going to work; we have no information or statistics.
Representative BROWN. Let me tell you how it works in my county.
I run a small newspaper business, and it's the accountant who figures
out the tax credit at the end of the year, and, if we have hired additional people, the benefit iniures, of course, to the company through
the tax credit. But there is very little linkup between the people who
file your taxes for you, sometimes a private accountant, and the people
who are making the job decisions, the hiring decisions.
If, in fact, you have a program where that job were known in
advance as a job that might be subsidized if you hired the right kind
of person, that is, a structurally unemployed person, it seems to me
that the effective locus of the decision would be put in the right place,
that it would be the hiring department rather than the accounting
department who would make the determination to go out and hire.
I noticed also you are asking for a stronger link between work and
school. I think you are aware, are you not, of the outstanding record
of intermediate organizations in strengthening this link? I am talking
about OIC and Operation Push, the Urban League, Chicago Alliance
of Businessmen for Manpower Services, among others, when I talk
about those intermediate organizations.
The record of success of these local nonprofit organizations is far
higher, at least in our area of the country, than the State employment
services and even the Federal unemployment offices, or employment
offices. Do you believe that we need more emphasis on this local nonprofit intermediate organization?
Mr.

MILLER.

Absolutely.

Representative BROWN. In the job-finding process?
Mr. MILLER. Absolutely. I know OIC has done an outstanding job;
the Chicago branch of the National Alliance of Business was nationally
known for its efforts. It shows what, can happen when the local leadership is mobilized and looks at the problem from a local point of view.
They were far more effective than in some other areas by approaching
the problem in a slightly different way.
The Manpower Institute, I mentioned, is organizing local councils
for somewhat the same reason. The new private sector initiative
contemplates such local activities. That is why I was encouraging
Congress to move rather quickly on appropriating the $400 million
for the private sector initiative. Obviously, it's too late to spend it all
in 1979, because we are many months into the fiscal year, but the
sooner that is appropriated, the more likely that local council effort
at linking up people with jobs will be increased.
I certainly agree with you that, if the job tax credit is merely used as
an accounting technique, we will get no results. That is why we need
more and more of local activity, where there is a perceived and measurecl benefit, bonus, incentive for managers who will be rewarded
because they have added more of the structurally unemployed to the
firm's payroll.
Representative BROWN. Thank you, Mr. Chairman.
Senator BENTSEN. Senat r McClure.
Senator MCCLURE. Thank you, Mr. Chairman; and thank you,
Mr. Miller, for your statement this morning.

224
There is much interest and much with which I agree in the statement, and I will want to commend particularly Congressman Brown
for his constructive suggestions in the line of questioning with respect
to structural unemployment.
I want to return for a moment to the comments that were made by
you in response to some questions by Senator Javits and again by
Senator McGovern. As I recall, your original statement was that your
expectation of unemployment would be a little less optimistic than
those of the administration in presenting the budget, that you thought
unemployment would be slightly higher, and that the rate of inflation
would be slightly higher, and that the rate of inflation would be slightly
high at the end of the year, higher than was reflected by the President's
budget message.
In response to Senator McGovern, I understood you to say that
while you thought inflation might go higher you did not think unemployment would be higher. Am I correct?
Mr. MILLER. Perhaps I should better straighten all that out again.
What I had intended to say was that, looking at the budget proposal
from the administration-at the components of real growth in the
economy, inflation, and unemployment-I came out about as follows:
I think that the real growth predicted is reasonable; I think the unemployment levels projected are reasonable; but I think that the
inflation projections were a little optimistic.
Now, the administration's inflation figure is down from the current
inflation rate. I agree that inflation will be down, but my own feeling
is that it will not be down quite as much as they are hoping for.
We are looking, of course, at the year that starts next October 1,
which is pretty far ahead in trying to guess these things. But from
what I see in the economy now, in terms of its balance, in terms
of inherent demand, and in terms of growth of the work force and
incomes, I would think that the real growth rate projected for fiscal
year 1980 is quite reasonable.
Perhaps I confused you by saying that I expected unemployment
to drift up somewhat in the calendar year 1979. That is probably where
I misled you; I apoligize for that.
Senator MCCLURE. Right.
Mr. MILLER. I was mixing up a fiscal year and a calendar year.
Senator MCCLURE. Even though the unemployment might drift
up in the calendar year of 1979, you think that the projections over
term are reasonably accurate?
Mr. MILLER. Yes, sir.
Senator MCCLURE. That is the reason why you can anticipate
slightly higher rate of inflation but still no larger deficit than s
projected?
Mr. MILLER. That is correct.
Senator MCCLURE. That contrasts, I am sure you know, with the
projections that have been made by the Congressional Budget Office
that show that, in their projections, the unemployment rate is optimistic, the rate of inflation is optimistic, the rate of real growth is
optimistic, and therefore the size of deficit is at the most favorable
side of each of the variables and, therefore, they conclude that the
budget deficit may be, indeed, some $10 to $12 billion higher than the
President's budget estimate.

225
Mr. MILLER. Senator McClure, I have
that Congressional Budget Office review not had a chance to analyze
in detail, but I believe that
roughly $4 billion of the difference in deficit
different viewpoint on spending; the rest of is accounted for by a
the
of a different view on the unemployment level.difference is because
on the unemployment level were more consistent If one's judgment
tration's judgment, then the difference in deficit with the adminisis quite
think the thing to focus on is what is the probability narrow. So I
of meeting the
employment goal? If we can achieve that goal,
then
levels will fall in with the administration's budget I think the deficit
submission.
Senator MCCLURE. I appreciate that clarification.
I think those are
extremely important points.
There is one other that bothers me a little,
emphasis that Congressman Mitchell placed and I agree with the
ployment, and that Congressman Brown did. upon structural unemcontinuing problems. But there another oneI think this is one of our
that,
enon that has accompanied our iscurrent economic another phenomdevelopment, and
that is the changing composition of the labor
If I recall the figures correctly, last year, if force.
pation rate were the same as it was 15 years the labor force particiago,
rates would have been at about 3 percent rather that unemployment
than the figure that
we had.
Now, you point correctly to the continuing activity
in the housing
market, and I think that that is probably
because of the inflation
expectation on the part of people who are paying
very, very high rates
of interest to get into housing, rather than
which they would be taxed upon if they saved trying to save money,
it-they would be taxed
upon the interest-and, if they paid very
would deduct that from their income. So high rates of interest, they
we
for them to go into the market from a taxing have made it favorable
policy.
But, as a result, that requires very high rates
of
high interest rates, high prices, low downpayments, monthly payments,
very high monthly
payments. That almost requires there be two
wage earners in the
family just to pay for housing.
I think that we see that occurring with many,
in particular where almost the total paycheck many young families
of one
earners in the family goes to pay for their house. of the two wage
Now, if interest rates remain high
inflationary expectation
remains high and housing starts remain and ifas
high, you indicate they may,
then we will also see an increasing or at least
a continuing pressure
for the increasing

numbers of two wage earners within the same
family.
It isn't totally a desire on their part. Sometimes
economic necessity or
a desire for things that money buys forces
them into the wage earners'
market.
Do you see any change in that, or am
that labor force participation rate change I correct in assuming that
that has been going on in
recent years will continue?
Mr. MILLER. The change in labor market
interesting phenomenon which undoubtedly participation rates is an
has been brought about
for a number of reasons.
One is demographic. The effect of
II reaching working age did have anthe baby crop after World War
impact.
role of women in society, which is a favorable Social change in the
trend, has also made

46-126 0 - 79 - 16

226
or more atan impact. Inflation has made it either more necessary
family to enter the labor
tractive for two or more wage earners per
force. These have all been interesting factors. percent of our adult
One outcome is that we now have the highest
percent for the
population employed that we have ever had-over 59
consequence, because
first time in our history. That has an economic
demand
certainly aggregate real income is up, and therefore aggregate is someup, and therefore the sustainability of economic growth
is
what different than it might have been under different circumstances.
of flexibility, because
We may even be introducing a higher degreemultiple wage earners,
do have households with
to the degree that we
own options
there is more flexibility within those families as to their
the labor force.
of entering or exiting
anticipatory
As far as housing is concerned, yes, there has been
of future price increases. There has been
buying of housing in fear
value that is reprebuying because of the recognition of the store of of the attractiveness
has been buying because
sented in a house. There
interest-and
of the method of financing-the tax deductibility of
continues, the repayment will be in
the recognition that if inflation
cheaper dollars. All of these have been considerations.
to conThe choice that we had, as a policy matter, was whetherinflation,
by
tinue to let interest rate cycles, fueled fundamentally
whether to let the
create a drying up of capital for housing, and do that, not because
market go into a slump. We elected not to
housing
of housing,
we believe that there should be an excessive production of boom in
we believe that little is gained by periods dismantling
but because
the
housing followed by the bust in housing that causes the breaking up
with resultant high unemployment,
of an industry
high cost of
and
of the employment pattern of skilled workers, sharpthe and downs
ups
industry back together. A pattern of
putting the
industries that
also has the effect of creating instability in the
materials; they tend to underinvest because they
produce building
are concerned with the prospects for steep downturns.
least to
So all of these reasons would tend to make us want at
that industry.
narrow the amplitude of swings within
housing at the 2-milOur expectation is not for continued rates ofdrop off to somewhere
rate will
lion level of starts; and anticipate the
we take to be
between 1.6 and 1.7 million starts this year, which
modest decrease in activity
healthy, because it would be a relatively but still sufficient to take
which would not dismantle the industry,
the cost
some pressure off and allow us to work on the side of reducing
of housing.
Senator MCCLURE. Thank you, Mr. Chairman.
Senator BENTSEN. Thank you very much. point, I thought a good
Mr. Miller, Congressman Brown made a
that the fellow
one, about the employment tax credit and the fact
its availability and that the
doing the hiring didn't fully understand
communication.
accountant might, but there was not sufficient credit that passed the
was the author of the employment tax
I
the Treasury.
Finance Committee in the Senate, and it was opposed by kept secret.
a well
finally got it into law in 1976 but it remained were opposed to it.
We
they
Treasury did nothing to publicize it, becauseof the University of Wisspite of that we had Professor Bishop
In

227
consin who testified before the Finance Committee that his econometric models showed that it did have salutory effects. Now the
administration has come along with what frankly I think is an improved version of what I had proposed and is getting it more on target
in relation to unemployment. The program is trying to get people not
to go into dead-end jobs, but jobs they have hopes of progressing in,
an jobs that add to productivity.
But I hope we get the kind of publicity where the businessman, the
small businessman, understands that it is available to him and that
he will do the things that Congressman Brown is talking about. Hire
this person, because there is an advantage if he will hire him and hopefully get him permanently into private sector employment.
But back to one of the questions on monetary policy. It seems to me
it is one of the few times we have seen foreign economic relationships
really dictate something to the Federal Reserve, as opposed to domestic considerations-at least take priority over them-that is when we
saw the substantial devaluation of the dollar, the drop in the value of
the dollar.
If you see another serious weakening in the foreign exchange
markets, would you be inclined to force up interest rates even though
that might be risky for the domestic economy? Where do you balance
this out?
Mr. MILLER. We have to be very cautious, Mr. Chairman. While
there has no doubt been a confluence of policies which protect both
domestic and international balance, it seems to me that our monetary
policy, in the past year has not really been dictated by international
factors. International factors have been one of the considerations that
influence domestic policy.
Senator BENTSEN. Well, maybe not dictated, but certainly iiifluenced by it, when the whole package was announced at one time-this
was apparently a part of it-to have some effect on saving the dollar.
Mr. MILLER. Let me just back to, though, to point out the interaction that I think exists and what our future policy reactions might be.
The decline of the dollar introduced a very serious domestic inflation
component. Failure to arrest the decline of the dollar would also
create a very great domestic impact.
Senator BENTSEN. Well, that was what I was pointing out.
Mr. MILLER. My point is that the 1-percent inflation we had in
1978 from the decline of the dollar, translates into about a $15 billion
effect on consumers. Any action has to be weighed in terms of whether
you can relieve what is, in effect, that tax. That is what I mean by
saying that we were also trying to protect our dom6stic economy from
the effect of the dollar's decline.
If we had some weakening of the dollar today, given the condition
that our own domestic economy is in, I would think that we would
want to look at a mix of policies. We would not want to crunch our
domestic economy, because we would gain nothing by doing that. At
the moment, I think other policies and opporrunities for dealing with
the dollar are more attractive.
We do have a very substantial interest rate differential now between
the deutsche mark, the yen, the Swiss franc, and the dollar, that
makes it quite attractive to hold dollars. The Treasury also has the
capacity, now that it has made the policy decision to borrow in foreign

228
the money
currencies, to intervene in markets without expanding
us another alternative.
supply of other countries. This gives
concludes
Senator BENTSEN. Thank vou very much, Mr. Miller. That
my questions.
Senator Proxmire.
else.
Senator PROXMIERE. I don't want any more time than anyone
go-round we ought to have 10 minutes.
I think on the second
can make a
Senator BENTSEN. Senator, let's do 5 minutes and we have other
have other members here that I know
third round. We
commitments, including me.
Senator PROXuMIRE. Very well then.
other comSenator BENTSEN. Maybe even Mr. Miller has some
mitments.
reports that
Senator PROX-MIRE. Mr. Miller, the New York Times
banks have reported some of the most extraorthe Nation's biggest
and elsewhere
dinary earnings in years. Regional banks in California up 28 percent
than the money centers. CIT Corp. was
did even better
was up 21.9
in profits, J. C. Morgan & Co., where I used to work, Bank Corp.
of America was up 34 percent, Western
percent, Bank
pushed the
was up 35 percent, and the explanation is that banks have
near all-time highs.
prime rate to
partner
A very interesting comment by Warren Marcus, a general
Bros.:
in Salomon

with interest rates
He says the most surprising thing is lack of political response expected the relathe all-time peak in the prime. I would have
flirting close to
poor, perhaps even a negative
tionship between it and the C.D. rate would be verywe don't have people running
happened. That is because
spread, but it hasn't
the country.
around in Washington claiming that the bankers are raping

quiescent.
The biggest question is whether the politicians will remainThe Times
want to count on this prosperity continuing.
I just don t
bankers, also
reports that this man isn't alone, that other banks and urging from
cited the absence of jawboning or public
bank analysts,
for the
Washington to hold down interest rates as a major reason
earnings.
impressive
need it.
I for one am delighted to see profits for the banks. They
is much too thin. This is one way of improving their
Their capital
of thing and I
capital, but there is a price you pay for this kind
if maybe it isn't time for some Wright Patman or Lyndon
wonder
the interest
Johnson, who were great people, to now jawbone down
to be
some success, to speak out in view of what appears slowrate with
rates in having any bite in
the ineffectual effects of high interest
ing down inflation.
Washington
What is your response to that, as the No. 1 politician in
Street looks to on interest rates?
who Wall
to respond.
Mr. MILLER. As a nonpolitician, I would be glad
Reagan
PROXMIRE. We are all nonpoliticians, and Ronald
Senator
too.
is still a nonpolitician,
is a poliMr. MILLER. Yes; and I understand Governor Connally
tician now.
had no bite.
I disagree, of course, that the monetary restraints have give everybite. The fact that we chose to
I think they have had a
capital doesn't
body a fair race-fairer competition-for the available
has not been restraint.
mean to me that there
Senator BENTSEN. You said "rate" or "rape"?

229
Mr. MILLER. ."Race." Yes; I would have to
be careful on that. I
hope you got "race."
For example, I am convinced that businesses
inventories more prudently because of the cost ofhave managed their
of carrying inventories, and this has had an effect. money, or the cost
I am convinced that, generally, throughout the
economy, many
decisions about spending have been somewhat attenuated.
Senator PROXMIRE. Let me just interrupt, Mr. MillerMr. MILLER. Yes.
Senator PROXMIRE [continuing]. To ask
disagree with the notion that these high you whether you wouldn't
interest
passed on in higher prices; that what business does rates tend to be
eat the higher interest rates and their profits are is that they can't
they must pass on this higher cost in money, which going up, too, but
element for many businesses. They must pass it is a very important
on in higher prices.
Isn't that correct?
Mr.

MILLER.

Not in all cases.

Senator PROXMIRE. Not in all cases, no, but in most
cases.
Mr. MILLER. In some cases, the cost is passed
the competitive nature of businesses, businesses on. But because of
still have to restrain
their inventory. Even if they carried higher inventories
to try to pass along the interest costs, they would becomeand were able
less competitive. So the truth is that inventories have been held
in extremely good
control.
I am not going to take your time here debating
had some bite. I think the rate of growth of the whether or not we
slowing, and is down from what it otherwise would economy has been
there is no question that the general perception have been. I think
is that
straint on business activities because of the monetary there is conrestraint that
has existed. We see the inverse yield curve which
is characteristic of
periods when there is actual restraint on the economy.
The second part of your question is, why not jawbone
interest rates
down? In terms of real interest rates, I must again
anything, they are low. On the one hand, I argue point out that, if
have had an impact on restraining the economy; that nominal rates
on
argue that real interest rates have not been very the other hand, I
they are not very high, the degree of restraint has high, and because
fore, the consequence of trying to jawbone down been affected. Therebe to stimulate more economic activity at a time interest rates would
when
to dampen inflation. That would seem to be working we are trying
in the wrong
direction.
Senator PROXMIRE. The issue is how high interest
rates restrain
and lower interest rates stimulate more activity.
There is some question about that.
Let me ask you another question right now because
the Governor
of California has just electrified the country by
coming out in favor
of a constitutional amendment to require a balanced
budget.
Now, you are a great believer in sound fiscal policy
and you are
viewed by many as the No. 1 economist in fighting
inflation in view
of your position.
How (lo you feel about the constitutional convention
balanced budget? As you know, 24 States have adopted to require a
this position.

230
that the 34 required States will
It appears very possible, maybe likely,to be faced with quite a dilemma
do so. If that is the case, we are goingIt might be very helpful in letting
here and we would like your advice.
know how the Chairman of
the State legislators around the country matter.
this
the Federal Reserve Board feels about that a constitutional amendSenator Proxmire, I feel
Mr. MILLER.
budget is inappropriate. The
ment to deal with the issue of balancing
such discipline. That discipline
Constitution is not the place to exercise by every administration. We
must be exercised by every Congress and lock into our Constitution a
must face the music, and we should not respond over the decades to
to
restriction that destroys our flexibility
we cannot now predict.
conditions
right place for such a restricI don't believe the Constitution is the
in
approving of our involvement we
tion. Many Americans were not too
saying
amendment
Vietnam, but we didn't adopt a constitutional be able to protect our
engage in war because we must
could no longer
country.
let me ask you: Would you
Senator PROXMIRE. My time is up, but
a perverse economic effect frefeel such an amendment could have
or depression?
quently in this country in times of recession us manage our economic
think I would like to see
Mr. MILLER. Yes. I
in our lifetime-in fact, in
affairs better, but we must remember that
history of modern nations-I
the history of this Nation, and in the
beginning of colonial times-we
don't know about way back at the peacetime except within this rehave not seen high inflation rates in
because we have gotten off
cent period. To change our Constitution
years and don't want to face
track one in peacetime in the last 100way to tamper with the fundathe issue, is I think, an inappropriate
The Constitution ought to
mental structure set by the Constitution. it ought not to be the place
Nation;
lay down the grand charter of the
for carrying out specific policies. more restraint than it is able to vote
If Congress feels that it needs
lay down a permanent law that
each year, there is no reason you can't
requires some discipline as to deficits. economic policy is to correct
What is important in exercising our into trouble and then manage
the fundamentals that have gotten us there will be business cycles,
our economy with a recognition that bands. We should not allow
but they should be within narrower
means there will be periods when
excesses in either direction. But thatyou need surpluses.
when
you need deficits and periods you.
Senator PROXMIRE. Thank
Proxmire.
Senator BENTSEN. Thank you, Senator
Brown.
Congressman
have straightened out the
Representative BROWN. Now that Iyou
would like to remind you that
State legislators around the country,in a similar nature to Governor
last month before this committee, electrified us with the announceBrown's electrifying statement, you
tight and that real interest
ment that monetary policy is not really
rates are very low.
submitted a chart with your
Now I agree with you on that, and yourates, indicating that in the
prepared statement here on mortgage a real mortgage rate impact of
had
period 1955-65 the mortgage rate real mortgage rates were about 3
from 1966-72
about 4 percent,
and, as I look at the 1978
percent; and 1973-78 it was about 1 percent

231
average, it is, I would say, one-eighth to one-tenth of 1 percent in terms
of real rates; in other words, what you get when you take the home
mortgage rate and lay it against the Consumer Price Index.
I would assume that the mortgage bankers would not be adopting
an interest rate that was a great deal below the Consumer Price Index.
You predicted that less money growth would reduce inflation and
bring nominal interest rates down, and it would help the dollar; and
you are right, I think, because that seems to occur.
Key interest rates are showing signs of falling and the dollar seems
to be firming. You agreed with me that problems with inflation and
taxes were discouraging investment. You discussed the indexing of
depreciation, or faster writeoff of equipment an example, and we got
some positive comments about that from Mr. Schultze yesterday,
although no indication that they are ready to bite that bullet and take
that action in the administration or that the Council of Economic
Advisers is ready to recognize that.
I am sorry that it is always going to be done tomorrow. I would like
for us to get to tomorrow sometimes. But last week you said the Fed
would ease up if recession occurred. You didn't want to get the
Government to stimulate growth through spending.
I agree with the spending restraint, but why should the Fed ease up
if you have not been tight, as we agreed the other day? Why shouldn't
you keep your moderate posture of restraint? If there is to be stimulus,
the Government should stimulate growth by removing tax barriers.
Wouldn't you accept that as another approach?
Mr. MILLER. Congressman Brown, I don't believe that I said that
we should ease up. I think I said that I would prefer a posture of
continuing to be disciplined and austere in spending, but if there was a
tendency for the economy to fall to too low a level of activity, we would
take a look at monetary policy.
Monetary policy should continue to treat inflation as the primary
enemy and not relent, not be too quick in removing the restraints put
on in order to wring out inflation. I certainly don't want to leave the
impression that we were suggesting or would suggest any easing in the
foreseeable future, but I think that we would let monetary policy be
more flexible and let the discipline stay on in Federal spending.
The time may come in the next few years, if the discipline in spending continues, when one would look at the possibility of tax relief to
recognize that spending has been cut and that a tax adjustment is
desirable.
Representative BROWN. Now, here again you seem to be putting
that off into the future.
Mr. MILLER. Yes.
Representative BROWN. I would like to see that future come a little
quicker. The broker loan rate fell at several major banks from 11.5
to 11 percent. Do you think we have seen a peak in other interst rates?
Mr. MILLER. I think it is premature to say. As we mentioned
this morning, we are still looking at performance of the economy. here
The
economy performed stronger in the fourth quarter than we would
have liked, in view of our objective to slow down activity. If that
carries over into this year at that level of activity, it is premature to
guess what interest rates will do. There may also be a seasonality in
this.

232
to contradict you in
Representative BROWN. Now, I don't wantPost at least as saying
in the
your own words, but you were quoted ease money and credit.
that if a recession does occur, you would predicts a recession this year
Mr. Miller, considering that the CBO that if the recession hits and
and inflation of 8 percent, don't you thinkeventually simply have more
if we have an easy money policy, we will
we are pushing to that
inflation, easily double-digit inflation? Because
another recession with even higher
point now, which would lead to I am describing here is kind of a
inflation. In other words, what
it gets further out of
harmonic effect that once it gets out of phase,
phase with each move.
with what you told us
How is what you said last week conflicting
fighting inflation, and how severe
today concerning the importance of you are forced to back down from
would a recession have to get before
your policies?
and I don't believe I did
Mr. MILLER. I don't recall what I said,
What I have said
say, there would be an easing of monetary.policy.
fiscal austerity, and that any
is that it would be better to continueon the monetary side.
adjustment in policy should be made than in saying we are about to
There is a difference in saying that
If you are talking about
ease up on money, which I don't foresee.
of getting away from high ampliamplitudes, I am certainly in favor which have been characteristic in
tude swings in economic activity, are poor policy. You can certainly
this decade and which, in my mind,
monetary effort than
deal with that problem much better through
because monetary policy can change
you can through fiscal policy, either direction quickly. It can be
more quickly and it can go in be eased up a bit-it can go in the
tightened up again, and it can
policy quite often takes a
direction that is indicated-while fiscal
long time to effect.
of voting on spending authorCongress goes through a long process a long time before the levels
it is
izations and appropriations, and
the spigot, it goes for
get adjusted again. Once you have opened that we should get rid
the thought
quite a while. So I share with youeasier to do so by letting the throttle
of the high amplitude swings. It is on the fiscal side.
be on the monetary side more than Mr. Miller, because my time is up,
Representative BROWN. Finally,
year, you recommended
in testimony before this committee last
as
recent minimum wage increase the anti-inflationary.
deferral of the
leadership of the
because apparently
We didn't get that deferral
taken.
Congress decided that no action should be for next January, from
How about the next increase scheduled recommendation in that
a
$2.90 to $3.15? Are you ready to make
area?
deferred or, as I menMr. MILLER. Yes; I would like to see that
differential which would address itself
tioned this morning, a youth
young people in the world of work.
to the problem we have of starting you. I finally would like to submit
Thank
Representative BROWN.
financing requirements that
a question on the inflexibility of Federal deficits that we have been
the increased
I think is resulting from
debt that must be serviced,
having, and the fact that it builds in majorinflexible as a result of it. I
be increasingly
and the fact that we will
will send you that question.

233
I would like for you to send me a written response.
Mr.

MILLER. I would be delighted to answer.
[The following question and answer were
subsequently supplied
for the record:]
RESPONSE OF HON. G. WILLIAM MILLER
TO AN ADDITIONAL
POSED BY REPRESENTATIVE BROWN WRITTEN QUESTION
Question. We are making great improvement
in the budget picture this year,
but $29 billion is still a very large deficit.
the past 4 years, and the credit demands In view of our economic expansion over
that have accompanied it, is there any
danger of "crowding out" in private credit
the rollover of our huge Federal debt have markets this year? What effect does
on the
Answer. Any time the Treasury has a budget capital markets?
deficit to finance, interest rates
tend to be higher and the volume of funds
available to private borrowers to be
lower than they would be if there were
no
billion, down significantly from preceding deficit. But, with the deficit at $29
years and a satisfactory supply of
loanable funds likely to be available in financial
markets, it dbes not appear that
crowding out will be a serious problem.
Treasury securities are free of default risk
and can be traded in a market in
which even large blocks of issues can be sold
quickly without significantly affecting
their price. Thus, financial institutions,
nonfinancial corporations and other investors wish to hold these securities in order
to
of their balance sheet positions. Accordingly, enhance the safety and liquidity
outstanding Treasury debt, far
from being an impediment to the efficient
actually serves to increase that efficiency. functioning of our financial markets,
The Treasury encounters little difficulty
in refinancing maturing Treasury
securities. Given the advantages provided
tendency for holders of maturing issues to by Treasury securities, there is a strong
roll
addition, of course, there are always investors them over into new issues, and, in
who wish to add to their holdings
of these securities. Treasury financing
operations proceed smoothly not only
because of the continued strong public demand,
but also because the Treasury
tailors its security offerings-by adjusting
maturities and other terms-to meet
the portfolio needs of investors.

Senator PROXMIRE [presiding]. Senator McClure.
Senator MCCLURE. Thank you. I just have a couple
questions and
a comment.
One, you indicated that the economy is quite close
ment already. We have bandied those figures around to full employin recent years.

It seems to me that there is a growing consensus
measure unemployment today, we have reached that the way we
relatively full employment at about 5.5 percent,

statistically.
What range would you use or what figure would you
use to determine
when we have reached full employment?
Mr. MILLER. I believe the Council of Economic
Advisers has now
adopted a 5.1 percent figure in their new analysis
of the growth
capacity of the economy, and I think that is fairly
reasonable.
Senator MCCLURE. Second, you have
starts coming down to maybe the 1.6 or made reference to the housing
1.7 million
reasons for hoping to be able to take the fluctuation range. One of the
market is the capacity of industry to provide the out of the housing
necessary materials
for the housing industry.

The housingf starts
expectation of what the market will return on will depend upon their
The timber industry has a fixed investment their investment.
equal to the needs of
housing at the rate of about 1.5 million per
year and anything we do
above that will either put a strain on timber
supply or induce further
investment in those production facilities.

234
against increased production
The thing that would perhaps militate from Federal lands, which is
facilities is the supply of timber largely Federal policies and lack of
now being inhibited by a whole range of expect that the investment
decision. If that is true, then you wouldbe there, the lumber supply
will not be made, the capacity will not see another spurt in timber
will grow tighter and tighter, and we will problem of importing soft
growing
price as well as an increase in the country.
supplies from outside the
lumber
Would you disagree or agree with my expectation? expressed, and I
have
Mr. MILLER. I share the concern that you Government lands for
to release additional
think efforts underway
That would be an anti-inflation
harvesting timber would be desirable. strains on supply that have been
some of the
move and it would relieve
or could be a problem to us.
importing 20 percent of the
Senator MCCLURE. We are already are not utilizing the wood we
we
Nation's softwood needs at a time has an adverse effect on balance
could produce in this country, which
effect on balance of
of payments as well, and an unneeded adverse
payments.
Mr. MILLER. I concur.
Mr. Miller, by making a
Senator MCCLURE. I might just conclude, I suspect that had there
that
comment to my friend from Wisconsin like oil companies equaling
been an increase in profits in something
industry, we would have some
the increase in profits by the banking were obscene profits, that, as a
of our colleagues proposing that those be required to divest, that we
matter of fact, the industry ought to
integration of the inwould be talking about vertical or horizontalup into smaller units so
break them
dustry, and trying to find ways to
they would make smaller profits.
it would be good
I suspect we might even have somebody assuming taken over by
industry
in the national economy to have the banking money that is printed
Federal Government because of all the
the
profits that are derived in using
belongs to all the people and any profit. But since it is the banking
that money ought to be a Federal 1 don't suppose we will hear those
industry and not the oil industry,
comments.
Senator PROXMIRE. Well, don't be so sure. good earnings last year,
Mr. MILLER..The Federal Reserve had very
Government, 100 percent.
too, but we gave those to the Federalbetter than the Government in
did
Representative BROWN. They
general.
standpoint, it is a great thing
Senator PROXMIRE. I think, from my is a great thing for this country
that people are growing up on profits. It people are better off. Profits,
when real waves go up, profits go up, andjobs and providing incentives
after all, are a big element in providingto applaud it.
and so forth. I think we always ought
When they go up that
At the same time we have to recognize that
a price to pay. There is no gain without
much, that there is often
paying.
Mr. Miller.
Let me get to a couple other things quickly, situation gets worse?
plans do you have if the
What contingency
a little worse on the inflation
You are assuming the situation will get but you say it will be an imfront than the administration assumes,
provement over this year.

235
Supposing it is not an improvement? Last year, as you recall, the
consensus was that inflation for 1978 would be about 6 percent. It
turned out to be 9 percent.
Now this year the administration's position is that inflation will be
7.5 to 8 percent. Supposing it turns out to be 10 percent? Do you
have any notion on what we can do about it or should do about it,
both monetary policy, fiscal policy and incomes policy?
Mr. MILLER. Among the things that are talked about, of course,
is a greater degree of controls, mandatory controls either on wages,
prices, or credit. I oppose those. I think that
Senator PROXMIRE. Even if the situation worsens substantially?
Mr. MILLER. Even if the situation worsens. Experience tells us that
those controls merely cap over the fundamental problem, but the fundamental problem doesn't get solved. We merely defer the day of
reckoning.
If we are wrong on inflation, then it means that we will be in for
more economic dislocations and the Nation will suffer. Our job is to
keep the situation from getting worse. But I don't believe that we
could contribute to the solution by imposing controls.
Senator PROXMAIRE. I agree with you on controls.
What can we do?
Mr. MILLER. I think the only thing we can do in the face of worsened
conditions is to look at a series of other possibilities. If the problem
were the dollar, it might be necessary to put some restraint, direct
restraint, on imports with a surcharge perhaps-although this is not
desirable or likely.
. Senator PROXIIRE. I am sorry, I didn't hear.
Mr. MILLER. We might have to do something on imports.
We might have to consider changing the conditions for financing
of housing, which we have preferred to leave with more freedom. We
might have to put some caps on that situation, in order to dampen
excess demand.
We mioht have to consider some of those kinds of things.
Senator PROXMIRE. Now the administration has proposed a wage
insurance program. In the first place, do you approve that?
Mr. MILLER. Well, I thinkSenator PROXMIRE. Is it vital? Is it marginal, or is it a fundamental
element in fighting inflation in your view?
Mr. MILLER. I have viewed it as a very interesting idea, one that
deserves consideration.
On the scale that is proposed, I have not considered it to be vital
to the antiinflation efforts, personally, but I have thought that the
idea of finding a technique, an automatic device, for motivating those
who set prices and those who bargain for wages is desirable.
Senator PROXMIRE. Now what the administration has done, as I
understand it, is to buy the Okun approach of the use of the carrot.
Now, Wallich, your colleague on the Federal Reserve Board, Henry
Wallich, Governor Wallich, prefers a penalty approach of the tax increases if you exceeded the guidelines on prices and wages?
Mr. MILLER. That is correct.
Senator PROXAIIRE. Do you think that is a possibility if the situation worsens?

236
at. Both
Mr. MILLER. Both of those approaches are worth looking their adin terms of
of them have a good many potential problems
ministration and in terms of their impact.
for
Let me give you an example. If you use a carrot, the tendency is
it. The first thing you know, a good idea can become
everybody to get
a carrot. If
a handout, because everybody complies when you have nobody to
the other hand, the tendency will be for
you use a stick, on
that
be subject to the stick. Those very capital-intensive industries wage
over complying with some of the price and
have the least control
stick.
standards may be the ones that get hit the hardest with thecapital
ones least able to provide alternate sources of
They may be the
to keep our economy going.
My only point, Senator, is that I am very openminded on the subject.
that
I think these proposals are well worth consideration, and I hope
will enlighten us all as to how they may work. I
debate and dialog
would look
see pluses and I see minuses. I would hope that Congressand find out
as possibly a good experiment,
at real wage insurance
works.
more about it, perhaps through a 1-year trial of whether itthink it
it is well worth doing. If it is not done, I don't
In that sense,
would be the end of the fight against inflation.
game, and
Senator PROXMIRE. To me, one of the real losers in this inflation is
are high because
you have talked about how interest rates
high, but the real losers are the small savers.
be
As you know, we have a statutory limit on the interest that canthe
saver at the bank of 5 percent and 5¼'percent at
paid to the small
Why
S. & L. As I pointed out, the banks are making great profits.
particularly when they can buy deposits at 5 percent
shouldn't they,
and can get 10, 11, or 12 percent for their loans? is growing, and it
The margin is enormous, and the discrepancy
a point where
seems unlikely that we will get interest rates down to fact that small
be fair to a small saver, in view of the
5 percent would
are
saver is by definition a person who has limited means. But there of
Why shouldn't we consider at least some program
many of them.
some relationship
changing regulations and making it possible for and the prime rate
interest that is paid to the small saver
between the
or other governing rates?
regulation
Mr. MILLER. Senator, I agree with you completely. The were then
times, for reasons which
Q ceilings came into being in other their usefulness. But I think we
logical; I believe they have outlived
have a timing problem. We cannot change them abruptly without
creating distortions.
Senator PROXMIRE. Supposing legislation that provides for gradual
increase at 6-month intervals, of a quarter or half percent?
Or cerMr. MT.LL.ER. T would think that that would be desirable. hope we
I
if we have an interest rate cycle downward, which as to allow
tainly,
will, we ought to use that occasion to change the ceiling so
yields,
the small saver to have the opportunity to earn appropriate cycle.
is available to others in another
more commensurate with what
as you well
I might point out that one of the problems, Senator, reality, then
rigid systems that do distort
know, is that when you have
because of our ingenuity, our Nation finds alternate solutions.
What is happening is that new forms of savings are being invented
for small savers, and this proves how unwise it is to have artificial

237
ceilings. For example, money market funds are now
growing up to
provide an alternate way for small savers to get a better
yield. Consequently, we are seeing passbook funds move out of
banks and thrift
institutions.
Well, that is not healthy because it disrupts a
has been built up over a long period of time, and financial system that
that is important to
our economy.
I agree with you in every way, and I'm pointing
out that if we
don't solve the problem, unfortunately things will
break down anyway, so we should solve the problem sooner.
Senator PROXLIIRE. Now, last November you
my committee, the Senate Banking Committee, told the Senate, or
that the Congress
should attempt to cut the deficit in 1980 toabout half
its level in 1979.
The current estimate for 1979 is about $39
therefore, a 1980 deficit of about $20 billion billion. You recommend,
rather than the $29 billion recommended by President Carter?
Mr. MILLER. Senator, I was referring to a
zero. I have also said, however, that from $38path, from 40 to 20 to
billion, to $29 or $50
billion, to virtually zero is not unreasonable on the
sis; I would prefer the figure to be a little lower, but basis of my analyI am not
by any discrepancy. It is consistent with the Economic disturbed
Report to
predict a modest deficit, if any, in fiscal year 1980.
We are getting there about on the track I had in mind.
Senator

PROXMIRE. Well, we are getting there,
ing again, they are putting off the day when it but they are expectis going to be tougher
to get to zero, or zero in 1980, if you only go down
to $29 billion this
year, is going to make it harder.
There are also going to be some very tough
example, there is growing sentiment to eliminate decisions made. For
would be a $6.9 billion savings right there. Therevenue sharing. That
States and localities
have had difficulties, but they are still running
compared to our deficits. That is not for any surpluses by and large
not as if you are taking it away from the poor specific program. It is
large, that money doesn't go in that direction. and the needy. By and
What would you think of eliminating revenue
sharing?
Mr. MILLER. My own information on the present
sharing money and the present plans is inadequate uses of revenue
to give you an
intelligent answer at the moment.
I am not that familiar with the present application
of those funds.
I would certainly not want to impact adversely
local programs that
are critical to revitalizing the cities or to assure
Senator PROXMIRE. Those are separate programs,
of course.
Mr. MILLER. Yes.
Senator PROXMIRE. We have community development
programs, as
you know, and the President's proposed an
Urban Economic Development Bank.
Mr. MILLER. Yes.
Senator PROXMIRE. What about a tax cut in
1980? It's an election
year, Presidential election year, and I think the
pressures for a tax
cut are likely to be very considerable, but I
think we ought to look
at this in the perspective we have this year,
and I would like your
advice on that.

238
must conMr. MILLER. I would think it unwise. I believe that we and maintoward a balanced budget
tinue on this track of moving
1980 would be
taining a moderate rate of growth. I think a tax cut in
premature.
Senator PROXMIRE. Even a moderate tax cut?
Mr. MILLER. I believe so.
insurance program
Senator PROXMIRE. You wouldn't view the wagethat?
it would result in
as a tax reduction even though
contemplated
Mr. MILLER. That is in the budget for $2.5 billion; it is
within the $29 billion deficit.
If we
Senator PROXMIRE. That may be a pretty modest estimate. than
it will be substantially higher
have the inflation you anticipate,
that.
Mr. MILLER. It would be a bit higher.
that's worth exIt's a form of tax reduction, one, as I said before, do think that a
committed to it, I
ploring. Without feeling that
one, in 1980, is premature.
general tax reduction, even a modest can maintain a moderate rate
we
Senator PROXMIRE. Do you think
of growth without a tax cut in 1980?
We all recognize
Mr. MILLER. The probabilities are that we could. and developments
looking pretty far ahead in this process,
that we are
based upon the
can take place that we cannot now forecast. But,are that we can
of the economy, the probabilities
general trend
and create conditions where
dampen the rate of real growth in 1979 of growth in 1980.
to see a moderate rate
we will continue
budget
Senator PROXMIRE. For the first time, the administration's
forecast of interest rates, the forecast average Treasury
contains a
What do you
bill rate of 8.8 percent in 1979 and of 7.6 percent in 1980.
that forecast?
think about
that is not a f oreMr. MILLER. I understood, Senator Proxmire, that the interest rate
that it is a mechanical linking of
cast. I understood
to be higher,
to the inflation rate. Had the inflation rate been projected in a higher
that that formula would have resulted rate would
I understand
the
interest rate. Had the forecast of inflation been lower,
lower.
have been
between inflaNow, there is, as we know, a reasonable correlation
I
interest rates, inflation being one component. So
tion and nominal
a formula that links assumptions
think there is some retionale for
related one to another.
to engage
I would not think it not desirable for the administration device for
forecasting, because that would become a
in interest rate
implications.
sheltering us all from looking at the realities of budget
more reason to believe that the linkage they have
There is much
inflation is slightly
adopted is reasonable because, as I pointed out, if
rates are slightly higher, revenues will be higher,
higher and interest
at an interrelation
but so will interest costs. I think the idea of looking
reasonable.
there is certainly
implied, at least, higher
Senator PROXMIRE. But you have already interest and inflation are
view of your feeling that
interest rates in
be higher than the
linked, and you told us that you expect inflation to be. Therefore, I
it will be or expect it to
administration assumes
would be higher,
would gather that you would assume that interest rates
am reading from the budget, which says:
too. You see, I

239
Average rate on new issues within the period in the past, interest
forecast period have been assumed to remain at the levels prevailing rates for the
the estimates were made because it would be unrealistic to assume at the time
of the current unusually high interest rates. These estimates assumecontinuation
by convention that interest rates decline with the rate of inflation.

Mr. MILLER. Yes. To the extent I believe that the administration's
outlook for inflation in fiscal year 1980 is slightly optimistic, I would
have to say that I would agree with you, that to that degree there
would be a slight variation from their view of interest rates, based on
the linkage to inflation.
Senator PROXMIRE. I understand. Incidentally, I have been given
a note, that no State is projected to have a deficit for fiscal year 1979.
Many of them are cutting taxes. In my State they are recommending
a tax cut. The Governor is recommending a very large tax cut. The
legislature is recommending a big one, biggest we have had in history
by far. New York is supposed to cut its taxes $750 million; they are
recommending another tax cut for this year. So those are reasons why
I think the revenue sharing does seem to be something that we might
reconsider.
Mr. MILLER. I would be delighted to take another look. As I say,
I have not been that close to the issue.
Senator PROXMIRE. I have no more questions. I would just like to
conclude, Mr. Miller, by saying that I think we ought to take a hard
look at the effect the very high interest rates are having in slowing inflation. I think we are tending to cushion almost everything, not only
housing, but with the futures market and so forth, a great deal of the
whole financial structure is being given an ability to resist the pains
of the credit crunch; and, while you can make a strong case in each
instance, the overall effect I think can be that we are disarming the
weapons we have relied on in the past to fight inflation, and I think
we should be sensitive to that.
Mr. MILLER. Senator Proxmire, I understand your point. I would
just point out that we do live in an adaptive society, and, as we have
experienced these rates of inflation in the decade of the seventies, rates
which we have never experienced in peacetime before, our system,
with its creativity, has begun to adapt. You are correct; attitudes and
expectations have changed and, therefore, it is true that it takes a
greater dose of policy input to shift behaviors. But I would also
suggest, very respectfully, that I am not sure we solve our problem by
seeking credit crunches, distortions, and stress in the economy. The
course that makes more sense to me is to move the throttle more
smoothly but surely toward restraint, and keep it there for a longer
period of time, in order to accomplish our objective.
Senator PROXMIRE. I just suggest that I think you are very right,
and, as this works out for a period of time, I think we ought to stick
with it for a little while. But I think eve ought to keep alerted to the
fundamental problem of fighting inflation, and maybe we have to
take a more tough, more painful route, if necessary, in some of these
areas, including even in housing, which I think is so important.
But, even there, in 6 months we may have to reconsider if the inflation situation continues.
Mr. MILLER. I think you are correct. We have been working and
mobilizing the anti-inflation forces now for 10 months-we really
started last spring in a serious way-and to the extent that the arsenal

240

beginning to have
of weapons we have mobilized and put in place is we are not making
to keep a very careful watch. If
an impact, we have
adjustments.
the progress we expect, we have to look at appropriate
are correct, the money market certificates have to be
And I think you
evaluated constantly.
and
We shall do that, and I shall certainly appreciate your counsel
guidance in this continuing dialog.
with
Senator PROXMIRE. I understand Governor Teeters is working get
monetary figures that we
you on revising the kind of aggregate
because of the shifts in financial structure.
the various
Mr. MILLER. This innovation in our system means that
of money are taking on new functions. What we are
deposit forms
soon, is a tentative
looking at, and what we are going to publish very that we can redefine
examination and input, so
proposal for everyone's
of money rather than
the monetary aggregates in terms of the functionall a better handle on
I think that will give us
the class of deposit.
economy, and
what is really happening on the monetary side of our
our capacity to respond.
perhaps sharpen
differences,
Senator PROXMIRE. Mr. Miller, you and I have had our
to let you know how much I respect you and how remarkbut I want
You have
ably responsive and direct and effective a witness you are.
fine job.
done a
Mr. MILLER. Thank you very much, Senator Proxmire. morning
Senator PROXMIRE. We will stand recessed until tomorrow
here.
at 10 o'clock, when we will have Secretary Blumenthal to reconvene
at 12:33 p.m., the committee recessed,
[Whereupon,
at 10 a.m., Wednesday, January 31, 1979.]
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