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THE 1979 ECONOMIC REPORT OF
THE PRESIDENT
HEARINGS
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
NINETY-SIXTH CONGRESS
FIRST SESSION
PART 2
JANUARY 31 AND FEBRUARY 5, 6, AND 7, 1979
Printed for the use of the Joint Economic Committee
U.S. GOVERNMENT PRINTING OFFICE
47-106 0
WASHINGTON: 1979
For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington, D.C. 20402
Stock No. 052-070-05082-9
32
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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
WILLIAM PROXMIRE, Wisconsin
ABRAHAM RIBICOFF, Connecticut
EDWARD M. KENNEDY, Massachusetts
GEORGE McGOVERN, South Dakota
JACOB K. JAVITS, New York
WILLIAM V. ROTH, JR., Delaware
JAMES A. McCLURE, Idaho
ROGER W. JEPSEN, Iowa
HOUSE OF REPRESENTATIVES
HENRY S. REUSS, Wisconsin
WILLIAM S. MOORHEAD, Pennsylvania
LEE H. HAMILTON, Indiana
GILLIS W. LONG, Louisiana
PARREN J. MITCHELL, Maryland
CLARENCE J. BROWN, Ohio
MARGARET M. HECKLER, Massachusetts
JOHN H. ROUSSELOT, California
CHALMERS P. WYLIE, Ohio
JOHN R. STARK, Executive Director
Louis C. KRAUTHOFF 11, Assistant Director-Director,SSEC
RICHARD F. KAUFMAN, Assistant Director-GeneralCounsel
CHARLES H. BRADFORD, Minority Counsel
(11)
CONTENTS
WITNESSES AND STATEMENTS
WEDNESDAY, JANUARY
31, 1979
Page
Bentsen, Hon. Lloyd, chairman of the Joint Economic Committee: Opening
statement......................................................................................................................
Blumenthal, Hon. W. Michael, Secretary of the Treasury .....................................
1
2
MONDAY, FEBRUARY 5, 1979
Bentsen, Hon. Lloyd, chairman of the Joint Economic Committee: Opening
statement ............................................................
Grayson, C. Jackson, Jr., chairman, American Productivity Center, Houston,
Tex ...............................................................
Carlson, Jack, vice president and chief economist of the Chamber of Commerce
of the United States, accompanied by Harry McKittrick, deputy director,
Productivity Center ...............................................................
McIntyre, Hon. James T., Jr., Director, Office of Management and Budget,
accompanied by Van Doorn Ooms, Assistant Director for Economic Policy ...
41
42
132
158
TUESDAY, FEBRUARY 6, 1979
Proxmire, Hon. William, member of the Joint Economic Committee, presiding:
Opening statement.......................................................................................................
Greenspan, Alan, president, Townsend-Greenspan & Co., Inc., New York, N.Y.,
.........................
and former Chairman, Council of Economic Advisers ................
Fair, Ray C., professor of economics, Yale University ....................
.........................
Christ, Carl F., Abram G. Hutzler Professor of Economics, the Johns Hopkins
University, Baltimore, Md .................
..............................................
Barrett, Nancy S., director, program of research on women and family policy,
the Urban Institute, Washington, D.C., and former Deputy Assistant Director, Fiscal Analysis Division, Congressional Budget Office .................................
183
184
187
189
205
WEDNESDAY, FEBRUARY 7, 1979
Bentsen, Hon. Lloyd, chairman of the Joint Economic Committee: Opening
239
statement......................................................................................................................
Bernstein, Edward M., president, E.M.B., Ltd., research economists ......... .......... 240
Perry, George L., senior fellow, the Brookings Institution ...............
......................
248
Stein, Herbert, A. Willis Robertson Professor of Economics, University of
Virginia; senior fellow, the American Enterprise Institute; and former Chair274
man, Council of Economic Advisers ................................................................
SUBMISSIONS FOR THE RECORD
WEDNESDAY, JANUARY 31, 1979
Blumenthal, Hon. W. Michael:
Prepared statement ..............
11
(111)
IV
MONDAY, FEBRUARY
5,1979
Page
Carlson, Jack, et al.:
..................................................
Prepared statement .............
Grayson, C. Jackson, Jr.:
Prepared statement, together with exhibits .......................................................
McIntyre, Hon. James T., Jr., et al.:
..................................................
Prepared statement .............
Response to Representative Brown's request to supply anticipated dollar
figures for individual income tax receipts for calendar years 1980 and
1981 due to inflation............................................................................................
Table reflecting individual income and employee social security tax liabilities as a percentage of personal income for the period from 1960 through
1979 ................................................................
Response to Representative Brown's query regarding the effect on the U.S.
economy if Congress passed legislation setting U.S. farm prices at 100
percent of parity ...............................................................
Response to Representative Brown's request to supply anticipated outlays
and budget authority for off-budget Federal entities for fiscal years
1978-84 ...............................................................
Response to Representative Brown's request to supply more detail of
uncontrollable programs than was previously published in the President's budget ...............................................................
Response to Representative Brown's request to estimate the effects on the
budget of higher unemployment and a drop in real growth output ..........
TUESDAY, FEBRUARY
137
45
162
169
170
172
174
176
180
6, 1979
Barrett, Nancy S.:
Table reflecting funds raised in credit markets by households and nonfinancial, nonfarm business, 1970-78 ...............................................................
Christ, Carl F.:
Tables:
1. Inflation and the growth of money stocks...............................................
2. Monetary growth rates before and after October 18, 1978 .......... ........
Prepared statement .............
..................................................
Rousselot, Hon. John H.:
Chart reflecting Federal and federally assisted borrowing ..............................
WEDNESDAY, FEBRUARY
210
193
194
194
234
7, 1979
Bentsen, Hon. Lloyd:
Prepared statement of Otto Eckstein, president, Data Resources, Inc., and
Paul M. Warburg Professor of Economics, Harvard University ................
Bernstein, Edward M.:
Prepared statement ..............
..................................................
Article entitled "The Balance of Payments, the Exchange Market, and
Interest Rates" ................................................................
Stein, Herbert:
Articles from the AEI Economist:
"The New Economic Policy: What Is It? Will It Work? What Next?"
December 1978 ...............
................................................
"The Next 'Recession,"' January 1979 .........................................................
291
243
259
277
285
THE 1979 ECONOMIC REPORT OF THE
PRESIDENT
WEDNESDAY, JANUARY 31, 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 Representative Reuss.
Also present: Louis C. Krauthoff II, assistant director-director,
SSEC; Richard F. Kaufman, assistant director-general counsel;
John M. Albertine, Lloyd C. Atkinson, William R. Buechner,
Thomas F. Dernburg, Paul B. Manchester, and M. Catherine
Miller, professional staff members; Mark Borchelt, administrative
assistant; Katie MacArthur, press assistant; 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.
Mr. Secretary, I am sure we will have a strong membership
representation in a few minutes, but we have a reputation of
starting on time here, and we know you have limitations on your
schedule, so we will get underway.
I do want to welcome you here this morning. This is the fifth in
a series of hearings discussing the state of the economy. There are
few witnesses I can think of, Mr. Secretary, who are in a better
position or who are better qualified than yourself to comment on
our economic problems, at home and abroad.
Let me first begin by congratulating you on the impressive success you have had in your recent program to stabilize the dollar. It
is rare, indeed, Mr. Secretary, to see our government react so
quickly and decisively and effectively in a crisis situation.
Relative stability for the dollar on international currency markets is obviously a prerequisite for economic progress in this country, and you are to be commended in this regard.
I would be interested, Mr. Secretary, in your longer term prognosis of international economic trends. What happens when we exhaust the $30 billion pool we have devoted to exchange stabilization? Will 1979 be a year of relative stability in foreign exchange
markets? To what extent is the international monetary system in
need of further reform?
(1)
2
I certainly don't have to tell you that one factor contributing to
the weakness of the dollar has been our balance of trade problem.
Part of that balance of trade problem is from unfair trade practices.
From recent reports, Mr. Secretary, it would appear that the
Treasury is less than enthusiastic about its obligations to protect
the domestic industry from unfair trade practices, dumping in
particular. Mr. Secretary, I am not just speaking of your tenure in
the Treasury. I am talking about a history in Treasury where, for
quite a number of years, we jumped at the opportunity to waive
countervailing duties when it had been demonstrated that a foreign competitor had altered his practices. We have seen the situation where countervailing duties have been imposed, and we have
seen, from what I have been told by a number of industries, that
Treasury moves rather quickly to lower them when they find the
situation has been corrected-but they drag their feet when it
comes to the point of putting it on. Treasury has been quick to
waive the duties, but slow to impose them.
The International Trade Commission in many, many instances
has found that (countervailing duties) should be imposed, but the
Treasury in a very small percentage of those cases has acted.
Now, Senator Danforth and I introduced legislation last week
designed to improve our ability to enforce unfair trade practice
statutes, and I believe that kind of legislation is called for.
I would like to see what you have to say about Treasury's ability
or inclination to deal with important trade problems like dumping
and subsidies and, closer to home, I would like to hear your comments on the problems of productivity. I have some figures which
suggest that if the average annual productivity growth rate which
our economy experienced from 1947 to 1968, if they had been
maintained last year, the Gross National Product would have been
$300 billion greater than it is today. I think the dropoff in productivity is one of the most significant factors in our current economy.
The Joint Economic Committee is going to be devoting a lot of
attention to it in trying to develop some long-term solutions to our
productivity problem.
Finally, Mr. Secretary, when we are talking about the administration's budget and where we can cut, I think a very compelling
case can be made to end revenue sharing for the States, and I am
going to introduce legislation today to try to achieve that objective.
Ending revenue sharing would cut the Federal budget by over $21/4
billion, and I think it would end the absurd practice that we have
today where we have a huge deficit in the Federal budget, and the
States run surpluses. Not one single State, to my knowledge, is
predicting a deficit in their budget in 1979. I am not talking about
the cities, nor about the municipalities, but about the States themselves, and I would like to hear your comments on that, too.
Mr. Secretary, we are pleased to have you.
Proceed with your testimony.
STATEMENT OF HON. W. MICHAEL BLUMENTHAL, SECRETARY
OF THE TREASURY
Secretary BLUMENTHAL. Thank you, Mr. Chairman.
3
I am grateful for the opportunity to appear before this committee, the Joint Economic Committee, which looks at questions of the
overall economy, both domestic and international. It is a vitally
important forum, Mr. Chairman, for our government's work on
problems that clearly are at the top of the agenda, and must be, for
this nation. The very careful consideration of these issues by you
and your colleagues will make a great contribution, and we are all
delighted to share our thoughts with you.
I think, Mr. Chairman, that the testimony that you have already
had from my colleagues here in the last 2 or 3 days will have
indicated that this administration and President Carter have a
clear economic policy, a clear sense of priorities, a clear viewpoint
of where we must go over the period ahead, and that that program,
that agenda, is geared entirely to our firm recognition that the No.
1 problem before this country is to deal successfully with the
problem of inflation, and that whatever we do, whether it be in the
international area on the dollar, whether it be domestically on the
budget, on monetary policy, on all of the matters that you have
raised and about which you have posed questions, all of this must
be dealt with in terms of the absolute requirement of coming to
terms with, and successfully overcoming, the problem of inflation
in this country. For, if we do not do that, then none of the issues
that you have touched on can be satisfactorily resolved; and the U.
S. economy and the world economy will suffer greatly.
Budget decisions that the President has made and proposed to
Congress have all been made with that viewpoint in mind. I have a
prepared statement which I would like to submit for the record. I
will not read it, Mr. Chairman, with your permission.
Senator BENTSEN. Without objection, your prepared statement
will be placed in the hearing record.
Secretary BLUMENTHAL. I will summarize some of the critical
points. I think I will be dealing with some of the questions you
have raised. I will be glad to deal with the others not covered in
the summary of my remarks.
As I have said at the outset, Mr. Chairman, the budget decisions
for 1980 are designed to move us along toward the solution of the
inflation problem. The challenge that the Congress has is to do its
part to help us achieve this goal.
In dealing with the inflation problem, it is important, always, to
recognize at the outset that what we are facing is not a weak, an
uncertain, or tired economy. On the contrary, the economy is
strong, remarkably strong. We are in one of the longest periods of
recovery and growth this nation has enjoyed, and we have nothing
to fear as regards the resiliency and strength of our economy,
except the problem of inflation.
We have created in the last 2 years 7 million new jobs, the
greatest gain in U.S. history. We have a higher employment-toworking-age population ratio than we have ever had. Our real GNP
is up over 10 percent in 2 years; real disposable after-tax income is
up almost 9 percent over the last 2 years.
So the basic strengths of the economy are clear for all to see.
The problem of inflation threatens this progress for the future,
and it is that that we must deal with.
4
In the seventies, inflation averaged 63/4 percent annually, which
is totally unacceptable, but what is more unacceptable, Mr. Chairman, is that last year that the rate of increase in consumer prices
accelerated to 9 percent, and it is not surprising, therefore, that the
dollar over the last year, beginning even in 1977, has come under
strong attack.
Putting the anti-inflation effort at the top of our economic priorities in my judgment is not a 1-year requirement. We must continue it for an extended period of time, and it is clear that we must do
so because no solution, no single or multiple set of solutions, is
going to allow us, or enable us, to bring inflation down to the more
acceptable levels, which clearly have to be below the 63/4 percent
that we had in the rest of the 1970's, and it is clear that we have to
set as our target a much lower inflation rate such as we enjoyed
and experienced in the early part of the 1960's.
That will require political courage and patience. It will require
long-term economic discipline, and I would say that our economic
system and our system of government has not yet shown that we
have the kind of economic discipline that we can bring to bear over
an extended period of time to get that under control.
There are some who say the problem is not solvable, Mr. Chairman. To those I would say that we have ample evidence that other
countries have managed to deal with this problem without putting
their economies into serious economic difficulty, and it seems to
me, therefore, that we ought to be able to, likewise.
Japan reduced its inflation rate from 221/2 percent to 4 percent
over the last 5 years. Germany reduced its inflation rate from 7
percent to 21/2 percent over the last 4 years. If they can do it, I
think we can do it. It is our job to do it, and in talking with
responsible officials of those governments, I have become convinced
that we can, but I have also become convinced, Mr. Chairman, that
this is a multiple-year effort, and that they also did not do it in 1
single year.
There are many causes of inflation. I wish there were a single
one. We would then be able to design a cure. There are many
complex causes. I am sure that we would not, and our economists
do not, fully understand all of them, for some of them really are
the result of new situations in the national and world economy.
We, therefore, must devise multiple cures and approaches to deal
with these multiple causes.
This morning I do not have time, of course, to deal with all of
them, or engage in an exhaustive analysis of the interaction of
these, but I do want to deal, as I did in my prepared statement
briefly, with four dimensions of those problems that I think are key
and critical in the overall scheme of the inflation situation that we
face.
These four are, first, excess aggregate demand; second, the point
you have touched on, sluggish productivity growth; third, the problem of the momentum of the wage-price spiral, once inflation
starts; and, finally, the other point that you have quite properly
pointed to, namely, the dollar's value in the foreign exchange
markets.
Let me first turn to aggregate demand. The administration feels
strongly, Mr. Chairman, that the key to an anti-inflation program
5
is firm and persistent restraint on aggregate demand through fiscal
and monetary policy.
There are two reasons why this is needed. First, because there
are signs now that there is excess demand pressure in our economy. One reason we had an acceleration of inflation by more than 2
percentage points in the course of the last year is clearly the
movement toward an economy that is increasingly tight, and where
there are some pressures of aggregate demand on the resources
available to us. The fact that in the last calendar quarter of 1978
the economy grew by a substantial amount, by some 6 percent, in
real terms, clearly indicates that these kinds of pressures do exist.
The 1 million new jobs created in the fourth quarter of 1978
alone clearly also had narrowed the margin of idle resources and
had put some strains on labor markets.
This is not a critical or serious situation, but it is obvious that
the kind of budget that the President has presented, which envisages a reduction of the growth rate in 1979, is absolutely essential
if we are not going to get further inflationary pressures from this
continued growth in aggregate demand which is in excess of the
long-run growth that this economy can sustain.
The President's budget, which has been drawn with that in
mind, clearly meets that need. The annual rise of Federal expenditures in real terms is less than 1 percent, versus some 3.2 percent
on the average over the last 8 years.
Outlays are down to 21 percent of GNP for fiscal year 1980,
versus 22.6 percent as recently as 1976.
The deficit in the Federal budget has been targeted at below $30
billion, and at a little more than 1 percent of our GNP for the first
time in 5 years.
Federal employment is actually to be cut by 58,000 persons, as
compared to January of 1977.
Let me note here that in participating over the last 2 years in
the difficult task of fashioning a budget for presentation to the
Congress, I have become impressed by the difficulty of the job. The
President faces a most difficult job because three-fourths of the
outlays are practically uncontrollable in the short run. Of $531
billion in this 1980 budget, over $400 billion are in fact mandated
by continuing statutes or obligations. Some $250 billion out of the
$531 billion relate to transfer payments of various types, which are
usually indexed to the rate of inflation.
You see here the great problem which indexing already poses for
our economy. This is one of the reasons why we oppose any further
extension of indexing, for it makes the problem of dealing with
inflation all the more difficult and really builds it into the economy.
The President, therefore, has to work with a very narrow segment of the overall budget that he presents. When people talk
about the need to cut the budget, about strong action by the
President and by the Congress, they must understand that under
our system, under the way that the budget confronts us, we have in
fact only a relatively small portion, less than a quarter, that we
can deal with, at least in the short run, in order to bring about the
kind of cuts that we need.
(
.i,
6
'The President, I think, has allocated the cutbacks from current
services fairly among the various competing needs, recognizing the
need to maintain a strong defense and our obligations to our allies
on the one hand, and recognizing the therapy which, overall, must
be extended for a period of time, but, nevertheless, must not be
done in such a way as to harm the poor, those with low incomes
and those that are particularly vulnerable to the ravages of inflation.
It is clear that inflation, if allowed to go on, inflicts great harm
on our society, and a budget leading to less inflation will, in turn,
be of greatest benefit to those sectors of our economy.
Similarly, monetary policy has to be restrained and consonant
with the fiscal approach that the President has reflected in the
budget he has presented to the Congress.
The Federal Reserve, I understand, has a long-term commitment
to keeping the monetary aggregates under control. There is a complete understanding between us on the need for coordination and
for concerted action on this matter, and I have no doubt that that
kind of coordination and consistency of basic approach will continue as long as this problem exists into the future.
It is also vital that we do not let the Federal credit demands rise
unduly, and this budget also reflects that understanding, one, obviously, that is of particular concern to us at the Treasury.
Next year, Federal borrowing from the public will actually decline, and the decline will be even greater relative to total credit
availability. Federal borrowing will be a little over one-tenth of
credit demands in 1979, and less than that in 1980. That compares
to one-fifth in 1976.
The concern that has to be always before us, namely, a crowding
out by the Federal Government of private borrowers in the credit
markets, therefore, is one that need not concern us greatly. We are
bringing down Federal borrowing substantially, and, therefore, the
pressures on the private credit market to an equal extent.
Productivity growth is another key area that I briefly want to
touch on. The growth in real output per worker is the key to real
growth in our economy. If we do not increase productivity, the pie
will not grow, and if the pie does not grow, we cannot do better in
real terms. It is in fact the fulcrum between wage inflation and
price inflation.
To the extent that we cannot increase productivity, we are likely
to have both.
Productivity growth in the private nonfarm business sector was
2.5 percent in the 1948 to 1968 period, and has fallen to 1.5 percent
in the last 10 years and fell to an abysmal eight-tenths of 1 percent
in 1978.
Price and wage inflation were nearly identical in 1979; 93 percent in one case versus 9 percent in the other. It is a clear indication that we must bring productivity up.
We need more investment and fewer costly regulatory constraints.
I think the tax bill that the Congress passed last year, which
contains $7 billion of tax cuts for business, including a reduction in
the taxation on capital gains, is a step in the right direction. That
7
is just being implemented. I certainly expect that that will have a
salutary effect on productivity in the economy.
The President's efforts to review all new regulations for their
economic costs and benefits will be of considerable help, and we are
going to need the help of the Congress in that area. We are doing a
lot of thinking and a lot of work. This is really one of the important areas.
If you will allow me for a second, it reminds me of a story I
heard just the other day, which is both funny and sad. It is about
the general counsel who was called before his board of directors,
who are of a company that are in some difficulty, and the general
counsel addresses the chairman of the board and says, "Mr. Chairman, I have some good news and some bad news for you."
And the chairman says: "Well, that is kind of worrisome."
And the general counsel says: "What would you like to hear first,
Mr. Chairman."
He said: "Well, tell me the bad news first."
He said: "The bad news is that we are broke, Mr. Chairman, the
company is bankrupt, finished, kaput."
"Well, that is awful. What is the good news?"
"The good news, Mr. Chairman, is that you are in compliance
with all Federal regulations." [Laughter.]
Senator BENTSEN. I have a Texas story that I should tell.
Secretary BLUMENTHAL. Clearly, the burden that regulation
places on business is heavy and has economic costs, fully recognizing that many of these rules and regulations are very important,
that they deal with goals that are very necessary. We need to get a
better handle on the economics of those kinds of regulations, the
costs and benefits that are involved, and we need to budget those
in terms of what we can afford.
It is obvious that to the extent to which business is forced to
allocate an increasing share of total available investment resources
to meeting regulations, rather than to the kinds of investment that
raise productivity and output per worker, to that extent, the overall productivity level in the economy will be reduced, and that, I
think to some extent, is what we have perceived.
Let me then turn to the third element, Mr. Chairman, that of
the momentum of the wage-price spiral. It is a tail-chasing process.
It involves inflationary expectations in which labor anticipates further inflation and seeks to make gains on the wage front which
puts it ahead of the game, its members ahead of the game.
It entails business recognizing and expecting further inflation
and engaging in preemptive price increases in order to protect it
against the ravages of inflation.
The result is the fact that once a certain chain of events has
occurred which pushes inflation up, it is very, very difficult to get
inflation back out of the economy.
The numbers indicate that clearly. Even in the 1974-75 recession, when certainly there was slack in the economy in overall
aggregate demand, we were only able to bring down during that
period the rate of inflation to 6 percent, which, in itself, was too
high.
8
There is no doubt that one of the reasons was simply the momentum and the fact that these kinds of expectations get built into the
economy and, once built in, are very difficult to root out.
The speed of the response of wages and prices to demand restraint is not fast enough and it is for this reason that the President promulgated his program of voluntary wage and price standards. These standards are an important part of the overall attack
on inflation.
They are not the key or the only element. They make sense only
in the context of the fiscal and monetary restraints to which I have
alreadv referred, and the attack on cost-ineffective regulations and
all the other things we are doing to deal with the inflation program.
The stress is on voluntary, Mr. Chairman and members of the
committee. It is voluntary, because experience shows mandatory
controls do not do the job. They sound easy, "Just pass the law and
everybody will abide by it and the economy will behave well."
Unfortunately, experience shows that is not the case. We burden
the economy with distortion of resources and incredible paperwork.
Once we give up on this, as we must, the burst of inflation in the
economy is greater than would otherwise have been the case. This
administration is firmly opposed to all kind of mandatory controls.
That, however, means that the voluntary program must work. I
will not go into the details by describing it. I think it is well known
to you, Mr. Chairman, and to the members of this committee.
I do want to mention in passing, and I will be glad to talk about
it more in the question period, that the real wage insurance which
the President has proposed, and on which I began the testimony on
Monday before the House Ways and Means Committee, is an important tool to enable us to make the voluntary wage-price program work more effectively. It is a tool that the President needs. I
do hope that the Congress will give him that tool.
There was a lot of concern, even before this legislation was
introduced, whether it was a workable, or sensible program. I sense
that as a result of the explanations that have already been given,
as a result of the close study which is now being given by the Ways
and Means Committee that there is an increasing recognition that
we do, indeed, have a program here that is worthy of a try. It will
make it much easier for labor to accept the kind of wage standard
we have in mind, limiting wage increases to 7 percent. It will make
it much easier for all American workers to abide, and employers,
by that standard, because they will know that if for reasons that
occur, despite their willingness to take that chance, inflation in the
economy should be greater, that workers will be compensated for it
up to the level of 10 percent, and certainly we don't expect inflation to be higher than that.
It is a way of breaking the vicious cycle with wages and prices chasing each other.
It answers the question that labor has posed:
Why should we be the first? How can we be sure that if we in fact take the risk,
that we will not still be confronted by rapidly escalating prices which will substantially reduce real income for our people?
It answers the problem with:
Look, if you are first, others will follow suit, the increase will abate, and we
provide you with insurance that if for some external reason that should not be the
9
case, your members and workers and employees throughout the land will not be
unduly harmed and the only ones making that kind of sacrifice.
Let me turn now to the question of the dollar's value abroad.
Clearly, we have learned in 1978 that we cannot contain domestic
inflation unless we also insure the dollar's strength. We think that
until the November 1 action, the substantial dollar decline, quite
apart from the temporary developments on the world monetary
scene and in the exchange markets, contributed as much as 1
percent to the rate of inflation in this economy. The actions of
November 1 put an end.to that vicious spiral of inflation feeding
dollar depreciation and, in turn, feeding inflation. And the results,
as you have indicated, are certainly encouraging.
The dollar has rallied more than 9 percent since October 31.
That was the low point. Markets reflect new confidence in our
determination to contain inflation and reduce the trade deficit, and
in the joint commitment, not only of the United States, but the
United States together with Germany, Japan, Switzerland, and
others, to use their full resources to keep the dollar strong and
stable.
The United States, Mr. Chairman, is determined to prevent any
resurgence of the kind of conditions in the foreign exchange markets which led to the action of November 1. Our resources are very
substantial, and we will not hesitate to use them as necessary to
achieve our objectives. The other participants have committed their
own substantial resources to those joint operations.
There is, in fact, no quantitative ceiling on the resources which
the four countries could use. Other members of IMF are also dedicated to assuring exchange market stability.
We are prepared to consider with an open mind ideas for evolutionary change in the monetary system. What is important is that
any change be an improvement and that the transition be accomplished smoothly and in ways which strengthen open international
trade.
Let me digress here, Mr. Chairman, and deal with one question
you raised, which is mainly with regard to the dollar. What is
there that can be done, will the $30 billion run out, and is the
system in need of further reform?
As I have already indicated, there are ample resources available
to us. We have been selling Treasury bonds denominated in the
currencies of other countries. We are committed to a program to
continue that. The other countries are equally committed to help
support the dollar. There are no limits on their resources.
In addition to that, of course, it is clear that the program, in
itself, will not do the job. The program will only work if in fact the
kind of budgetary restraint that the budget shows and monetary
restraint, are continued and if the trade deficit is reduced and if
inflation comes down.
I will be dealing with the trade deficit in a minute.
Meanwhile, there are discussions underway to see how the international monetary system can be strengthened further. This is a
gradual process. I would like briefly to read from my prepared
statement on that point, because it is critical.
First, while we do not believe the reserve role of the dollar is a
major source of current exchange market difficulties, we are pre-
10
pared to consider proposals for evolution of the international reserve system. We have no interest in preserving an artificial role
for the dollar, and we are quite prepared to contemplate a reduction in its relative role in the international monetary system.
Second, substitution proposals are under discussion in the International Monetary Fund, and we are participating in those discussions. Our objective will not be to resist change, but to insure that
any change be an improvement from our own point of view and
that of an open and stable system.
Third, while the substitution idea may look simple, appearances
can deceive. There are serious questions about the costs of such a
scheme and their distribution among countries; about the implications of a substitution account for the exchange rate system; about
the contribution such an account could make to a better sharing of
responsibilities for operation of the system; and about whether
such an account would in fact contribute significantly to greater
monetary stability.
In sum, the substitution approach involves questions that deserve
careful evaluation-and certainly closer examination than they are
frequently given. We intend to give the idea full consideration,
weighing both its potential contribution and its potential costs.
While it may be that some form of substitution proposal will ultimately be found practical, useful, and agreeable to the international community, I would prefer that the United States suspend judgment on that matter pending careful study.
To conclude this discussion of the international dimensions of
our economic situation, let me stress that to keep the dollar firm,
the United States must continue reducing its trade and current
account deficits. The portents are hopeful on this front. Containing
inflation at home will make our goods more competitive both at
home and abroad. Foreign economies, and thus markets, will grow
faster than our own economy in 1979 for the first time in 5 years,
and this will provide better export opportunities.
Our trade balance showed marked improvement during 1978,
and we expect this to continue. In the second and third quarters of
1978, the trade deficit narrowed to a $311/2 billion annual rate
(balance of payments basis), some $14 billion below the rate of the
preceding 6 months. In the fourth quarter of the year, the trade
deficit averaged about $21/2 billion, a $30 million annual rate.
Export volumes have risen strongly since March 1978; growth in
nonoil import volume has slowed down substantially. We expect
continued strong export growth and a very small increase in
import volume in 1979. Although the oil price rise will add about
$4 billion to oil imports, the trade deficit should decline to about
$25 to $28 billion for the year as a whole and, owing to our growing
net invisibles surplus, the current account deficit could drop by
about 50 percent from the $17 billion estimated for 1978.
All this, Mr. Chairman, leads us to the expectation of a moderating real growth in the domestic economy from 41/4 percent down to
the 2 to 21/2 percent range and the inflation from 9 percent down to
about 71/2 percent for this year.
I think the recession forecasts are wrong. Of course, no one can
be completely sure, but we feel confident that our forecasts are
accurate.
11
First of all, the momentum in the fourth quarter of 1976 showed
strong real growth. Second, inventory remains low and well balanced. Third, housing starts are good, but will level off. Fourth,
exports should continue to be a source of growth, and that will be
helpful, and also consumer spending, while leveling off, will continue at an acceptable rate. We don't see any sign of collapse in
that area.
Finally, the investment picture is more mixed than we would
like, but we expect at least moderate growth in that sector.
In conclusion, therefore, Mr. Chairman, we think that since November 1 there are hopeful movements in the economy.
Let me conclude by citing some of these.
The dollar has rallied by more than 9 percent against OECD
currencies, the stock market gained substantially after the President's action. Financial leaders here and abroad now recognize that
the Government is determined to see the inflation fight through to
its successful conclusion.
It is no longer the smart bet to wager against the American
economy. The recovery remains resilient. The American people
have ignored the cynics and have shown a receptivity to a common
voluntary effort to restrain wages and prices.
All this adds up to evidence that our economy can be steered to a
less inflationary pattern without dislocation. These hopeful signs
do not, of course, mean we have won the fight, but they give us a
genuine chance to win it if we can maintain the momentum.
What we need to maintain our momentum is a sign that Congress too is committed to maintaining our prosperity for the decade
ahead. I look forward to working with you and your colleagues on
this important enterprise.
Thank you, very much.
[The prepared statement of Secretary Blumenthal follows:]
PREPARED STATEMENT OF HON. W.
MICHAEL BLUMENTHAL
Mr. Chairman and Members of this distinguished Committee, I appreciate this
opportunity to discuss with you the President's economic and budgetary plans for
1979 and 1980.
The American economy is at a critical juncture. Since the deep recession of 197475, we have enjoyed an unprecedented recovery of employment and production, but
we have had less success in maintaining the value of our currency at home and
abroad. This imbalance in our achievements cannot persist. Either we shall right
the balance ourselves by bringing inflation under orderly control, or events will
reassert equilibrium for us, by bringing the economic recovery itself to a disorderly
close. There is no doubt which alternative best serves the public interest. The only
question is whether we in Washington, subject as we all are to the usual political
cross-currents, can find the will to choose and hold to the correct path. The stakes
are high. In deciding upon this budget, the new Congress will largely determine
whether or not we enter the 1980's with a firm foundation for long term prosperity.
We reach this decision point after several years of truly exceptional economic
performance. Since President Carter assumed office, the gains in employment and
output have outpaced even optimistic expectations:
Over 7 million new jobs have been created. This is the largest gain in employment
during any two year period in our history, and the ratio of employed persons to the
working-age population is at an all-time high.
The number of unemployed has been cut by more than 1 million persons, and the
rate of unemployment has been reduced to below 6 percent. By way of reference, the
rate peaked at 9 percent in 1975 and was still close to 8 percent at the end of 1976.
Real output has expanded by 10 percent, and industrial production has risen by
13 percent.
12
Real disposable personal income-income after taxes and corrected for inflationmore than
has risen by almost 9 percent. Corporate profits have also increased-by
a third-even after adjusting for the rise in replacement costs.
Unless we
But all of these achievements now stand threatened by inflation. economy's
the
assure the integrity of our currency, both at home and abroad,financial dislocaforward progress will reach the familiar dead-end of recession and for an extended
tion. We can avoid these evils, but only if we are prepared now, and
of economic
perind, to move the fight against inflation to the top of our list
priorities.
are
That is the message of the President's budget. I believe the American people
to reprepared to respond to that message-to join earnestly in a common effort
not sense
secure the fundamentals of economic progress for the next decade. I do because it
that the people share the superficial view that this budget lacks interest in its very
is short on new ideas for spending their tax dollars. They realize that initiative
spareness the budget constitutes a new initiative of major importance: an
to assert responsible control over our economic destiny.
1. THE INFLATION PROBLEM
progress
Over the 1970's, inflation has posed a critical threat to economic
probthroughout North America, Europe, and Japan. It has made all of our other
lems much worse. In some countries, inflation has compromised political stability
and democratic procedures. More than once, it has seriously shaken the internationprogal monetary system. Everywhere it has retarded economic growth and social more
ress. Inflation has proved to be far more destructive of prosperity, and far
intractable, than any of us would have imagined possible ten years ago.
As the decade comes to a close, however, we have learned that inflation is not like
percent
death and taxes: we can rid ourselves of it. In 1974, Japan suffered a at221/2
4 percent.
rate of inflation; the Japanese inflation rate is currently running
over
Similarly, Germany has reduced its inflation rate from 7 percent to 2½/2percent
the past 4 years, and the British brought their inflation rate down from 24 percent
to 81/2 percent between 1975 and 1978.
That is cause for hope. But it is also reason for impatience about our own
experience. The inflation record of the United States has been less than admirable.
The dollar's buying power has been cut in half since 1967. In the 1970's, inflation
here has rarely gone into the double digits-but it has averaged 6¾ percent. Last
year, the inflation rate experienced a disturbing acceleration. At the end of 1978 the
CPI was 9 percent higher than at the end of 1977. This constituted an increase of
more than 2 percentage points over the previous year's inflation rate.
The roots of our inflation problem are numerous and deep. There is no one cause
for the problem, and we cannot expect to solve it either quickly or with any single
panacea.
In the spring of last year, the President moved the fight against inflation ahead of
all other objectives and began to mobilize the full arsenal of weapons necessary to
win the fight.
During the spring and summer of 1978, the President worked with the Congress
to reduce the 1979 budget deficit to less than $38 billion. In late October and
November, the President added important new weapons to the arsenal. He set a
target of $30 billion or less for the 1980 budget deficit; he announced that the
Federal Reserve Board would take strong steps to contain credit expansion; he
arranged with Germany, Japan, and Switzerland a far-reaching program to stabilize
and strengthen the dollar in the foreign exchange markets; he set in place an
unprecedented program for reviewing the economic impact of federal regulations; he
promulgated a full program of voluntary wage-price standards, supported by an
innovative plan for real wage insurance to encourage compliance with the wage
standard.
The emerging anti-inflation strategy addresses virtually every major dimension of
the problem, but I would like today to lay stress upon the four aspects of inflation
that require governmental responses of a particularly determined, sustained, and
concerted character: excess aggregate demand, sluggish productivity growth, the
sheer momentum of the wage-price spiral, and the dollar's value on the foreign
exchanges.
11. AGGREGATE DEMAND: THE NEED FOR SUSTAINED FISCAL AND MONETARY RESTRAINT
The centerpiece of the President's anti-inflation strategy is sustained and concerted restraint on aggregate demand, effected through both fiscal and monetary policies. There are two reasons for this emphasis on prudence in the making of budgets
and the creation of dollars.
13
First, there have been clear warning signals of demand excess in recent months.
The economic recovery has been sufficiently powerful and prolonged to absorb most
excesses and indeed to generate inflationary strains in some labor and product
markets. Our real economic growth has averaged 5.1 percent over the last 45
months; in the last quarter of 1978, real growth proceeded at a 6.1 percent annual
clip. We are clearly reaching a point where the margin of idle resources is very thin
in many sectors of the economy. Unless we now apply fiscal and monetary restraint
in a controlled but firm and definite way, we risk hitting unmoveable barriers. This
would throw us into a wholly unnecessary recession, with a great deal of unnecessary hardship.
There is a second reason for demand restraint: both here and abroad, experience
has demonstrated that no anti-inflation effort-no array of policies-can succeed
without the long-term, unwavering support of fiscal and monetary discipline. This
long-term discipline is essential to reduce inflationary expectations and reverse the
wage-price spiral. The President has not joined this battle against inflation to win
temporary victories. Our goal is not a momentary pause in the wage-price spiral,
but an economy securely settled on a path of long-term price stability and sustainable progress in growth and employment. This will require a long-term commitment
to hold down the government's claims on the economy's real and financial resources, and a long-term commitment to keep the supply of dollars from validating
excessive demands.
The President's fiscal year 1980 budget sets an example of restraint for the
economy:
Federal spending will be nearly frozen in real terms. After adjusting for inflation,
Federal outlays in 1979 will grow by only 0.3 percent and those of 1980 will be only
0.7 percent higher than in 1979. These are the smallest increases in five years and
far below the 3.2 percent average increase for the previous 8 years of this decade.
Federal spending will be held to levels that absorb a smaller share of total output.
Outlays in 1980 will be down to 21 percent of GNP, compared with the recent high
of 22.6 percent in 1976.
The Federal deficit will be below $30 billion for the first time in five years and
will be barely more than 1 percent of GNP.
Federal employment will actually be reduced. Civilian employment in the government will be about 58,000 less by the end of 1980 than it was when President Carter
took office. This will bring the ratio of federal workers to the total population to
about 1.24 percent, the lowest point since 1950.
To achieve this degree of budgetary restraint is a major feat. Our long-term
defense needs are substantially dictated by foreign dangers beyond our control.
About three-quarters of federal budget outlays-over $400 billion of the $531.6
billion-are mandated by continuing statutes or obligations which are nearly impossible to alter in the short term. About one-half of budget outlays-over $250 billion-represent transfer payments for individuals, which are usually indexed to the
rate of inflation, so that total spending has a nearly inexorable tendency to rise in
times of inflation. This leaves only a relatively small portion of the budget susceptible to practical control on a year-to-year basis by the President and the Congress.
In his budget the President has taken great pains to allocate the needed cutbacks
fairly and sensibly among the many competing public demands, showing particular
regard for those groups most in need of federal help and support. But make no
mistake: The budget makes a major contribution to the poor and the disadvantaged
in its very restraint, its very emphasis on fighting inflation. For it is society's most
vulnerable members that suffer most grievously from inflation.
Fiscal austerity must be complemented by monetary restraint until the inflation
problem is brought firmly under control. As Chairman Miller stated last week: "The
Administration's wage-price standards and other anti-inflation initiatives can be
successful only if they are backed up by macro-economic policies of restraint . . .
We must find the courage to adhere for a sustained period to the course of policy we
have charted."
Innovations in our financial system are keeping monetary restraint from concentrating its impact predominantly on the housing industry, which in previous cycles
was the earliest victim of increased credit stringency. The impact of monetary
restraint is now less discriminatory, but it remains a powerful and necessary component of our anti-inflation arsenal. And it is being used.
Our tight budgetary policies are easing the task of the monetary authorities. With
a reduced deficit, and with off-budget financing activities being monitored more
closely, Federal demands on financial markets will be substantially reduced. Federal
borrowing from the public this year and next will be declining both absolutely and
relative to the total amount of credit raised in financial markets. In 1976, the
47-106 0 - 79 - 2
14
federal government accounted for over a fifth of total credit demands. This year,
federal borrowing will be around a tenth of the total, and the share of credit
absorbed by the government will decline further in 1980. This means that monetary
aggregates can be restrained without choking off essential flows of credit to the
private sector.
III. SLUGGISH PRODUCTIVITY GROWTH
Another major source of our inflation problem is sluggish productivity growth-a
low rate of increase in real output per hour of work. On this criterion, we have been
finishing dead last among industrial nations throughout most of the 1970's.
Productivity growth is the fulcrum between wage inflation and price inflation.
Over the long term, one can usually approximate the figure for price inflation by
subtracting productivity growth from the rate of wage inflation. From 1948 to 1968,
productivity in the private non-farm business sector rose about 2V2 percent a year;
labor compensation rose at 5 percent; and price inflation averaged below 3 percent.
Over the last ten years however, productivity growth in the private non-farm
business sector has averaged only 11/2 percent, and last year it fell to an abysmal 0.8
percent. This means that average wage increases and price inflation now run at
nearly the same rate: last year, for instance, compensation per hour (wages plus
fringes) rose by about 93/4 percent; with productivity growth depressed, price inflation tracked right along at about 9 percent.
To improve productivity growth requires a long term effort to increase our investment in productive resources and to refrain from imposing excessive regulatory
burdens upon the private sector. Last year's tax bill, involving substantial incentives for investment, will help. The President's new program for reviewing regulatory costs and benefits will help.
But it will take persistent policy attention over a number of years to return
productivity growth to the high rates that made life so cheerful for economic
advisers in the 1960's. Until then, price inflation will parallel average wage inflation: to bring down price inflation, we must bring down wage inflation, and vice
versa.
IV. THE MOMENTUM OF THE WAGE-PRICE SPIRAL
Central to our long-term inflation problem is the sheer, self-reinforcing momentum of the wage-price spiral.
Inflation persists because everyone expects it to persist. Expecting high inflation,
business sets high prices, labor demands high wages-and we thereby generate
precisely the high inflation that was expected.
The wage-price spiral is enormously stubborn. Demand restraint can have some
effect on it, and is clearly a necessary part of any cure; but, acting alone, demand
restraint works its cure quite slowly and harshly. The U.S. inflation rate in the
1970's has declined with painful slowness even during periods of great slack in labor
and product markets. Even when aggregate demand is sharply cut back, business
and labor continue for a substantial period to act upon deeply ingrained expectations of high inflation. The inflationary momentum persists and, while it does, the
decline in demand delivers its impact on the only remaining targets: employment
and real growth. It is only after a considerable period of demand restraint that
inflationary expectations finally begin adjusting to the changed economic conditions.
To succeed in reducing inflation, we must learn patience, but we must also seek to
speed up the response of wages and prices to conditions of demand restraint. Every
advanced nation has recognized this. Each has established its own particular procedures and institutions for braking wage-price momentum-for overriding unrealistic
inflationary expectations-so that demand restraint can reduce inflation without
socially wasteful delays.
It is for this purpose that the President promulgated voluntary wage-price standards last October. These standards describe a path for wages and prices consistent
with the general moderation of economic activity that is assured by our application
of fiscal and monetary discipline. If these standards are followed, the inflation rate
will adjust downward to the slowing pace of the economy. We will avoid an unnecessary, sharp fall-off in real growth rates and an unnecessary, large increase in
unemployment.
The wage-price standards are voluntary. The President strongly opposes mandatory controls. The U.S. experience with controls, and that of virtually every other
nation, is that they saddle the economy with enormous bureaucracy, miles of red
tape, and crippling inefficiencies. Very quickly, mandatory controls collapse under
their own weight. Controls are an attempt to usurp the roles of the marketplace and
the collective bargaining table in setting every price and wage throughout. the
15
economy. That's an absurd and unnecessary project. Our purpose is merely to brake
the momentum of wages and prices that is unresponsive to basic macro-economic
conditions. That vital, but limited, purpose can be accomplished without excessive
government interference in allocating resources and incomes throughout the
economy.
But voluntarism raises a basic issue. It requires that everyone forego apparent
short-term economic gains in exchange for long-term economic improvements of a
much more substantial, general, and lasting character. Every working person has
the legitimate concern that his or her compliance with the program will not be
matched by others and will accordingly result in reduced real income as inflation
continues beyond a 7 percent level. Wages are set for extended periods-6 months, a
year, sometimes several years. Compliance on the wage side constitutes a relatively
long-term commitment, and thus triggers a particularly acute concern about real
income loss. This is the concern that drives the wage side of the wage-price spiral.
The President has proposed an innovative program for real wage insurance to
meet directly this central concern of working people. The proposal would materially
reduce the financial risks of compliance; it would lead to more widespread compliance, and thus to a more rapid and pronounced impact on the inflation rate.
The proposal in effect sets up an insurance contract. In this contract, we ask wage
restraint from each employee group, so as to reduce inflation for the benefit of all;
in return we offer to share the risk that inflation will in fact exceed the wage
increase ceiling. This is a novel, but natural, response to a dilemma that has evaded
solution for many years. In the overall structure of our anti-inflation policies, real
wage insurance plays an important role for which there are no readily imagined
substitutes.
V. THE NEED FOR A STRONG AND STABLE DOLLAR
The dollar's value cannot be protected at home if it is weak abroad, and we
cannot maintain its integrity abroad if it is shrinking at home. Last year, that
maxim received a sharp and painful illustration. The acceleration in domestic
inflation served to weaken the dollar on the foreign exchange markets, and this in
turn raised the domestic price level even further-as the cost of imported goods rose
and provided an umbrella for domestic price increases. We estimate that the dollar's
depreciation last year may have added as much as one full percentage point to our
inflation rate.
The President moved forcefully on November 1st to put an end to this vicious
cycle. He endorsed the imposition of greater monetary restraint domestically and
arranged with Germany, Switzerland and Japan a program of closely coordinated
intervention in the foreign exchange markets.
The U.S. has mobilized most of the $30 billion in foreign exchange resources being
used to finance our share of this effort. These funds have been obtained partly
through use of U.S. reserves and partly by borrowing, including the issuance of
foreign currency denominated securities.
The increase to $15 billion in the central bank swap lines with those three
countries took effect immediately on announcement. Drawings on the IMF in Deutschemarks and Japanese yen, amounting to the equivalent of $2 billion and $1
billion, were made in early November. Later that month we sold about $1.4 billion
equivalent in SDR's for Deutschemarks and yen. To date we have undertaken two
issues of foreign currency bonds totaling the equivalent of $2.8 billion-a DM issue
of about $1.6 billion in January, and a Swiss franc issue of about $1.2 billion in
January. We expect to borrow additional amounts during the fiscal year but have
not yet decided upon the details of further issues.
The shift in intervention practices announced on November 1 was designed to
restore order in exchange markets and a climate in which rates can respond to the
improved outlook for the economic fundamentals that underpin the dollar's value.
We are not attempting to peg exchange rates, nor to establish target zones, nor to
impose exchange rates inconsistent with the fundamental economic and financial
realities.
The initial response in the foreign exchange markets to the November 1 actions
was good. From its low point on October 31 the dollar recovered on a trade-weighted
basis by 12 percent by November 20. Against the DM and the yen the recovery was
also 12 percent; against the Swiss franc, 18 percent. Subsequent pressures from
political developments in Iran and the OPEC decision to increase oil prices substantially were met by forceful action from monetary authorities and by the resiliency
of two-way trading. The dollar has stabilized and, today, on a trade-weighted basis,
the dollar is over 9 percent above the October low.
16
We are beginning to see a change in tone and expectations in the foreign exchange and domestic money markets. Markets have been much more orderly and
better balanced, although there is still some nervousness and uncertainty. I believe
we will see increased stability as our determination to persevere becomes more
evident.
The United States is determined to prevent any resurgence of the kind of conditions in the foreign exchange markets which led to the actions on November 1. Our
resources are very substantial, and we will not hesitate to use them as necessary to
achieve our objectives. The other participants have committed their own substantial
resources to those joint operations. There is, in fact, no quantitative ceiling on the
total resources which the four countries are ready to use.
Other members of the IMF are also dedicated to assuring exchange market
stability. The recently amended IMF Articles of Agreement provide for strengthened surveillance of members' economic policies to insure achievement of this
objective.
We are prepared to consider with an open mind ideas for evolutionary change in
the monetary system. What is important is that any change be an improvement and
that the transitions be accomplished smoothly and in a manner which strengthens
our open international trade and payments system.
Mr. Chairman, at this point I would like to comment briefly on proposals to
substitute special drawing rights for a portion of official dollar reserves, proposals
that have been endorsed by some members of your Committee. I have three observations.
First, while we do not believe the reserve role of the dollar is a major source of
current exchange market difficulties, we are prepared to consider proposals for
evolution of the international reserve system. We have no interest in preserving an
artificial role for the dollar, and we are quite prepared to contemplate a reduction
in its relative role in the international monetary system.
Second, substitution proposals are under discussion in the International Monetary
Fund, and we are participating in those discussions. Our objective will not be to
resist change, but to ensure that any change be an improvement from our own point
of view and that of an open and stable system.
Third, while the substitution idea may look simple, appearances can deceive.
There are serious questions about the costs of such a scheme and their distribution
among countries; about the implications of a substitution account for the exchange
rate system; about the contribution such an account could make to a better sharing
of responsibilities for operation of the system; and about whether such an account
would in fact contribute significantly to greater monetary stability.
In sum, the substitution approach involves questions that deserve careful evaluation-and certainly closer examination than they are frequently given. We intend to
give the idea full consideration, weighing both its potential contribution and its
potential costs. While it may be that some form of substitution proposal will ultimately be found practical, useful, and agreeable to the international community, I
would prefer that the U.S. suspend judgment on that matter pending careful study.
To conclude this discussion of the international dimensions of our economic
situation, let me stress that to keep the dollar firm, the United States must continue reducing its trade and current account deficits. The portents are hopeful on this
front. Containing inflation at home will make our goods more competitive both at
home and abroad. Foreign economies, and thus markets, will grow faster than our
own economy in 1979 for the first time in five years, and this will provide better
export opportunities.
Our trade balance showed marked improvement during 1978, and we expect this
to continue. In the second and third quarter of 1978, the trade deficit narrowed to a
$31 2 billion annual rate (balance of payments basis), some $14 billion below the
rate of the preceding six months. In the fourth quarter of the year, the trade deficit
averaged about $2 2 billion, a $30 billion annual rate. Export volumes have risen
strongly since March 1978; growth in non-oil import volume has slowed down
substantially. We expect continued strong export growth and a very small increase
in import volume in 1979. Although the oil price rise will add about $4 billion to oil
imports, the trade deficit should decline to about $25 to 28 billion for the year as a
whole and, owing to our growing net invisibles surplus, the current account deficit
could drop by about 50 percent from the $17 billion estimated for 1978.
VI. THE ROAD AHEAD
We are mobilizing every element of economic policy behind the fight against
inflation-fiscal policy, monetary policy, international financial policy, regulatory
policy, wage-price policy, and more. None of this will work instantly; for success, we
17
will need a long-term commitment by the entire federal government, supported by a
determined nation, to keep the anti-inflation effort at the top of our list of priorities
for a number of years.
This does not mean that we face a bleak future. Quite the contrary. It is only by
turning firmly against the forces of inflation, and then holding our course, that we
can save our economy from economic turmoil in the short run and the trap of
stagflation in the long run. If we show the requisite discipline, this economy can be
successfully steered, without a recession, on to a path of price stability and steadily
enlarging prosperity.
I am well aware that some are forecasting a recession for 1979 or 1980. In passing,
I would note three points: First, we have been hearing such forecasts for better than.
a year now, as the economy shows continued resiliency, the predicted recessions
keep getting a rain check. Second, the recession scenarios all involve much milder
and much shorter downturns than we experienced in 1974; no one sees us on the
road to a serious bust. Third, with very rare exceptions, the forecasters are not
suggesting that we should seek to avert a downturn by now liberalizing our fiscal or
monetary policies; this could only lead to a much more severe and prolonged
recession.
My major point, however, is that the path we are now pursuing need not involve
a recession. We do foresee a definite slowing in the pace of real growth-from 41/4
percent last year to the 2 to 21/2 percent range this year-and a concommitant
moderation in the pace of inflation-from 9 percent last year to about 71/2 percent
this year. Our projected growth rate is just about where we ought to be-for the
economy to cool itself off in a measured fashion, for inflation to turn resolutely
away from the double digit range, for the trade deficit to narrow significantly, and
for the dollar to firm up substantially.
Our projected moderation in inflation will come from a number of sources: the
slowdown in growth itself, a fall off from last year's abnormally high rate of food
price increases, the renewed stability of the dollar, a slower pace of advance for
housing costs, and the discipline of the wage-price standards.
The respectable, though clearly diminished, rate of real growth in 1979 will follow
from the continued resiliency and balance of the recovery. On this point, I believe,
the private forecasters have been too bearish. Let me draw you attention to a
number of hopeful signs.
Momentum: Contrary to most forecasts, the economy was growing at the end of
1978 at a very strong annual rate of over 6 percent. One million new jobs were
added in the last quarter of the year, three million for the year as a whole, and we
entered the new year with the ratio of civilian employees to the population at a
record high.
Inventory balance: We have avoided excessive inventory accumulation throughout
this recovery. Businessmen have been alert in keeping their stock-building close
relative to sales. Even after adjusting for the inflationary bias in inventory/sales
ratios (sales are recorded at current prices, but inventories may be carried at earlier
and lower prices), these measures show reasonably good balance in most industries.
Housing While housing activity can be expected to taper down some next year,
partly in response to the high prices of new housing and partly because of the high
level of financing costs, there is no reason to expect the sharp drop in housing
activity that has been characteristic of past cyclical swings in the economy. Usually
an early victim of credit stringencies, housing starts have been at over a 2 million
unit rate since last winter. This strength reflects in part the strong support of the
mortgage market by government housing agencies, but more importantly, the
changes in financial structure that have enabled the housing sector to compete for
funds in the financial markets despite sharp increases in interest rates. At the same
time, social and demographic changes in family structure should continue to support strong housing demand.
Consumer spending: The ratio of consumer debt to personal income is high by
historical standards and bears very careful watching. But the reasons may be due
more to demography than to a serious abuse of consumer credit. There are now an
unusually large number of consumers in the 25- to 44-year age group. People in this
age category are typically the heaviest users of credit-they are forming households
and buying homes and durable goods with the reasonable expectation of rising
incomes in the future. The increasing trend toward two wage-earner households is
another factor encouraging durable goods purchases often financed on credit. In
view of these demographic factors, and of the fact that delinquency rates have been
relatively stable over the past three years, the rise in consumer debt appears
somewhat less alarming. It remains in need of careful monitoring, but a consumer
18
debt appears somewhat less alarming. It remains in need of careful monitoring, but
a consumer-led recession does not at this point appear likely.
Exports: Exports are finally becoming a potent source of growth, as domestic
demand abates and recent exchange rate changes work to increase the foreign
demand for U.S. goods. Signs of accelerated export growth are already clearnonagricultural exports in the latest three months, September-November, increased
by more than 20 percent from levels of six months earlier.
Investments: Signs here are more mixed. The recent surveys indicate somewhat
slower real growth for 1979 in business fixed investment, compared to the past two
years. However, other advance signs of capital spending, such as new orders for
capital goods and construction contract awards, indicate continued strength in this
vital area. Our attack on inflation requires that we accelerate the extremely slow
pace of productivity advance, and this means we need increased capital formation,
to upgrade and modernize our capital stock. This was a primary emphasis in last
year's tax bill, and I expect its enactment will help this sector toward at least
moderate, continued advance in the coming year.
Taken in sum, this evidence points to a pronounced but orderly easing of the
economy's advance; it does not point to an actual reversal. Obviously, all economic
forecasts leave a great deal to be desired, but the available evidence does not justify
a gloomy view of our prospects.
VII. CONCLUSION
I began by noting that the American economy is at a critical juncture. Let me
close with a word of guarded optimism.
It has been just three months since the President took a series of bold and
coordinated steps in fiscal, monetary, exchange rate, and wage-price policy. These
steps have set in motion broad and hopeful trends throughout the economy.
The dollar has rallied by more than 9 percent against OECD currencies, and the
stock market has gained substantially, since the President acted. Financial leaders,
both here and abroad, now recognize that this government is determined to see the
inflation fight through to a successful conclusion. It is no longer the smart bet to
wager against the prospects of the American economy. The recovery remains balanced and resilient. The American people have ignored the cynics and have shown a
genuine receptivity to a common, voluntary effort to restrain wages and prices.
All this adds up to strong evidence that our economy can indeed be steered to a
deflationary path without dislocation, turmoil, and recession.
These hopeful signs do not of course mean we have won this fight, but they give
us a genuine chance to win it-if we can retain the momentum.
What is needed now, to maintain our momentum, is a clear sign that the Congress too is committed to securing the foundations of our prosperity for the decade
ahead. I look forward to working with you on this important enterprise.
Senator BENTSEN. Mr. Secretary, I will limit the questions to 10
minutes per member. And if time permits, we will make a second
round, as long as we get the Secretary out by 12 o'clock, and no
later.
Mr. Secretary, I have already commented on the dollar rescue
that you introduced in November and I congratulate you on being
able to sell the administration on that with very positive and
affirmative results.
I certainly agree with you on the regulation phase. I introduced
four bills this year, and passed three of them last year through the
Senate, aimed at cost-effectiveness, and the problems of conflicts in
regulations, and the regulatory budget, and extending these to the
independent agencies to try to accomplish more in this area. I
would appreciate your looking at some of these proposals, and
having your staff look at them to see where you can be supportive
of my efforts).
Now, concerning the problem of inflation, one of the ways that
Germany and Japan cut their inflation down to 4 percent was
through the strengthening of their currencies, and, frankly, I
think, through the use of trade restrictions, particularly by Japan.
19
We had a $281/2 billion deficit last year, according to the Washington Post, and we are predicting something like a $25 billion
deficit next year. That is some improvement, but it is pretty
modest.
Yesterday, we asked Chairman Miller the following question:
Suppose the dollar weakens once again in the months ahead.
Would you prefer to attack that problem by increasing interest
rates, or would you prefer to see an import surcharge imposed like
the one that was put on back in 1971?
At that time, I think, we put on a temporary 10-percent surcharge and one of the reasons, as I recall, was to get some support
for a floating rate.
Now, you are long experienced in some of these trade problems,
and I recall one story in which, in the middle of the negotiations,
you walked out on them, and virtually started to walk up the
gangplank to the plane, looking back over your shoulder, I guess.
At that point, as I understand it, they stopped you. But you had to
do that to get some of these things accomplished.
I think we have to do some of those same kinds of things now. I
am not criticizing Ambassador Strauss, who I think has done a
very fine job, but we started off the Tokyo Round with such imbalances. For a long time, we thought we had so many claims that we
could lose some of them and still come out all right. We argued
that it was trade, not aid. But we carried it to such a degree that
imbalances were created. Now, when we try to get some kind of
consideration, they want it on a quid pro quo basis, and we start
from a position where we have very little to give, unlike some of
our counterparts. It is a very serious problem for us.
Chairman Miller said if he were faced with the choice of higher
interest rates and a surcharge, he would favor a surcharge. I know
that a surcharge is a very dramatic approach, which will have a
profound effect, but most of the decisions we have made on trade
since World War II have been based on their political consequences
and not their economic consequences. But if we lose the economy of
this country, the political consequences will be nothing. We are
down the tube.
I think we have to give serious consideration to a surcharge as
one of the possibilities. I guess one of the options is to just tough it
out, but that can be a long-term situation, with a very debilitating
effect on the dollar.
I would like to have your comment on this, Mr. Secretary.
Secretary BLUMENTHAL. I will be glad to comment, Mr. Chairman.
Let me say that it is always difficult, and I try to avoid it, to give
comments or opinions or answers on hypothetical situations.
Senator BENTSEN. That $25 billion deficit doesn't sound too hypothetical.
Secretary BLUMENTHAL. The choice between a surcharge and
escalating interest rates at this point, however, is hypothetical, and
it is difficult for me to comment in those terms. I would say we
have to be aware of the fact that a surcharge on our imports would
in the first instance be inflationary.
20
Senator BENTSEN. That is right, but at the same time it strengthens the dollar, which works to slow inflation. The decline of the
dollar last year added about 1 percent to our inflation.
Secretary BLUMENTHAL. I think the dollar is affected by two
basic considerations, Mr. Chairman, our ability to get inflation
under control and the prospects for a permanent, sustainable reduction in our deficit in trade and current accounts.
Let me deal with the problem of unfairness in trade.
As you indicated, I do know a certain amount about that, and I
fully share your concern. I think that there are some markets, and
I think the market of Japan is one of them, where we do not have
sufficient access, and where, clearly, it is necessary and essential,
and I know that Ambassador Strauss and all of us have made that
very, very clear, that we cannot conclude a multilateral trade
negotiation, we cannot maintain the kind of situation that present-
ly exists if there is not substantially greater and better access to
the Japanese market, and to other markets, in which products of
the United States are dealt with discriminatorily.
There are a whole range of these practices that have to be
removed. We have in the area of subsidies, for example, all kinds of
hidden and open subsidies all over the world which discriminate
against American products, and the subsidy code which is being
negotiated in the MTN, would make an important contribution in
that regard.
I think there is another factor, however, that we have to bear in
mind, and that is that we have to instill in our own people a
greater export consciousness. Big companies do export, but that
whole vast segment of medium sized business in the United States
looks first at the American market and not at the overseas market.
It looks at it quite differently than European or Japanese businessmen do. That requires a lot of work on our part, on the part of
the Government. There is the whole problem of productivity. If we
can accelerate productivity and get inflation under control, we will
be able to compete better in international markets.
More R. & D., promoting our technology, more investment in
productive plants, all of that allows me finally to deal with the
question of the Treasury's administration of the statute on antidumping, which you raised earlier.
We do our very best to administer that statute fairly and efficiently. We do not seek to administer it in a protectionist way. We
do not see the Congress mandate as being one in which we are
asked to use the antidumping statute to move the U.S. economy to
a protectionist stand.
We do use that statute as it was written to protect the U.S.
domestic manufacturer from sales into this market at less than fair
value.
Senator BENTSEN. Mr. Secretary, my concern is that Treasury
carry out the intent of the law as passed by this Congress, not that
it be done in a protectionist way, but that we do it for equity in
trade and that we see we are not discriminated against. I have had
many, many statements made to me by representatives of domestic
industry who say that it is not evenhanded; that if a situation is
found where the subsidy problem has been corrected, the Treasury-and I am not just talking about your tenure, but about a long
21
history at Treasury-is very quick to maneuver to handle that, but
if discrimination is found to exist, Treasury officials drag their feet.
They bend it, and we have had this kind of action taken by some of
the people in the Treasury.
Secretary BLUMENTHAL. Mr. Chairman, I will personally want to
look into any instance in which it is felt that we are not carrying
out the intent of the statute. My instructions to the Department, as
long as I am there, are to comply fully with the intent of the
statute.
There are frequently, of course, as you realize, technical decisions that have to be made. We want to be fair to the importers
and to the American consumer, as well as to the domestic competitors, but the instructions are clear.
If you know of an instance, or any of your colleagues, where we
are dragging our feet, I wish you would let me know, and I will
look into it personally.
Senator BENTSEN. We will go back to these people for specific
instances so that we can submit them to you.
I think Japan is particularly flagrant in this regard. I think they
are one of the most protectionist of the modern nations.
With respect to their concession on beef, they can afford to be
magnanimous. They, at the present time, allow the importation of
one thin hamburger patty per Japanese resident per year; now
they have agreed to a quarter pounder.
They made $250 million in concessions, but they had an $8
billion trade surplus in 1977. They said, "Give us a little time, and
we will take care of that." They took care of it all right. Their
surplus went to $12 billion. You have a concession which is one
forty-eighth the size of the problem.
I am sorry. My 10 minutes have expired.
Senator McClure.
Senator MCCLURE. Thank you, Mr. Chairman.
I notice with some interest your statement with respect to the
reforming of the IMF, in which you indicate that we are not
blindly opposed to the creation of a new reserve system, but if I
read in context all of the statements that were made in your
prepared statement, it seems to me that you are taking a cautious
view of the possibility of substitution of something else for the
dollar as a reserve currency.
Am I correct in that assumption?
Secretary BLUMENTHAL. We are taking a cautious view, and I
have tried to indicate why that is. It is not because we are opposed
to a relative reduction in the use of the dollar as a reserve asset in
the future. It is for two reasons, or maybe three.
It is, first, that we are conscious of the fact that the dollar's
reserve role evolved gradually, and that any evolution toward
greater use of other currencies as reserves will have to be gradual
if it is not to cause a lot of difficulty.
Second, there are difficult technical and to us very important
questions that have to be resolved, and I gingerly referred to some
of them in my prepared statement. They require very careful negotiation, or the results could be harmful.
The third point is that we are in discussion of this problem, of
course, within the IMF. Those discussions are going on, and we
22
wish not to prejudge them or harm the probable outcome. But the
overall thrust of what I attempted to say, sir, is that we certainly
recognize this evolutionary development, and it is not one that we
want to resist.
Senator MCCLURE. There seems to me to be a shift in policy as
far as the trade vehicle is concerned, or the enunciation of a new
policy, because 2 or 3 years ago, the Treasury was eagerly promoting the idea of substitution of something else for the dollar as a
reserve currency, and as I read the statements and listened to the
testimony of Treasury and others before this committee and before
the Budget Committee, they were pushing the idea that we had to
abandon the dollar as reserve currency, that the dollar as a matter
of fact should not be a store of value, but only a medium of
exchange, and that was its only appropriate role.
I take it that you don't agree, or you don't agree as I stated it.
Secretary BLUMENTHAL. Well, I don't, Senator.
I would say I would be surprised-certainly not as long as I have
been in the Treasury.
Senator MCCLURE. This was before you were Secretary.
Secretary BLUMENTHAL. Now, if you are referring to the SDR's,
the special drawing rights, we have continued to be strongly supportive of strengthening the role of the special drawing rights.
That policy has not changed at all. It is really the terms and
conditions under which this happens, including the idea of substitution accounts and all those things, that I was referring to. But
we are still in the lead in promoting the SDR's role and strengthening that role, and, again, it is a gradual process. We cannot do it
in 1 year.
Senator MCCLURE. I was hoping there was a more pronounced
change of direction than that statement would indicate. I have
never been enthusiastic about it, but the idea that substitution of
paper accounts for real mediums of exchange was a substitution in
the long run.
I think that is how we got into this problem in our country. It
was too easy to juggle paper accounts and turn on the printing
presses and print money.
Now, there are $500 billion in Eurodollars. I don't see how we
can meet that problem when we continue to run a deficit in our
balance of payments which is chronic, and it continues to be chronic.
You know, we are always measuring progress against the worst
it has been, even though by any other test, the current statistics
would be horrendous, whether it is inflation rates, or interest rates,
or unemployment rates, or deficits in balance of payments.
They only look good by comparison to the alternative of what
they have been and might be.
Secretary BLUMENTHAL. Senator, I certainly agree with the fact
that while you can show some recent progress compared to the
nadir of the situation, it is hardly a satisfactory situation at all. I
would agree with you.
Second, I think that we have to be realistic about what is possible. There are some countries that have some reticence about the
international use of their currencies, and which have limited capability of promoting their currencies' reserve status.
1
I
23
Some of them are concerned about the impact of reserve currency use on their domestic money supplies. Some of them do not have
the well developed capital markets that would be required for this.
But we have seen over the past an increase, some expansion, in use
of the German mark and the Japanese yen, for example, in both
absolute and relative terms as reserve currencies. And we would be
quite prepared to see a further expansion of this, in addition to
considering the other kinds of reforms in the IMF to which I
referred a little bit earlier.
Let me make one final point about the overhang you have referred to, the $500 billion-nobody knows exactly what it is. It
would be erroneous to leave the impression that that amount of
dollars is out there because we have been running, for a number of
years, an adverse current account balance.
Certainly, in recent times that has contributed to it. But, a good
portion of those foreign dollar holdings represents borrowing by
foreigners in the United States for productive purposes. As a
matter of fact, I am not totally sure what would have happened to
the international economic system if we had had controls on this
market, or even whether such controls would have been possible.
Now, a problem has been created as a result of it, and I don't
want to underrate the significance of that, but it would be wrong to
say it is all due to the profligacy of the United States-that there
are many hundreds of billions of dollars out there, and that they
represent only our deficits.
Our deficits represent a relatively small portion of that total.
Much of the rest of it is borrowing by foreigners in this market
which is very helpful to them.
Senator MCCLURE. Assuming for a moment that foreign governments operate as ours does-which they don't-they have frequently taken our advice and sometimes they have been right.
They could have created the capital necessary for expansion in
the same way we have: Simply print more money. They didn't
choose to do that. They came to borrow from us. We accommodated
them by creating more money which they could borrow from us.
I assume that that money flowed out because the return on the
dollar was better in foreign countries than it was here. Otherwise,
they would not have come over here to borrow, where it is cheaper,
and would have invested there where the opportunities are greater,
except for the fact that their own countries are more restrictive on
monetary policies than we.
Thirty years ago, the French were here to complain about the
effects of the chronic deficits which supported our currency surplus
to France, and caused their economy to suffer the inflation caused
by that increased capital, while we escaped some of the inflation in
this country because we had exported some of our excess capital.
I know the West Germans have absorbed nearly $50 billion in
their dollar support operations up to now. I know, too, that they
have expressed their concern that they have had to create deutsche
marks in response. In that process, and when they have done that,
they inflate the German money supply which produces a major
inflation in their own country. I would think they would be clearly
unhappy, in view of their past history of management of their
economy and the monetary system, if we were to throw more of the
24
burden of the support for the dollar onto their shoulders by increasing the rate at which we create dollars.
Are you in support of the Federal Reserve's current practicecurrent posture, I should say-with regard to the rate of money
growth?
Secretary BLUMENTHAL. I am. That is a responsibility that the
Federal Reserve has, of course. I have been encouraged by the way
in which the aggregates have been moving, at least over the last
several months.
As Chairman Miller has testified, they are moving in the right
direction. I think, really, it comes back to-and I could not at all
disagree with you, Senator-our budgetary policies and the kind of
restraint that the President has been urging.
I think if we do that, if we bring the budget deficit down and
bring it down further in 1981 than in 1980, and move it toward
balance, as the President wants and has committed himself to do, I
think the problem will take care of itself.
I have been encouraged by talking with my colleagues in Germany and elsewhere in Europe, and also to the bankers and other
private groups. They are now seeing daylight. They do see our
policies as being correct and, with your help, I think we will
succeed.
Senator MCCLURE. Thank you, Mr. Chairman.
Senator BENTSEN. Congressman Reuss.
Representative REUSS. Mr. Secretary, I am delighted to hear in
your statement what you have to say about a possible substitution
account in the International Monetary Fund. My happiness relates
somewhat to what Senator McClure was just saying. Without the
express willingness of the United States to discuss a substitution
account in an international forum, we don't really have any
answer for the complaints of some of our friends abroad, who talk
about the exhorbitant privilege which the United States has, as the
possessor of a key currency, and about being able to pay for its
debts in its own money.
I quite agree with what you have to say. You have to inspect
proposals very closely; in your words, "Weighing both its potential
contribution and its potential costs." But with that very necessary
caveat, I think we are in a much better position internationally.
I commend you for the willingness you are displaying. To any
foreigner who makes the suggestion, from here on out, that the
United States is simply printing money to pay its debts, I think we
can now respond by saying that we are as cognizant as anyone else
of the odd situation where the key currency country also runs a
deficit, and that we are ready to cooperate with those who think
that their exchange risk should be cushioned.
I think it can be done in a way that minimizes costs to the
United States, but that remains to be determined by negotiation.
That is your job, not our job.
Secretary BLUMENTHAL. Congressman Reuss, may I make some
comments on that, because that is a very important issue. You are
right. We are willing, and that willingness is clearly on the record.
Second, may I say-and I will phrase myself carefully-the point
to which you mention and which we hear from some of our friendly
partners in other countries from time to time, about the exorbitant
25
privilege of the United States, at times strikes me as somewhat
disingenuous.
Perhaps that is the right diplomatic way of putting it, for with
the exorbitant privilege also goes an obligation. Others are well
aware of the fact that we bear that obligation, and they are quite
happy to have us bear that obligation, in fact, that is part of the
negotiating problem, Congressman Reuss. There are certain obligations that they have to take on. They would like us not to have any
privileges but to have all the obligations. What we are negotiating
about is sharing the privileges and the obligations.
For example, it is clear that we cannot succeed in the world
unless there is cooperation on both sides. That is implicit in what I
have said. For each deficit there is a surplus someplace. The chairman quite properly referred to the large and increasing surplus on
the part of the Japanese. It has been a tenet-unfortunately, one
observed more in theory than in practice-in international discussions that surplus countries have an obligation to adjust their
positions. I must say those discussions go back to the last time I
was in the Government, almost 20 years ago. We used to say
almost ritualistically that the surplus countries have as much obligation to get rid of their surpluses as the deficit countries do to get
rid of their deficits. While there is still a ritualistic bowing in that
direction, we don't see as much effort at reducing surpluses as they
would like us to pursue in the reducing of our deficits.
As for substitution accounts, without elaborating further, I would
say there are very important questions here that require careful
negotiations. The exchange rate is a very important issue. The
interest rate to be paid on the account and by the account to the
depositors is important, as is the medium in which it is to be paid.
There is a whole range of not just technical questions, but questions that have a financial impact. If we agreed on them in the
wrong way, I know I would be before this committee and many
others very, very quickly, and be subject to a great deal of critical
scrutiny with reference to what it is we had agreed to. There is a
road to travel toward a willingness to work these things out, and it
is really that key issue-an appropriate balance of privileges and
obligations-that I have in mind when I note a certain amount of
caution in this exercise.
Representative REUSS. As I said, I am pleased with both the
position and the caveat, and I note what you said about getting rid
of surpluses. I think we Americans can point with some pride to
the fact that in the last 25 years we have done a more stupendous
job than any nation in the history of the world in getting rid of
surpluses-if that is cause for congratulations. [Laughter.]
I liked what you said in your prepared statement, "To keep the
dollar firm, the United States must continue reducing its trade and
current account deficits."
Our thinking is on target with what the West German finance
minister has to say, and although I don't always think foreign
advice is on target, I think he is right there. We note a $28 billion
deficit last year in our trade account-Secretary BLUMENTHAL. $20 billion.
Representative REUSS. $28 billion.
26
Secretary BLUMENTHAL. In balance of payments terms, last year
it was almost $35 billion-$341/2 billion.
Representative REUSS. Oh, yes.
Secretary BLUMENTHAL. We are a little concerned that there be
no confusion about that number you saw in the prepared statement. The number you saw in the prepared statement-$26 billion
or something-is on a census basis. We use the balance of payments basis of $34 1/2 billion, and we expect that to decline by
something like $10 billion.
Representative REUSS. Then you say you are hopeful that we will
get a decline in our deficit. You point out reasons for hopefulness.
One is that containing inflation will make our goods more competitive at home and abroad. We must continue to hope for that.
Second, you point out that in 1979 our economy is not going to
grow as fast as others in 1979, and that ought to help us. Perversly,
that is true, but you and I, and everybody else, hope that this will
be a 1979 phenomenon by itself, and that we will start growing
again, just as soon as we get inflation under control.
What I am getting at is this: We now import some $40 billion
worth of oil. It is down a couple of billion, I suppose, from the year
before, but the price of oil is going up again this year. What real
way is there of getting our trade and current account deficits
under such control that the international dollar, without market
rigging, will be strong, other than some combination of taxes and
rationing, for cutting down on the pleasure use of gasoline in this
country?
It is pointed out that if we could restrict unessential driving, that
alone could enable us to bring our oil imports under control, and
thus our trade and current account deficit.
I know that there are problems, but it does seem to me that by a
combination of taxation and rationing, having in mind the necessity of protecting American workers and others who need gasoline
for essential getting to and from work and for other purposes, we
could accomplish a diminution of the record dimensions of our
pleasurable and joyous, but economically disastrous, use of this
fossil fuel.
Secretary BLUMENTHAL. There are a number of points, sir.
The first one is that we expect our current account deficit this
year to decline by about 50 percent from some $17 billion to about
half that.
Representative REUSS. Our deficit?
Secretary BLUMENTHAL. Yes, our current account deficit to decline. Our trade deficit, if our projections are correct, will be in the
area of $25 billion. Our current account deficit will be significantly
smaller because we have historically had-and continue to have-a
large and growing surplus on invisible items. I make that point to
underscore the fact that it is not necessary, nor perhaps even
desirable, for an economy like that of the United States to have a
balance in the trade account. We don't object to it, but that does
not need to be our goal.
What the foreign markets and international observers watch is
not only the trend, both as to trade and current accounts, but also
whether or not the current accounts get in reasonably stable bal-
-I
27
ance for the longer term. We must improve our trade balance. I
want to come to that point now.
Our trade deficit must be reduced, but it need not be totally
eliminated for us to have a balance or, indeed, a surplus in the
current account.
Now, the problem of energy to which you refer is clearly a very,
very critical matter. We estimate that the cost of energy imports in
this coming year, in the one that has just begun, will be some $4
billion more than it was last year due to higher prices, and that is
a burden. I think there are a variety of ways to improve our trade
balance generally, and our deficit on energy accounts.
I would have to say to you-and it may not surprise you greatly-that before I would urge that we move to rationing of gasoline
for other than essential use, I would want to seriously explore and
try all kinds of other things, because when I inveigh against controls, I include those kinds of controls as well.
In my judgment, the black market for gasoline coupons and the
distortion-the determination of what is or is not essential driving
is difficult-you know, one would have to be in a pretty extreme
situation to want to resort to that.
Increasing production in the United States, increasing research
on alternate sources of energy clearly are other ways, and perhaps
more effective ways, in which we can reduce our independence on
foreign energy.
The President has previously said that the domestic price of oil
will have to rise. Now, that has some short-term inflationary effects. I don't think they will be there over the long term. I think
that would be helpful. So we have to use various ways to bring oil
imports down and get our exports up. I would hope-and the tax
system can be used in a variety of ways-that we don't have to go
to rationing. I would be very dubious about that.
Representative REUSS. My time is up, but I would give part of a
rejoinder.
All of the difficulties you see with controls I would agree with,
but I still think it would be very helpful if the President went on
television, and outlined precisely the kinds of things like driving
habits, family budgeting, carpooling, cutting down on pleasure driving, coordinating trips, smaller horsepower-the whole businessthat are needed, and educate the American public so that the
average citizen could see, as he now cannot, the real need for this
kind of conservation.
I think that the American people-on a voluntary basis-would
be willing, as they have been in other fields, to surprise some of
their governors on how much voluntary conservation they are capable of.
So, I would hope, that among the things that we do, would be
some sort of a real, understandable, commonsense, voluntary program of gasoline conservation to try to cut down on nonessential
driving.
Senator BENTSEN. Thank you very much, Congressman Reuss.
Senator McGovern.
Senator McGoVERN. Mr. Secretary, as long as we are on the
trade question, I would like to raise one additional question.
28
In the Sunday New York Times, there was a piece by Mr. Nevin,
president of the Zenith Corp., in which he was giving his analysis
of why we have this large trade deficit, especially with the Japanese. He made the comment that it is commonly thought that it is
related to productivity, but actually the American worker is 50
percent more productive, at least in the television and electronics
fields, than his counterpart in Japan, and that the real problem is
the taxing differential, which has the effect of making American
products more costly than the Japanese exported products.
To what extent do you share that analysis?
That may not be the full picture. He was talking about the whole
problem of dual pricing of goods that are produced in Japan as
compared to American goods. They are priced in a discriminatory
way.
Secretary BLUMENTHAL. Senator, I think there is something to
what Mr. Nevin says. The American worker is quite productive. He
has a lot of capital available to him. Our technology is as good or
better than that of any other country, so that point is well taken.
I must say that the growth in productivity, the relative development we have here, is, as we said earlier, very worrisome. The fact
is that it has not been growing.
Senator McGOVERN. When we use that phrase, is it the total
productivity or the individual per worker productivity?
Secretary BLUMENTHAL. We are using it in macro terms. We are
using it for the economy as a whole, but we are relating the total
output of the economy to the total efforts of all workers, and when
you add it all together; that is, you add the television industry,
which Mr. Nevin knows something about, and the service industries and everything else, we come up with the results that you get
very little additional output per unit of labor input last year than
you did the year before.
That is worrisome, that it does not continue to grow. It should
grow by 2 or 3 percent at least.
Senator McGOVERN. I was startled by his contention that the
individual American worker's productivity is 50 percent higher
than the Japanese worker.
Secretary BLUMENTHAL. Well, I don't know that exact figure, but
let me give you the figures for the growth in manufacturing output
per hour.
Senator McGOVERN. Yes.
Secretary BLUMENTHAL. During the period 1960 to 1977-a fairly
long period-the United States, being a more mature economy,
grew by 2.6 percent output per hour.
The Japanese grew by 8.8 percent. They, I think, led the parade.
Germans grew by 5.5 percent; twice as much as the United
States.
In the period 1970 to 1977, just taking this decade, we dropped
from 2.6 to 2.3 percent. The Japanese were still about double ours
at 4.2 percent. They also slowed down, and the Germans really
went up a little more, to 5.7 percent. That, again, is more than
twice as fast as we.
I have given you our productivity figures for the last year in my
prepared statement. I think the key point that you make is correct
in that the whole structure of costs, which is not just output per
29
worker and pricing, is quite different in Japan than it-is here, and
that at times tends to be discriminatory toward the U.S. markets.
I did not read the article, but knowing the problems of the color
television industry, that is one that Mr. Nevin has great concern
about, and he is right to be concerned.
It has to do with a number of things. The first is that we use
direct taxes, income taxes. Germans, other Europeans, the Japanese and others use a much higher proportion of indirect taxes,
value-added taxes.
Under the international trade rules, indirect taxes are rebatable
at the border. Direct taxes are not. There has been some suggestion, and I think Senator Long has raised that issue, and I believe
Congressman Ullman has raised that issue, as to whether or not
the United States should not consider changing its tax system more
in the direction of that kind of a value-added tax.
Senator McGOVERN. Either that, or change the trade rules.
Secretary BLUMENTHAL. That would be another way. But if you
are referring to the tax system, the differences in the tax system,
that is the issue that has to be addressed. My answer would be that
we shouldn't do it just for trade purposes. The primary purpose of
taxation is to have a fair and equitable system of raising revenues
for national needs. However, that would be one important consideration if we do make a change, that it would probably help on the
trade front.
I personally welcome a careful and clear study of that issue,
which I hope will get underway, so that we may move in that
direction.
Now, apart from that, it is true that in that industry, the Japanese have at times been selling at what we considered to be less
than fair value under the definition which the Congress has laid
down in the antidumping statute, and we have acted.
Now, again, people could quarrel as to whether we acted sufficiently, or fast enough. It is very difficult to establish what fair
value is, under the terms that we have to use, but that has been
done, and we have brought about some correction of that.
Senator McGOVERN. Turning to another matter now, Mr. Secretary, the administration has repeatedly stated that the present
inflation has not been caused by excessive demand, and last year's
report of the Council of Economic Advisers, in there there was a
rather lengthy explanation of why demand restriction is a costly
and inefficient way to deal with inflation.
Just to bring the language back to mind, I am quoting from last
year's report:
An attempt to purge inflation from the system by a sharp restriction of demand
would require a long period of very high unemployment and low utilization of
capacity.
That same view is echoed by a number of former members of the
Council. Mr. Okun said that trying to balance between reduced
inflation and reduced growth can cause severe consequences-suggests that a 5-percent slowdown in GNP under present circumstances would cut the inflation rate by less than a percentage
point, and cut the growth of real output by more than 4 percent. In
short, it would eliminate real growth and barely put a dent in the
inflation rate.
47-106 0 - 79 - 3
30
My question is: Have conditions changed so drastically that what
was considered sound doctrine a few months ago is no longer
sound?
Secretary BLUMENTHAL. No, they have not, Senator. I think if
you were to draw one distinction, one principal-and there are
many-but one principal distinction between the approach to economic policy of this administration as compared to that of the
previous administration, it is that we do not believe that there is
one single cause for inflation, and that we can cure inflation in 1
year or in several simply by tightening the economy, by restricting
overall demand, letting unemployment rise, and wringing inflation
out of the economy in that way.
That is not only, in our judgment, ineffective, it is unjust, and
would not do the job.
It is for that reason that the President has proposed a whole
series of measures which would impose restraint, certainly a moderate restraint, under which we assume the rate of unemployment
would rise only very slightly from the present levels in overall
terms. Obviously we face a somewhat different situation now than
we did in the period for which this report was written, because at
that point the total percentage of productive capacity being utilized
in the economy was lower than today. We do have today a pressure
on resources, and, therefore, we clearly have to slow things down.
We cannot grow as we did in the last quarter, calendar quarter, of
last year, at a 6-percent annual rate in real terms, or we would
have demand-induced inflation added to all the other factors.
We want to slow it down somewhat, not to put this economy into
a recession, not to raise the rate of unemployment substantially,
but to moderate the rate of expansion. That kind of moderate
program means a lower budget deficit but not trying to do too
much in any one year. We need to take action on all these other
fronts: stimulating productivity and strengthening the dollar. We
need to do all these things to bring about a continually expanding
economy and not one that we put into a tailspin in order to deal
with inflation.
Senator McGOVERN. Thank you, Mr. Chairman. My time is up.
Senator BENTSEN. Senator Javits.
Senator JAVITS. Mr. Chairman, I join my colleagues in welcoming
the Secretary. I have noted with great satisfaction your response to
suggestions of Congressman Reuss and myself respecting the substitution approach to dealing with the huge overhang in the world
markets. While this approach has problems attached to it, it also
may have enough attractions to justify it. This will depend on
whether we can get the necessary agreement and cooperation from
other major nations whose currencies would be involved.
I appreciate your views very much, and I feel that Congressman
Reuss and I will be patient. We understand the problem, but you
also understood very clearly our concern with this overhang where
the dollar is always in jeopardy. There is a great note of uncertainty, especially in view of the volume of the overhang, despite the
enormous resources that we now have to deal with raids on the
dollar. In the face of such a vast amount outstanding, our reserves
would hardly be adequate.
31
So I hope, Mr. Secretary, that this represents an important priority, and that it will be pursued and that we will hear from you on
it.
Secretary BLUMENTHAL. It certainly is, Senator Javits.
I commented on this not only in my prepared statement, but in
my exchange with Congressman Reuss, rather fully. I will not
repeat it here. We are working on this problem, and as I indicated,
we are not resisting it. We are trying to promote progress in the
light of a lot of technical problems that have to be worked out
which have great financial and policy implications for us.
Senator JAVITS. Also, I gather from your interchange with Senator McClure, that you indicated our willingness to see the very
strong currencies-the deutsche mark, the yen, and the Swiss
franc-as contrasted with our own, some added reserve role.
Secretary BLUMENTHAL. Yes, indeed.
Senator JAVITS. Now, one question I would like to ask you about
Japan. Their balance of trade with us, of course, grew, rather than
receded. Nonetheless, you anticipate a material drop in the U.S.
trade deficit this year.
I would like to, therefore, ask you for your appraisal of the effect
of continued growth in the United States: You just testified to that
to some extent. I want to ask whether that would have a negative
effect on the trade deficit, as forecast by the President.
Could we have a little better idea as to the plans of the administration in that.regard?
Secretary BLUMENTHAL. As to trade, Senator, we believe the
improvement is there for us to see. Looking at the numbers that
they have developed for a variety of reasons, we see that, overall,
first, nonagricultural. exports are up for the United States. These
nonagricultural exports, seasonally adjusted, are up over 40 percent at an annual rate since the first quarter of 1978, as against a
decrease of about 7 percent in the prior 6-month period. So that is
a marked improvement.
While nonpetroleum imports are up about 15 percent over that
same period since the first quarter of 1978, I think we made headway there, as against a 40-percent rate of growth in nonpetroleum
imports in the prior period. So the situation has shifted overall.
We think that the reduction in the growth rate in the United
States which we anticipate for this year will help, and the program
for further domestic demand expansion in Japan as well as in
Germany, which was discussed and agreed to, and is being carried
through in Germany and in Japan, will be important factors that
will further move us in that direction.
Now, what has happened in the case of the Japanese is that they
have had some real problems, which I think they honestly did not
anticipate. I think they are genuinely embarrassed about it, in
bringing about a reduction in their surpluses.
The first thing that happened, of course, as the dollar went down
is that their raw materials became cheaper in terms of their own
currency while the value in dollars of exports at constant yen
selling prices rose, because of the cheaper value of the dollar in
terms of yen. Thus, they, in the beginning, tended to increase their
surplus, expressed in dollar terms.
32
The slowdown in exports by Japan in industrial products, which
is what they mainly sell, is already noticeable. It has been noticeable for some time in yen terms, or in volume terms, physical
volume terms, and we have seen that it is becoming noticeable,
also, in dollar terms.
Now, does all of that, that effort to encourage domestic demand
expansion in Japan and elsewhere, and to bring about a slowdown
in the rate of growth in the United States economy represent fine
tuning?
I don't really think so. You have to have some targets of direct
tuning to which you want to go, and while we have to give you, as
we do, precise numbers in the economic report and have to use
rather precise numbers for estimating the budget and the impact of
the economy on the budget, we all know that obviously we cannot
tune the economy down to one-tenth, two-tenths, or three-tenths of
a percent. That is why a lot of the discussion about whether there
is going to be or not going to be a recession in 1979 sometimes
strikes me as unreal. Because the important thing, it seems to me,
is that both we and virtually all of the private observers, including
the Congressional Budget Office incidentally, are pretty much
agreed on the force of the economy. The differences, some of the
slight differences, which would involve, I think, real fine tuning to
hit one instead of the other, lead some to say that technically there
is going to be a recession and others to say that we will barely
escape it. That is because there is an arbitrary dividing line.
We are not trying to fine tune the economy, but to slow it down
to a moderate extent so that during the four quarters of this year
we expect to have growth in real terms of 2 percent or a little
more, and an average for the year of perhaps a little more than 3
percent. We want that instead of negative growth, and we think we
can do that without fine tuning.
Senator JAVITS. I have two other questions.
Is it fair to characterize the view of the administration that we
will not have a recession in 1979, but we will have a diminution in
growth which will give us the elbowroom that we require to correct
the imbalance in our trade?
Secretary BLUMENTHAL. That is clearly our objective, Senator. It
is our clear view.
We felt confident of that when we established those numbers.
Subsequently, as the result of what we have seen in the fourth
calendar quarter of 1978-very substantial growth-we are even
more confident that we will not have a recession in 1979.
Senator JAVITS. Now, Mr. Secretary, I have a question on New
York City. Would you mind answering that?
The paper this morning indicated that you told Ed Koch, our
mayor, that your good news was that the administration had
cranked the $100 million into the budget that he counted on to
make up his serious deficit, but the bad news was that Congress
"was unlikely to approve it."
Now, can we have some idea as to whether that is a fact and why
you came to that conclusion?
Secretary BLUMENTHAL. Yes, sir.
Let me put it a little differently with regard to good news and
bad news.
33
I told him the good news was that we could, under the terms of
the statute, approve his financial plan for 1980. That financial plan
contained budget cuts that the city would have to make, what they
call level-i cuts and level-2 cuts.
Level-one cuts were necessary, in any case, in the view of the
city to help bridge the budget gap. The level-two cuts would only be
necessary if there was a shortfall in their projection of increases in
Federal and State aid. The Federal share was about $100 million,
composed of essentially a few legislative proposals as well as certain administrative actions.
One was countercyclical revenue sharing and the others included
changes in public assistance programs. The administrative issues
included a range of actions the Government could take.
I told him the bad news was that they would have to make the
level-2 cuts, because we had attempted to get an extention of
countercyclical revenue sharing last year in the last session of the
Congress, that we had failed, that we were reintroducing it on a
much more limited basis, and that, if passed by the Congress it
would, in fact, under certain assumptions make available to the
city $50 million.
My sounding of the Congress indicated that the chances of passage of that proposal were not overly great, and, therefore, they
were not a great deal greater during the new session.
I hoped it would be passed and we want it to be passed and we
will argue for it, but prudence dictated that they not count on it,
because the Congress did not pass it last year and may not pass it
again.
The other legislative proposals by the city were increases in
categorical aid-I was going to say balance of payments-and not
unrestricted revenue made available for other purposes, and accordingly that that really should not be counted on.
The Financial Control Board has also told the mayor that they
would institute both the level-1 and level-2 cuts, and based on
implementation of those actions, we would be in a position, under
the statute, to approve the fiscal year 1980 financial plan.
Senator JAVITS. Thank you, very much.
Senator BENTSEN. Senator Jepsen.
Senator JEPSEN. Thank you, Mr. Chairman.
Yesterday, I asked Mr. Miller if he thought it was time to index
the tax code for inflation. I understand from the remarks you made
earlier this morning that you indicated opposition to indexing.
As you know, inflation puts individuals up into higher tax brackets, creates illusory capital gains and results in a steady increase in
the real tax burden on the American people.
Mr. Miller replied that indexing was wrong because it would
shelter us from the effects of inflation, lead to larger budget deficits and exacerbate the budget deficit.
Since then, I have received from the CBO the budget projections
for the next 5 years. On page 63 of this report, the CBO indicates
that even with indexing, the real tax burden will still increase in
the coming years.
Without indexing, the magnitude of coming tax increases is enormous, on the order of $200 billion over the next 5 years. This, I
might add, just figures in the income tax increase.
34.
The CBO even says that tax reductions like those in the RothKemp bill might be possible even with indexing. If you could, I
would like you to comment on this situation and see if you can
come up with additional justification, better ones, for opposing
indexing, than Mr. Miller made.
Secretary BLUMENTHAL. Yes, sir, I would be happy to.
You are correct. I strongly oppose indexing. The administration
strongly opposes indexing, for the very important reason that indexing would make it all that much more difficult to get rid of the
problem of inflation in the American economy. It would bake inflation into the structure of the economy rather than to purge it out.
Let me deal separately with the two problems of taxation;
namely, income taxes and payroll taxes.
The fact is that in 1979, the income taxes as a percentage of
personal income remained at roughly 10.6 percent, which is about
the rate at which personal income has been taxed for as far back
as my statistics go here, which is 1960.
The range has been roughly between 10 percent and 11 percent.
In the early 1960's, it was 10.2 to 10.4 percent. In 1969, it went as
high as 11.6. In 1974, and I picked these numbers at random, sir, it
was 10.7. In 1978, 10.7; and 10.6 as a result of the tax reduction
that has just been voted.
In other words, income taxes, contrary to what some people
think, have not increased as a percentage of personal income.
It is clear, as the Congressional Budget Office points out, if you
project forward without any further tax decreases, the result of
inflation on this, you will get an increasing percentage.
For example, my numbers indicate, and I am sure the Congressional Budget Office would confirm this, that if we just went forward on the present basis,, including the effects of legislation proposed in the 1980 budget, we would be at almost 14 percent by
1984, which would be a historical high. I pick that year at random,
too. There is no significance to 1984. But the Congress periodically
votes tax reduction in the light of overall circumstances, and in the
light of its desire further to improve the justice and effectiveness of
the tax system.
That kind of tax reduction provides flexibility to the Congress to
take over all economic circumstances into account. To do it on an
automatic basis would put it into a straitjacket and would reward
those in the economy who are least cooperative with bringing
inflation under control.
The more you raise your prices and your wages, the more you
are going to get back in the way of tax reductions. What we would
rather have is the kind of program of fighting inflation, which
would reduce the rate of inflation. This includes and real wage
insurance, which rewards only those who are willing to play their
part in reducing their increases in prices and wages. That is a
short answer.
Now, on the income tax side, what is increasing are social security taxes and payroll taxes, and those are around 3 percent of
personal income in 1979.
That hasn't changed much in the last 5 years, but it is up from,
say, 2.2 percent in 1970, and 1.3 or 1.4 percent in 1961.
35
That is due to the fact, sir, that the Congress, for a lot of good
reasons which we understand, has voted to increase benefits and
has indexed some of those benefits. It seems to me that the solution
to dealing with the increasing burden of payroll taxes lies not in
indexing the rest of the system and creating further inflation, but
rather dealing with the social security problem-benefits as well as
taxes-so that we keep the payroll taxes under control.
If we don't want to spend more of the taxpayer's money, then we
need- to ask ourselves what is going to happen to those benefits.
You cannot have it both ways, I guess, is what I am saying.
I would hope that the Congress would carefully look at the social
security tax situation not for fiscal 1980, because we cannot afford
it that year, but by 1981. I believe that inflation will have eased at
that point, and the solution will not be to index,-but the solution
will be to look at the overall problem of what to do about the
burgeoning costs of social security.
Senator JEPSEN. Thank you.
I understand you are saying that the spending programs, some of
them are indexed, so we cannot afford to index the taxes.
Spending programs rise about 10 percent for a 10 percent rise in
prices. Taxes rise 16 percent for a 10 percent rise in prices.
Now, using indexing, that only lops off about 6 percent, so that
leaves taxes rising by about 10 percent.
Keep in mind that it is the Government that creates inflation,
and the more inflation, the more revenue the Government gets.
Secretary BLUMENTHAL. Right.
Senator JEPSEN. It is the Government which is rewarded by
inflation under current law.
Secretary BLUMENTHAL. Senator, first of all, there is an interaction between inflation on the one hand and the growth of the
economy on the other, and we have accelerated inflation, and we
have a number of devastating consequences.
One of those is that the economy soon goes into a tailspin. We
have had that experience many times before. That reduces the
growth, and therefore, the taxes which we can collect.
You are right. There is a large share of government spending
which is due to what is already indexed on the spending side.
I would rather see us deal with that than to index the system. I
would point out, however, that Congress. does take care of reducing
taxes every couple of years, and it seems to me that that kind of
balanced consideration by the Finance Committee and the Ways
and Means Committee and by both Houses, -provides a greater
flexibility to reduce the tax burdens on the average American than
the straitjacket approach which allows no leeway whatsoever.
It is also true that the President is already in a large straitjacket, because of spending that is beyond his immediate control.
I would not want to extend that and make it even tighter.
Senator JEPSEN. Thank you, Mr. Secretary.
I may have, if we have an opportunity, to ask some other oral
questions.
Senator BENTSEN. Thank you.
Senator Proxmire.
36
Senator PROXMIRE. Mr. Secretary, I am glad to see you. I have
read your prepared statement, and I concur in the stimulating
discussion you have had here.
You say we have to move the fight against inflation toward the
top of our economic list of priorities, and that the budget constitutes a matter of importance.
Yet this is a budget that goes up 7.75 percent. It doesn't even
comply with the President's guidelines.
The President is asking business not to increase their prices over
6 percent and yet the President is asking for an increase well
above that. This is not an austere budget, Mr. Secretary.
After all, you have a very big increase for defense. You have the
big increases all along the line.
Sure, many expenses are uncontrollable, but why can't you come
up here and ask us to rescind revenue sharing, for example?
The Governors are saying that we are spending too much, that
we are an engine of inflation. They are getting the revenue sharing.
The educational programs aren't working. The cities are in worse
shape than before we started the programs. Why can't we cut some
of those?
Secretary BLUMENTHAL. Well, Senator, the budget is increasing
by less than 1 percent in real terms.
Revenue sharing, a program that you mentioned, is due to expire
in, I believe, 1981, which means that we have to consider what to
do about that program.
Senator PROXMIRE. Why can't we rescind it now? Just because it
expires in 1981 doesn't mean that we can't take action to knock it
out in 1980 and 1981.
Secretary BLUMENTHAL. It is our judgment that there are a great
many areas and localities which are very much dependent on it.
We don't want to create undue unemployment. The question has
been raised, I believe by the chairman earlier, as to whether or not
the States, as against the cities and localities, should continue to
get it.
President Carter himself, as a candidate, raised that question. It
is clearly something that we ought to look at.
I would say that we have to do things in an orderly manner. I
think to bring down the budget in such a way-and we have
already cut $18 billion out of the current services budget-that is, I
would say, a considerable feat, especially if you consider that threefourths of the budget was really beyond the President's control.
The judgment was made by him that he could not and should not
go further.
I would say that if the conference finds wavs that vou can agree
on for further cutting in spending, further cutting the budget in a
fair and effective way, maintaining the strength of our defenses
and maintaining the kind of justice and help that some people and
particularly poor people require, the President could-Senator PROXMIRE. I welcome that statement very much.
I want to follow up on what Senator Javits asked about New
York City.
This is a responsibility of our committee to some extent, and we
are very concerned about it.
l
-
/
37
You said that you told the mayor that it is not likely that
Congress would act on the recommendations to assist the cities,
including New York.
Then you indicated that he should make the level-2 cuts that you
described. What was the mayor's response?'
Did he say he would make them?
Secretary BLUMENTHAL. I was very encouraged, Senator. The
mayor takes a very. responsible attitude. He says, "Look, we have
to do what we have to do. We have obligations, and we will carry
them out. This is a painful process, but we will do what is required
of us."
Senator PROXMIRE. If the mayor does not make the cuts, do you
feel you could make the guarantee on February 15?
Secretary BLUMENTHAL. I made it clear to him that our approval
of his program and the guarantees are dependent on his balancing
his fiscal year 1980 budget.
He would not be in compliance without balancing the budget.
Senator PROXMIRE. Did he make a specific commitment on level-2
cuts?
Secretary BLUMENTHAL. He said they would make whatever cuts
are necessary, taking into account what they did not get in unrestricted aid from the State and Federal governments to balance
their budget.
Senator PROXMIRE. Regulation limits interest rates to 5 percent
and 5.25 by the thrifts, and is outpaced by the prime rate, which is
twice as high, and other sources of income to the banks and S. &
L.'s.
This creates a very serious inequity. He indicated he would consider consideration by Congress of legislation that would gradually
increase the ceiling in regulation Q.
In view of the fact that we can't expect to have inflation conquered, as you say, in 1 or 2 years-we are going to have it for
some time-would you or would you not support legislation that
would permit us to raise regulation Q and allow small savers to get
a better break than they get now?
Secretary BLUMENTHAL. I can't give you a definitive answer. We
would want to see a consideration of that. I would want a little
more time before I give you a definitive answer as to interest rates.
Senator PROXMIRE. I think the President's program will work if
you stick to it and the Congress will support you, and I hope they
will.
I intend to do all I can.
Many people don't agree with that. They think inflation is going
to get worse, and a very large number of very wise people think so.
As you know, we can't predict inflation. Last year, the prediction.
was 6 percent. It ended up at 9 percent.
I would like to know what you propose if the President's current
program fails and inflation accelerates.
What do you do?
Secretary BLUMENTHAL. That is one of those hypothetical questions that I try to avoid.
Senator PROXMIRE. It is a distinct possibility.
38
Secretary BLUMENTHAL. I really believe that it is only a question
of time before this program will work, and I think it will work in
the time frame that we have laid out.
Senator PROXMIRE. You mean you have no contingency plans?
Secretary BLUMENTHAL. We are always planning, Senator, what
we would do, and we are always asking "what if," but we don't like
to talk about that to the public too much, because it would create
the wrong impression.
What I would suggest is that we continue for as long as necessary the kind of tightening in the deficit, maintain monetary policy
consonant with that kind of approach and make an even more
vigorous effort to increase productivity and cut regulations that are
cost ineffective.
I think that approach-Senator PROXMIRE. Would you have a tougher incomes policy?
Would you go for a penalty, penalizing by taxes, when wage and
price increases exceeded the guidelines?
Secretary BLUMENTHAL. I think the range of TIP programs
should be studied further, those rewarding as well as punishing.
We have presented to the Congress a simple program of real
wage insurance. I think we ought to give that a chance to work for
a year.
We will know over the next year or so whether it is effective or
not. I think it will be effective in inducing people to meet the wage
guidelines.
If not, I would go to using the tax system in other ways.
Senator PROXMIRE. What about more drastic cuts in spending?
Secretary BLUMENTHAL. I think that would have to be considered, too.
Senator PROXMIRE. In your prepared statement, you stated, "Our
tight budgetary policies are easing the task of the monetary authorities.
"With a reduced deficit, and with off-budget financing activities
being monitored more closely, Federal demands on financial markets will be substantially reduced." But according to the budget
figures in the special analysis of the budget, total borrowing would
be $40 billion in fiscal 1979 with a deficit of $37.5 billion, and
borrowing for fiscal 1980 is $39 billion with a deficit of $29 billion.
I am wondering how that will help the economy at all.
Secretary BLUMENTHAL. Let me see if I can find the numbers
here.
Credit market conditions are going to be changing substantially,
so that the share of resources that the Federal Government has to
use in borrowing will be substantially reduced.
Here are the numbers: On a calendar year basis, borrowing from
the public by the Federal Government in 1979 will represent about
12 percent of the total demand in the credit market, and in 1977 it
was 14.2 percent, and in 1976, 21.9 percent; in 1980, we estimate it
will go down to about 9 percent.
So, it is representing an increasingly smaller portion of the total
requirements.
Senator PROXMIRE. Now, the table on page 106 of the Special
Analysis does show a sharp reduction from 1978 to 1979.
39
It goes from $59 billion down to $40 billion, but it shows, again,
the 1979 estimate is $40 billion total borrowing requirement from
the public, and in 1980, $39 billion.
So, there is no change.
Secretary BLUMENTHAL. That is, in part, because we anticipate
some changes in cash balance, to get drawn up or down. So, even
though we are reducing the deficit, we anticipate a much smaller
reduction in total borrowing, since the economy and total credit
flows are expected to grow between 1979 and 1980, the $39 billion
would translate into a smaller percentage as compared to the $40
billion.
It is more than $1 billion worth, because the whole economy is
growing. If our cash balances are somewhat better, and we estimate that conservatively, then, of course, there would be a further
improvement.
Senator PROXMIRE. Thank you, Mr. Chairman.
Senator BENTSEN. Thank you.
I promised to get you out of here by 12 noon.
Let me make a closing remark. You said when the deficit in
trade with the Japanese was $8 billion, and it went to $12 billion,
you felt they were embarrassed.
I don't think they embarrass very easily. They took affirmative
action to moderate the change between the yen and the dollar, and
they took it for 2 years, and they took it to help moderate largesized and small-sized companies.
In addition to that, on their own government procurement program, they issued directions and they very carefully held off the
purchase of American goods.
The telephone company is a prime example of that kind of
situation.
Now, with respect to revenue sharing, the Center for Policy
Research for the Governors' Conference is projecting that the
States are going to have a substantial surplus, an overall surplus
in their budget, and that not one State is going to have a deficit in
1979.
Now, it just doesn't make any sense to me that we should send
them another $2.25 billion to add to their surpluses while the U.S.
Government has gone all the way from a $29 to a $37 billion
deficit, whichever one of the estimates you want to take. It seems
to me that there is one place where we can have an affirmative
cut. I understand that we are going to have a confrontation with
some of the Governors, but I think we have to face up to some of
these responsibilities.
Secretary BLUMENTHAL. I think it is worth looking at.
Senator BENTSEN. It is worth doing.
Thank you very much, Mr. Secretary. The committee stands
recessed.
[Whereupon, at 12:07 p.m., the committee recessed, to reconvene
at 10 a.m., Monday, February 5, 1979.]
THE 1979 ECONOMIC REPORT OF THE
PRESIDENT
MONDAY, FEBRUARY 5, 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: Senator Bentsen and Representative Brown.
Also present: Richard F. Kaufman, assistant director-general
counsel; L. Douglas Lee, John M. Albertine, Paul B. Manchester,
and Thomas F. Dernburg, professional staff members; Mark Borchelt, administrative assistant; Katie MacArthur, press assistant;
Charles H. Bradford, minority counsel; and Robert H. Aten, minority professional staff member.
OPENING STATEMENT OF SENATOR BENTSEN, CHAIRMAN
Senator BENTSEN. This hearing will come to order.
We would probably have better attendance if we held it down on
Memorial or Chain Bridge.
Mr. Grayson, why. don't you come up to the witness table. We
will get started even though, obviously, a number of people have
not been able to surmount the traffic problems.
Today, we begin the third week of the Joint Economic Committee's annual hearings on the Economic Report of the President.
The committee will hold 3 days of hearings this week, and will
receive additional testimony following the February 12 recess. We
shall announce the remainder of our schedule during the next few
days.
President Carter has stated that reducing inflation must be our
No. 1 economic priority this year. I agree entirely with this proposition.
In his economic report, the President points out the clear relationship between inflation and lagging productivity in our economy. He suggests that unless we can come to grips with our productivity problems, we stand little chance of overcoming inflation.
If anything, I would go even farther than the President in stressing the key role of productivity in that complex equation that has
given us inflation for so long. The simple fact of the matter is that,
in the absence of dramatic gains in productivity, our efforts to stem
inflation cannot succeed.
That is not a very cheery prognosis, but it is also difficult to
refute. I personally do not see how it will be possible for the
(41)
42
President to meet his objective of a 7.4 rate of inflation this year
unless we exceed his target for productivity growth.
Last year, productivity grew at less than 1 percent; one-tenth of
what it is in Japan.
The President's productivity goal for 1979 is 0.4 percent-a really
modest objective by any standard; a rate of growth that is one-half
of last year's disaster.
But the President also forecasts an 8.5 percent rise in total
compensation per hour. Now, if you perform a little simple economic arithmetic and deduct expected productivity growth from growth
in total compensation, you end up with an 8.1 percent increase in
unit labor costs for 1979. And that figure is especially alarming
because unit labor costs normally rise less than the rate of inflation.
The problem is clear: How do we get inflation down to 7.4 percent if unit labor costs rise by 8.1 percent? What happens to the
rest of the administration's forecast if inflation is higher than the
target? What should be done to increase productivity in our economy?
These are difficult questions and we are pleased to have with us
today two distinguished experts who we hope will try to help find
answers to them. Jack Carlson, vice president and chief economist
of the U.S. Chamber of Commerce, who will be here shortly, and C.
Jackson Grayson, chairman of the American Productivity Center,
have already rendered valuable service to their nation from the
private sector viewpoint and the academic viewpoint, and is really
zeroing in on these questions.
They have been in the forefront of the effort to call attention to
the important problem of productivity.
At 11 a.m., if he is able to wind his way through the tractors, we
will hear from James T. McIntyre, Director of the Office of Management and Budget.
You may proceed with your oral presentations and then we will
ask our questions.
Please proceed, Mr. Grayson.
STATEMENT OF C. JACKSON GRAYSON, JR., CHAIRMAN,
AMERICAN PRODUCTIVITY CENTER, HOUSTON, TEX.
Mr. GRAYSON. I have submitted a prepared statement to your
staff and ask that it be printed in the record with the exhibits.
Senator BENTSEN. That will be done.
Mr. GRAYSON. I will confine my oral remarks to a few succinct
remarks in the interest of productivity and in the interest of my
voice which I hope will hold out.
I would like to home in on the centrality of productivity in
economic policy. As you stressed, Senator, the President's Economic
report pulled productivity up to the level of attention that it deserves.
He said, and I quote one section: "The primary concern in economic policy is inflation;" and, then, in another section of his
report, and I quote: "A large part of the worsening of inflation last
year stemmed from poor productivity."
43
Then, he goes on to state that the productivity slowdown is one
of the most complex and misunderstood questions, which lacks
understanding.
If you take those statements together, it says in effect that
productivity must be the cornerstone of our economic policy. That
in itself finally is getting the attention it deserves.
I left the Price Commission with the firm conviction that this is
one of the areas that the country had not paid enough attention to
in recent years. All of the attention has been focused on fiscal and
monetary matters and, certainly, they are important, but one of
the root causes of inflation is poor productivity.
It is not a recent phenomenon that it has been slowing down. It
has been slowing down for a decade. If we pay attention to only the
branches on the tree of high inflation, high unemployment, high
interest rates, balance of payments and don't attack the fundamental causes, we will forever be spinning our wheels.
We have to get to the root causes which are fiscal and monetary
policies and productivity.
The position today is that not enough is being done by the
Government and the private sector; what we need is a "National
Productivity Program." That is what I am recommending to you
today with my testimony.
Efforts that are underway in the executive branch by the National Productivity Council, in my view, are not going to get the job
done. I think that the efforts are underfunded, not staffed, not
given enough attention, and not given a seat on the economic
policy matters of the country.
We must correct that or we will continue to drift in this very
important sector.
Wage and price controls, with which I have had some experience,
are counterproductive and tend to lower productivity instead of
going the other way.
What I have outlined in my prepared statement is the blueprint
for what would be a national productivity effort or program. I am
calling upon all sectors to launch such a program. I spelled out in
my testimony things that I would recommend for the Federal
Government to do, things for industries to do, things for individual
firms to do and the international dimensions connected with that
program.
Primary in my recommendations to government would be, first
of all, to select two focal points for attention to productivity, one
focal point in the Congress and one focal point in the executive
branch.
I would further recommend that the focal point in the Congress
be the Joint Economic Committee. The JEC would be the best focal
point for directing the efforts from the congressional side, paying
constant attention to the subject of productivity.
I will make a further recommendation that when the productivity figures are released quarterly, that the JEC hold hearings just
as you now do monthly on unemployment figures, for productivity
also ranks as one of the top concerns of the economy of the Nation.
I would recommend the same focus for the executive branchthat there be one single focal point for paying attention to productivity, not diffused, not scattered among a number of agencies, but
I
i
44
one focal point in the administration looking at productivity in its
broadest aspects throughout the Government.
Unless we do that, I think we are going to continue giving
productivity lipservice and rhetoric, writing memos, forming committees, giving lots of articles and speeches and not getting action.
I have described in my testimony some tests I would recommend
for anyone to use in order to see that that focal point is created.
It should be funded and staffed. There should be power, timeta-.
bles, accountability, and there should be followup.
Unless they exist, which I do not now find in the "National
Productivity Council," then I don't think there will be the action
that is needed.
I have also recommended in my prepared statement what such a
focal point would do, including such things as creating a productivity impact analysis of all of the regulations that are existing and
all new regulations.
This would be in line with the regulatory and budgetary analysis
of regulations now being proposed in various bills, but we still need
one group to have sustained, long-run accountability for following
those.
I further recommend we assist the State and local governments,
that we look at productivity in the Federal Government, and
expand the efforts now underway in the Office of Personnel Management and the GAO.
In other words, what we need to do is organize the efforts, not
centralize them, but centralize the focal responsibility for an overview of what is being done.
In the private sector, I have recommended several things that
need to be done at the level of the individual firms and industries
of the Nation. If we continue to look only at macro-economic policies and don't get down to the micro level down to individual
industries and individual firms, we may continue to remain mystified about this slowdown without understanding it.
I am recommending that we have industry productivity studies,
with inter-firm productivity comparisons and industry measurement systems, combined into industry productivity programs. We
should do this not only for the industries where we know we have
problems with productivity but eventually with all of our industries and firms.
Unless we get down to the firm level, where most of the action is
in this country, we won't get the results we need in productivity
across the Nation.
So, I am recommending both a macro approach and a micro
approach.
Last, I recommend a very strengthened program in research. We
simply do not understand some of the productivity slowdown that
has occurred. In particular, we need to have a strengthening of
productivity measures. I know measures by themselves don't improve productivity. But if you don't have good measures you don't
understand where you have been and you don't understand where
you are going.
We need to know the causes of the slowdown and that not
enough research is being done on the subject. I have looked at the
measurement program in the Bureau of Labor Statistics and it is
45
good. But they simply don't have enough funds and resources to do
the job that is required. They need to strengthen and expand their
program together with the private sector also expanding its own
programs in productivity measurement.
In summary, if we were to have a collective effort by the Government, by industries, and by individual firms, I think we could
make some progress in productivity improvement.
I think that is absolutely essential if we are going to solve the
problems of inflation, unemployment, balance of payments. All else
will be rhetoric and talk and we will end up a year from now still
talking about productivity problems without progress.
Thank you.
[The prepared statement of Mr. Grayson, together with the exhibits, follows:]
079
47-106
4
-
47-106 0
-
79
-
4-
46
PREPARED STATEMENT OF
C. JACKSON GRAYSON, JR., CHAIRMAN,
AMERICAN PRODUCTIVITY CENTER
Before the-Joint Economic Committee of the
Congress of the United States
February 5, 1979
Mr. Chairman and Members of the Committee, I am
C. Jackson Grayson, Jr. Chairman of the American Productivity
Center (APC) in Houston, a privately funded organization now
in its second year.I
I was formerly Dean of the Graduate Business
School of Southern Methodist University and, as some of you
remember, I served as chairman of the Price Commission from
1971 to 1973, this country's previous serious attempt to
control wages and prices in a peacetime economy.
I deeply appreciate the opportunity to appear
before you today on the subject of productivity--and to urge
upon you, as a matter of high national priority, the creation
of a comprehensive national program to address this nation's
very serious productivity crisis in both the government and
private industry.
It might be of interest to the members of this
committee that it yas my experience in the Price Commission-not as a business school dean--that first convinced me that
1.
A description of the APC is contained in Exhibit A.
47
our economy had a real and growing productivity problem.
my opinion then,
inflation,
In
this was at the root of our problems of
unemployment,
and balance of payments, and this is
even more true today.
In the interim, we have had seven years of deteriorating productivity and increasing inflation--and throughout this time,
the problem has been largely ignored by the
leaders of government,
industry and labor.
It has been
equally ignored by our economists, our business schools, and
to a large extent by our national, business and academic
press.
Little wonder, then,
that today we are faced with
the situation in which a major national productivity crisis
is upon us.
The alarm bells are finally beginning to ring.
Speeches are being made.
Memos and articles written.
committees are being formed.
bells do not put out fires.
More
But we all know that alarm
And articles do not solve prob-
lems.
We need action.
And we need it
immediately.
Strong, decisive coordinated action.
This is what
I have come to urge
upon you today.
I have some very specific proposals which require
such decisive action by the Congress and by the Administration.
These are spelled out in some detail in my written comments
2.
Two illustrative productivity articles are reproduced in
Exhibit B.
-2-
48
which have been distributed to members of your staff.
I
would like to review them for you briefly.
I believe this nation needs a National Productivity Program involving government, management,
and labor.
There should be programs created that operate at
four levels:
* Government--federal,
' Industry
Individual firms
International
state,
At each of these levels,
and local
programs must be created
that are specific and action oriented,
and they must include
attention to such fundamental variables as:
funds,
(3) incentives,
(4) timetables,
(1) power,
(2)
(5) accountability,
(6) leadership, and (7) long term commitments.
These are the variables that have been missing
from some of the earlier attempts to improve productivity,
and they are the principal reasons that many of these efforts
fell far short of the mark.
Government
Government should have an organized productivity
program at all levels--federal,
state, and local, but the
leadership for a government program has to come from the
federal government and the Congress,
through the following
steps:
(1) Creation in the executive branch of a single
focal point with responsibility for a national
Not an oversight or
productivity program.
But a focal point with
coordinating group.
the power and the responsibility and the funding to make the program work.
-3-
49
(2) Creation in the Congress of a productivity
focal point with responsibility for overseeing
productivity legislation and conducting investigations.
I feel these two institutional steps are absolutely
essential if a government productivity improvement program is
to have any significant impact.
Why?
Because unless productivity improvement is institutionalized into the power mechanisms of government, little
more will happen than is already happening today.
Future
work will consist of "coordination, meetings, studies,
recommendations,
reports," and we will go on recording stag-
nant productivity growth in 1979, 1980, 1981 and so on.
It is not that the government is doing nothing.
There is work underway and there are people in the federal
government vitally interested and concerned about productivity.
In-particular, there is some work in the Departments
of Labor and Commerce, the General Accounting Office, the
Office of Personnel Management, and the Office of Management
and Budget.
But their work is underfunded, understaffed, outside of the power circles that influence policy, and little
noticed.
The activities are scattered with no central direc-
tion or focus to maximize their impact, or to enhance learning from one agency to another.3
3.
Most of their activities
An inventory of productivity related activities in the
Executive Branch was given by Mr. Wayne C. Granquist,
Associate Director of OBM, before the House Sub-Committee
on Economic Stabilization of the Committee on Banking,
Finance and Urban Affairs, Ninety-Fifth Congress, Second
Session, September 14, 1978, pp. 113-115.
-4-
50
are buried in their respective agencies,
and their views
are seldom heard in any of the economic policy power groups
in the Congress or in the White House.
And yet,
this is the problem that was labeled in
the 1978 Economic Report of the President as "one of the
most significant economic problems of recent years" and
highlighted again in the 1979 Economic Message,
with the
statement that "If we ignore the realities of slower productivity growth...our inflationary problems will worsen."
Until September of last year, the belief existed
in the minds of some that the Federal Government had an organized and active productivity program in the form of the
National Center for Productivity and Quality of Working Life
(NCOPQWL).
But that belief was wrong.
from the beginning in
its charter,
The Center was flawed
funding,
and location;
and it never really succeeded in its mission.
September 30,
It died on
1978 because of a lack of support from either
the Congress or the White House.
There was some hope that productivity work would
be undertaken by the Council on Wage and Price Stability
(COWPS) because its authority states,
in part,
that COWPS
shall "focus attention on the need to increase productivity
in both the public and private sectors of the economy."
4
But that has not happened.
In fact, the opposite has occurred.
4.
COWPS has
Section 3 (A) (5) of the Council on Wage and Price
Stability Act, 12 U.S.C.S. 1904.
-5-
51
been handed the responsibility for implementing the wageprice standards program which,
productivity.
ceilings,
in and of itself,
lowers
The application of wage standards and price
regardless of productivity differentials,
ignores
the adjustment process essential to a dynamic economy with
widely varying productivity levels among firms and industries.
Furthermore,
some specific standards in the COWPS
regulations will seriously curtail some of the most effective productivity improvement programs existing in the
nation.
We and others have to date been unsuccessful
in our
efforts to have these anti-productivity elements corrected.5
In fact, we have been given a very clear message that the
Council on Wage and Price Stability is aware of the productivity problem,
but intends to do nothing.
One way,
incidentally, to force a change in this
particular feature would be for Congress to enact legislation similar to its amendment to the Economic Stabilization
Act of 1971 which removed some of the anti-productivity
effects of that Act.
(See Exhibit D.)
In a recent meeting of the National Productivity
Council (NPC),
Chairman Kahn referred to the difficulty of
developing wage and price standards which would encourage
productivity.
On the question of how and what COWPS could
do, Chairman Kahn said--I quote--"more research might be a
possibility."
There is, of course,
5.
no question that more research is
Comments by the APC on COWPS proposed standards are
contained in Exhibit C.
-6-
52
needed.
But,
if I may say so,
this is a clear example of
what is wrong with governmental efforts to improve productivity when they are given to any department, office,
council,
or agency with a crowded agenda that has higher
priorities or even conflicting goals with productivity.
It is for these same reasons that I am very
skeptical about the present plan to allocate to various
groups some of the late National Center for Productivity
and Quality of Working Life
(NCOPQW'4) efforts, meager as
The operating functions were sent to the Depart-
they were.
ments of Labor and Commerce and to the Office of Personnel
Management.
Overall policy formulation and coordination
were given to the newly created National Productivity Council
(NPC), chaired by the Director of the Office of Manage-
ment and Budget\(OMB).
I fear\'that
be meager, undireAted,
these efforts will also continue to
low in priority, underfunded,
and
outside of the real power circles that create policy and
change.
OMB is an extremely competent and influential
Office.
But it has higher priorities, an already over-
crowded work agenda, and it has never assumed responsibility
to date for an operating program.
Furthermore,
it is subject
to short term crises and, unless separately structured, productivity would likely become a stepchild.
I suppose the focal point could be located in OMB.
There is no reason that this could not be done,
provided that the program was openly supported by the
-7-
53
President,
significantly funded,
given adequate power, set
up as a discrete operating unit and provided that a Committee of Congress had oversight and investigative powers over
Anything short of that is likely to produce no
the unit.
significant action.
I also do not think that an agency,
co-chaired by
the Secretaries of Commerce and Labor, is likely to produce
results.
All of my experience says that any responsibility
that is co-chaired is not likely to be accepted by either
party with real accountability.
I could cite other instances of how the productivity issue is being Balkanized in government and how it is
likely to continue that way unless institutional change
is
undertaken.
My own preferences for the "single focal point"
would be either (1) a properly authorized and funded responsibility as a unit of OMB, or
(2) the creation of a new
"National Productivity Office," with adequate funding, power,
staffing, etc., as part of the Office of the President with
a seat on the Economic Policy Committee.
What would this "focal point" or "Federal office"
do?
(1) Hold all Cabinet officers and agency heads,
responsible for setting and achieving explicit, measurable productivity goals, and
installing productivity programs.
(2) Bring together managers of like functions in
government to share productivity ideas, programs, facilities, etc.
(3) Assist State and local governments to improve
their productivity through (1) the Federal
-8-
54
grants system, and (2) management improvement
assistance.6
(4) Require a "productivity impact statement"
of all significant new Federal Regulations
and for selected existing regulations.
(5) Examine the method by which each regulatory
agency acts to achieve its objectives, and
make productivity studies of various alternative methods that could improve productivity.
(6) Make recommendations to Congress of possible
changes in anti-trust laws to allow for appropriate private sector cooperative efforts to
improve productivity.
(7) Initiate studies of changes in various fiscal
policies to encourage productivity-improving
capital and research and development investments with assistance from other policy and
operating organizations of government involved
in fiscal policy
(8) Perform a special analysis of the federal budget to document where federal support of private sector improvement is being spent, and
how it can be made more efficient and effective.
(9) Instruct all government agencies to work with
private sector organizations by providing them
with information, literature and direct assistIt would be particularly helpful for the
ance.
Departments of Labor, Commerce, and the Small
Business Administration to provide such help.
(10) Examine other ways in which the government
can provide incentives for higher productivity
in the private sector.
In addition to the work of this new Federal office,
I believe that two other important units of government should
be encouraged to play a more active role in improving productivity.
-- The Council of Economic Advisers (CEA) shall
perform a continuing overall economic analysis
of the short and long term impact on productivity
6. Details of such a system are outlined in a GAO publication
entitled: State and Local Government Productivity Improvement: What is the Federal Role? 660-78-104, December, 1978
-9-
55
of various structural blocks to productivity
improvements in the economic system and periodically report to the President and Congress.
--
The Bureau of Labor Statistics shall be given
additional funds to enlarge and improve its
productivity measurement work.
The present
level of work by BLS is extremely useful and
performed by competent people.
But BLS is
underfunded, and their charter of work is
limited.
Both should be enlarged.
The forthcoming productivity measurement recommendations of the National Research Council Panel
on Productivity Statistics and the GAO should
be given top priority for funding, and implementation.
A later part of my testimony also
addresses the measurement needs in more detail.
The Role of Industry
As a part of this National Productivity Program,
entire industries should create explicit productivity improvement programs,
and the Federal office should provide some
assistance.
The prime locus of the work,
however, would rest
with industry trade associations, professional societies,
and
other organizations involved in industry-wide endeavors.
The reason for the Industry part of the National
Program is that productivity improving actions must get
below the national macro-economic level, down to the level
of entire industries, and eventually to individual firms.
Individual industries vary widely from extremely
low to very high productivity growth.-
For the period 1972-77,
output per employee-hour rose in the hosiery industry by
10.2% per year, whereas coal mining and iron mining dropped
by 3.5% per year.
For the industries measured by the BLS in
in about three-fourths of the industries,
-10-
1977,
productivity growth
56
was lower in 1977 than in 1976.
Twenty-five of the 66
measured industries showed productivity declines in 1977
compared to only 10 in 1976.
Coal mines declined for the
ninth consecutive year.
Clearly, we need to know more about what is happening to individual industries--why their productivity is
declining or growing, what the sources and obstacles are to
change, and how labor-management-government can work together to improve productivity.
This is particularly true
of those industries where growth has stopped, slowed, or
declined.
The nation must handle the social and economic
problems of phasing workers and capital out of these
industries into higher productivity areas.
We need early
warnings of such slowing industries so that the decline
trend can possibly be reversed in time, or the proper
preparations made for change.
Such studies and action programs are rarely done,
or they are only initiated after an industry is in trouble.
This is not only costly in the form of government support,
but also leads to embittered labor-management fights over
declining jobs and profits.
The vital question is how to
prevent the stagnation of such industries, or if the decline
seems inevitable, how best to prepare for it.
Such changes
may now come more rapidly and frequently as the higher cost
of energy changes the economics of industries, and as foreign
competition increases from the developing nations with
cheaper labor costs.
Specific programs should include:
-11-
57
(1) The creation of "Industry Productivity Task
Forces" in selected industries, with representation from labor, management, and government.
These Task Forces would identify sources and
obstacles to productivity improvement, and
would work over a period of several years to
seek improved solutions.
(See Exhibit E.)
(2) The creation of industry wide productivity
improvement programs in all dimensions-measurement, incentives, quality of working
life, technology, etc.
(3) The creation of inter-firm productivity
measurement systems, by which individual firm
productivity data are gathered, analyzed,
compared, and reported back to firms on an
anonymous, coded basis.
Other nations are
already doing this.
(4) The collection and dissemination of "best
practices" of individual firms in industries
for the spreading of productivity ideas.
It is estimated that at the present, there is
a seven year time lag before "best practices"
are disseminated throughout an industry.
Individual Firms
Government, at
positive role to play
all levels,
has an essential and
in improving national productivity.
But it should be stressed that we must rely primarily on
the private sector,
the profit motive,
and market competi-
tion to achieve productivity improvement.
And, in the private sector,
is where the action is.
the-individual firm
There is where the main thrust of
the private sector productivity program must come from.
That message was loud and clear when GAO sent
questionnaires to 1,200 forms throughout the nation in 1977
to ask about the role of.the government in productivity
improvement.
A vast majority did not want Federal assistance
and were adamantly opposed to further governmental intrusion
-12-
58
into their businesses.
Given a choice between (1) receiving
help from the Federal government or (2) from private sector
institutions, 85% opted for the private sector.
The individual firm is also the only context
in which we can ever hope to understand what is really
happening to productivity in this nation.
The economist's
theory of the firm may be good for describing overall market behavior, but not for describing real firms.
If we are to escape from the "productivity slowdown puzzle," we must go to the individual firm level.
The
analysis of what is happening and why must come from microeconomic data to see what the consequences are as a result
of changes in tax laws, government regulations, new technology, interest rates, wage price standards, higher energy
costs, patents, etc.
We must be able to link the basic productivity
output, materials volume, capacity, fixed invest-
variables:
ment, and utilization, with some of the macroeconomic variables.
We must be able to tie together at the individual
firm level:
labor costs, energy costs, materials costs,
and capital costs and understand the interaction and tradeoff variables.
Such a system is being planned by the American
Productivity Center, called the "Productivity Analysis and
Strategic System" (PASS).
An outline of PASS is given in
Exhibit F.
Any individual firm program must include cooperation
on the part of management and labor.
-13-
Management clearly has
59
an interest, but in the end it is labor that has the most
at stake.
Specific individual firm efforts should include:
(1) Every firm should be urged to adopt a formal,
sustained productivity program, organized by
management with the assistance of labor, organized and unorganized.
(2) Labor/management productivity teams should be
created in every organization.
(3) Productivity incentives and gainsharing programs should be organized in individual firms.
(4) Employee adjustment programs should be created
to assist those employees dislocated by productivity improvement.
(5) Quality of working life programs should be
created to operate jointly with productivity
improvement programs. The two are interdependent.
International
The international element of a national productivity program should not be overlooked.
The world economy is becoming increasingly interdependent.
Our balance of payments problem is at an all
time high.
Developing nations are seeking USA markets.
Furthermore, our principal foreign competitors,
Japan and West Germany, have consistently had higher productivity growth rates in recent years.
At presently projected
growth rates, both Japan and West Germany will exceed the
USA productivity level in the 1980's.7
7. If the USA grows at a rate of 1.5% for future years, and
Japan grows at its projected growth rate of 6% per year,
Japan will exceed the overall USA productivity level by
1988--just 10 years away. If West Germany were to grow at
its recent rate of 5.4% annually, they will pass us by 1984.
-14-
_V
60
Our national productivity program should include:
(1) Measurement of international productivity
levels and trends by nations and by industries.
(2) Organization of international productivity
tours.
(3) Study and dissemination of information about
international technology to American firms.
Other nations learned productivity ideas from
us. We can learn from them in many areas,
such as automaking, videotape recorders,
steel making, machine tools, and others.
(4) Assistance to developing nations in the establishment of their own productivity centers.
It is better to have trading partners than
warring opponents.
Research and Measurement
There are two additional items that should be part
of the National Productivity Program that do not fit neatly
under either government, industry, individual firms, or
international.
They either run across all categories, or
need special consideration.
One is research.
The other is measurement.
Fundamental and applied research is desperately
needed in the area of productivity.
It is a sad and shocking commentary that so little
is known about one of the most fundamental economic variables
in the American economy.
There are legions of economists
who have worked thousands of man-years on other macroeconomic
variables, in the area of fiscal and monetary policy.
We
have elaborate macroeconomic models that encompass almost
every form of variable, but only simplistic notions of how
productivity fluctuates.
Respected academic productivity researchers have
-15-
61
reached similar conclusions regarding the slowdown:
"We
simply do not understand it."
This should not be allowed to continue.
Part of the National Productivity Program should
be a greatly expanded program of productivity research-reasons for productivity change,
interactions and tradeoffs
among input-output factors, projections, impacts of alternative macroeconomic policies, total factor productivity,
so on.
and
This research should be undertaken by both the pri-
vate and public sectors, both macroeconomic and macroeconomic
The disciplines should not be only economics,
research.
but also accounting,
industrial engineering,
behavioral science, management,
relations,
industrial
international
trade and law.
A suggested agenda for research is included in the
Exhibit G, as well as my own views about the causes of the
productivity crisis (Exhibit H).
Measurement
Though many people understand what productivity
means at a conceptual level, precision in understanding or
action is not likely to occur until some measures are
established.
Our chief measuring organization in the USA today
is the Bureau of Labor Statistics (BLS) in the Department of
Labor.
BLS is an extremely competent organization, with a
long career in productivity measurement.
They are probably
the best in the world.
But what they are doing is not adequate to the task,
-16-
47-106 0 - 79 - 5
62
simply because they have not been given the charter, nor
the funds, nor the staff, nor the leadership to ask them
to do more.
approximately
I understand that their annual budget is
U4
3/
million, a pitifully small amount
relative to the demands of the situation.
There are many areas needing attention, but to
mention two general areas would help illustrate the problem:
--
BLS productivity indexes should be expanded
and improved. At present, they do not explicitly
include input factors of capital, energy, and
They measure hours paid for, but
materials.
not hours actually worked. They do not measure
plant level productivity. BLS publishes
officially only about 75 industries out of
over 400 identifiable segments.
--
Federal, state, and local government productivity figures need strengthening. A good start
has been made at the Federal level, but the
program needs strengthening and expansion.
Output measures need refinement. Data collection needs to be expanded and made more consistent. Only a very few state and local government units have good productivity measures
These and other improvement areas are addressed
by the National Research Council's Panel on Productivity
Statistics and the GAO, and their recommendations should
be considered strongly by the appropriate executive and
legislative bodies for immediate funding and implementation.
Summary
In summary, this country is facing a productivity
crisis.
stood.
The implications are just beginning to be underThey range from continuing high levels of inflation
to a gradual stagnation of American economy and the end of
its world economic leadership.
The American Challenge of
the 1950's and 60's, could easily become the American
-17-
63
Tragedy of the 70's and 80's.
On behalf of the American Productivity Center,
which was founded two years ago to help focus on this
problem and help the nation to find solutions to it,
I
reiterate that we need a firm commitment at the highest
levels of government and industry to a National Productivity
Program.
To initiate such a program will require Congresand cooperation of
sional action, support by the President,
labor and management.
It
will also require funds.
funds will be required,
I do not know what
likely
the total program
to add up to an additional $50 million if
were adopted.
is
but a guess is that it
In a "lean and austere" budget,
that may be
looked upon with concern.
Let me point out two things.
One,
the budget for the Japan Productivity Center
was $22 million last year.
ours,
Japan's GNP is
about 1/3 of
so a comparable expenditure to just match their present
level would be about $66 million.
And we need to do some
catching up.
Two,
if
the USA had maintained its 1947-67 growth
rate of 3.2% per year from 1967 onward,
our real GNP would
be $268 billion higher in the year 1978.
That's $268 billion,
not million.
Not a bad
return for a $50 million investment.
The GNP increase would show up as more jobs,
more capital and R&D investments,
-18-
reductions in unemployment
64
assistance,
less inflation,
less unemployment,
higher tax
revenues, and lower costs of performing the same governmental services,
You in
etc--all across the board.
this Committee are to be commended for
holding the subject of productivity up to such a high
level of visibility and concern.
I urge you to take what-
ever action you feel appropriate to help make a commitment
to a National Productivity Program a reality.
Let's make it happen.
-19-
65
EXHIBIT A
AMERICAN PRODUCTIVITY CENTER DESCRIPTION
The American Productivity Center (APC) was founded
in 1977,
for many of the same reasons that have been dis-
cussed in this testimony.
I saw during my experience with price controls
during the 1971-73 Phase II of the Economic Stabilization
Program that (1) price controls did not work and (2) that
productivity was a relatively neglected,
but extremely
important area.
I saw the persistent inflationary tendencies of the
economy and the slowing of our productivity growth.
my prediction then that the public sector center,
Center for Productivity,
It was
The National
had little chance for success for
the same reasons that eventually killed it.
As I looked around the world,
I also saw our
strongest competitors--Japan and West Germany--had strong
productivity growth and each had a productivity center.
I
believed that this nation would also benefit from such a
center,
and a recommitment to productivity improvement.
With this belief,
I began a fund raising effort
in 1976 to secure funds from private sector organizations
to establish a private,
effort was successful,
in Houston, Texas.
zation,
non-profit productivity center.
and the Center is in operation today
It is non-partisan,
not a lobbying organi-
and involves labor, management and the academic
community.
That
66
There are 48 staff members in Houston today,
with
22 of them contributed by their corporations to spend a year
or two at the Center working on productivity problems.
contributed executives,
These
called "Associates", will return to
their organizations with improved information and experience
in productivity
improvement.
The purposes of the Center are threefold:
Develop a broad awareness of the need for gains
productivity and the quality of working life.
Develop specific techniques for productivity
improvement.
Assist public and private sector organizations
in achieving improvements in productivity.
It
is financed primarily by contributions and grants
from 156 corporations,
foundations and individuals,
composed of prominent
governed by a Board of Directors,
from business,
and is
leaders
labor and academia.
The APC plans to accomplish its purposes through
five strategic objectives:
(1)
Programs, seminars, conferences,
Awareness:
publications that make audiences (micro and
macro) aware of the productivity problem,
(2)
Applied research to organize
Research:
existing knowledge and to discover new knowledge about productivity and quality of working
life, in all aspects.
(3)
A variety of seminars and
Standard Programs:
learning packages offered on a wide and
repetitive basis to large numbers of audiences
on all aspects of productivity and quality of
working life improvement--measurement, appraisal,
incentives, techniques, government regulation,
etc.
(4)
Custom
Programs:
A customized set of programs
-2A-
I
67
to help specific organizations and groups
so that they can learn from the APC, and the
APC can learn from the applications experience.
(5)
Programs to relate
Institutional Relations:
corporato a wide variety of institutions:
tions, unions, media, academia, government,
non-profit organizations, associations, foundations, individuals, and international groups.
To give some specific examples,
the APC offered in
1978 25 programs in nine cities around the nation:
Minneapolis, Cleveland,
Chicago, Philadelphia,
San Francisco,
New York,
Atlanta,
Houston,
and Los Angeles.
These programs were attended by about 1,100 participants, all of whom are interested in some aspects of improving
The participants came
productivity in their organizations.
mostly from business,
but also from the federal government,
state and local government,
hospitals,
unions, and schools.
The programs are concrete and practical.
Some
sample program titles are:
How to Plan and Manage a Successful Productivity
Program
How to Measure Productivity at the Firm Level
Productivity Appraisal:
An Executive Overview
In addition, the APC held a national conference
in New-York in October,
1978 on how productivity helps to
reduce inflation and unemployment.
It was attended by over
300 people and had prominent speakers from government, business,
labor, academia,
and international organizations.
National Productivity Program
The American Productivity Center was created
-3A-
68
specifically for some of the same goals envisioned by the
National Productivity Program recommended in my testimony
today.
Whether or not my recommendations are adopted,
the APC will continue its work as indicated.
National Productivity Program is created,
part,
However,
if a
in whole or in
the APC stands ready to assist in the execution of
any or all parts of it.
-4A-
69
St
"
. .dedicated to
strengthening the
free enter rise system
b~edve10pmng programs
to improve productivity. . "
American
Productivity Center, Inc.
70
Productivity:
A growing
national problem
Our country currently faces one of its most challenging economic
problems-legging productivity growth. The rate of productivity growth
in the United States during the last decade has slowed alarmingly.
According to the Council of Economic Advisors, it is much more than just
a periodic slovwdown-it is a subject for major national concern.
From 1947-66. manufacturing output per man-hour grew by 3.2%o per year,
but from 1967-77, it slowed to only 1.5%. This compares poorly to other
nations such as Japan, West Germany and Great Britain who have 9 5
achieved yearly productivity gains ranging from 400 to as high as i.
If this slowdown isn't reversed, our country faces continued problems with
high inflation, high unemployment, a declining dollar, reduced profits
and uncompetitive American products. In short, the declining U.S.
productivity growth rate is a serious national problem which must be
addressed immediately.
The American
Productivity
Center
The American Productivity Center (APC) was created as a privately
funded, non-profit organization dedicated to strengthening the free
enterprise system by developing practical programs to improve productivity
and the quality of working life in the United States. The APC is:
* Dedicated to developing practical, company-level methods for
improving productivity
* Neither pro-management nor pro-labor, but brings both together to
find ways to solve productivity problems
* Free from bureaucratic constraints and political influences
* Non-duplicative of productivity improvement efforts of other groups
and organizations
The idea for an American Productivity Center was first conceived by
Dr. C. Jackson Grayson, Jr., former business school dean and Chairman of
the Price Commission from 1971-73. Grayson realized that while most
American firms agree that productivity is important, the majority of them
do not have coordinated, ongoing productivity improvement programs;
only a very few of them understand the value of productivity measurement
as a key management tool; and that many obstacles, such as management
inattention and increased government regulation, have slowed productivity
growth.
With pledged financial and personnel support of $10 million from 75
national corporations and foundations who shared his concern, Grayson
launched the American Productivity Center in January, 1977. Since then,
support has grown to $13 million from more than 100 organizations.
71
Objectives
Awareness
The
APC this
is committed
to operate
a practical,
maoner. In
fulfilling
commitment,
the APCinhas
developedbusiness-like
a sound management
system and detailed plans for accomplishing written objectives which have
been grouped into the following seven categories:
American business, labor and government must be made aware of the
importance of productivity, its trends and what it means to our economic
future. Productivity is often mistaken as a code word for speed-up, layoffs
and stop watches. Some feel it is only applicable to heavy industry, blue
collar workers or industrial engineers. These mistaken impressions are
holding us back in improving our productivity levels.
The APC is developing materials and methods to increase awareness of
productivity, its importance and its benefits-ranging from major media
exposure to company awareness programs.
Information
Decision-makers in business, labor and government are rapidly discovering
the need for formal information systems to help them solve critical
productivity problems. Until now, they have not had a single, centralized
source for the specialized productivity data they require-it has been
buried, scattered and, for practical purposes, inaccessible.
APC Information Services acts as a central clearinghouse reference
source for productivity information, providing a wide range of productivity
data from more than 70 computerized data bases, preparing bibliographies
and reading lists and maintaining a library of books, periodicals, films
and other published materials dealing with productivity and the quality of
working life.
Appraisal
individual plants, firms and industries require a comprehensive productivity
audit to determine (1)their levels of productivity. (2)their productivity
problems and (3) opportunities for improvement. They can benefit greatly
from a thorough internal and external evaluation of their productivity
measurement systems, communications systems, incentive systems,
productivity program organization, accounting systems, capacity utilization
and labor/management cooperation.
The American Productivity Center is developing special briefings and
seminars on how to conduct productivity appraisals to identify
opportunities for improvement.
Programs
While many firms agree that productivity is important, most of them do not
have an explicit, ongoing program for productivity improvement. Some
give periodic pep speeches, or initiate cost-cutting drives, but few have
created sustained, formal programs.
To help organizations develop programs to improve their productivity, the
APC has developed a series of one-day briefings on "How to Plan and
Manage a Successful Productivity Improvement Program," that are
presented in several cities throughout the nation. Managers who attend
these sessions take with them a greater awareness of what productivity is
and why it is important: specific guidelines for developing their own
integrated productivity improvement programs; and the first-hand
experiences of managers who have tackled productivity improvement
head-on, dealt with the associated problems and pitfalls, and have started
effective, integrated programs within their companies.
2
72
Measurement
Productivity measurement tells an organization how well it manages its
labor, capital, material and energy resources. The less resources used
for a given output, the more productive they are. However, most firms
rely on dollar accounting data to analyze their operations, even though
these data include the effects of such things as inflation, tax depreciation
and arbitrary fixed cost allocations-information often unrelated to the
productive process under study.
The APC is focusing its efforts on total productivity measures, which take
into consideration all resources. The measurement information developed
by APC will be presented in the form of special educational courses. Some
of these courses will include full explanation of the newly developed
APC Performance Measurement System which emphasizes total
productivity measures.
Major features of the APC system are:
* It measures the productivity of each resource element in relation
to total output
* It provides a total productivity measure
* Elements are weighted to recognize quality differences
* It can analyze performance at several organizational levels
* It measures the effect of productivity on profits
* It isolates the effects of inflation on profits
Human Resources
Both the individual and the organization benefit from productivity
improvement. Labor and management can work together on programs for
improved productivity and quality of working life. Joint productivity or
labor-management teams at the level of individual firms or for a whole
industry are strong evidence of this fact.
The APC is playing an important role in bringing individuals and
organizations together to work toward lasting cooperative relationships.
Techniques
There are literally thousands of ways to improve productivity and new
ones are created almost daily. The problem is that many of these
techniques are not widely disseminated. Sometimes they are not
transferred among members of the same industry and sometimes not even
from department to department within a single firm.
The goal of the APC is to compile a body of information about the various
productivity improvement techniques and make them available wherever
and whenever they are needed by business and industry.
3
V
73
Products
The APC is currently developing and marketing a series of special
"products," which take the form of briefings, seminars, workshops,
conferences, advisory services, books, manuals, case studies, pamphlets
and audio-visual materials.
Products planned for the immediate future include:
* Productivity Awareness Programs-publications, films, slides, tapes,
speech materials and posters
* Productivity Information Serviceas-books, periodicals, reference
services, data bases, research sources and case studies
* Productivity Appraisal Methods-briefings and seminars on how to
determine the most productive areas to direct improvement efforts.
* Company Productivity Programs-special briefings on how to plan,
implement and manage productivity improvement programs
* Cross-industry Productivity Measurement Seminars-courses on how
to measure productivity at the company level
* Multi-firm Comparisons of Productivity Data-confidential collection
and analysis of productivity data in conjunction with industry trade
associations
* "Inflation and Unemployment: The Productivity Solution"-a special
conference emphasizing labor and management cooperation to
reduce inflation and unemployment through productivity improvement
Location
The American Productivity Center is currently located at 1700 West
Loop South, Suite 210, Houston, Texas 77027.
The APC was moved to Houston from Dallas in June, 1977, when a group of
Houston business leaders expressed interest in having the APC based in
their city. These business leaders formed a special foundation to raise
$5 million for the construction of permanent facilities, planned for
completion in late 1979. The new facility will be adjacent to The
Houstonian. an 18-acre conference center complex which includes living
quarters, executive meeting rooms, a medical center arid physical fitness
facilities.
Finances
The APC receives the majority of its operating financial support through
contributions from major corporations and foundations. More than a
hundred firms are now listed as APC Founders as a result of their
contributions.
Most of these contributions are in the form of five-year pledges of cash
and/or personnel. Within five years, the APC intends to generate a major
portion of its operating funds from the nationwide marketing of its own
products.
74
Management
Although the APC is organized as a non-profit group, it is operated as a
managed goal-seeking organization. It has adopted a sound management
system which establishes priorities and assigns responsibility for
completion of various projects.
Dr. C. Jackson Grayson serves as Chairman of the Board and has overall
responsibility for the direction and operation of the American Productivity
Center.
The President and Chief Operating Officer, like his industry counterpart,
is responsible for directing the day-to-day activities of the Center and its
staff.
Most of the APC's management team are managers experienced in line
operating positions. Their broad experience in a varietv of industries
provides depth to the Center's operational capabilities and maintains a
focus on the development of practical programs.
Associates
Program
The APC is unique among other organizations in that a portion of its staff
is comprised of key executives from major national firms. These
"Associates" are assigned to work at the APC for periods of a year or
more and bring with them a wealth of practical business experience. They
come to APC from such leading firms as Gulf Oil. Weyerhaeuser.
Honeywell, Mead Corporation, Exxon Chemical, International Multifoods,
Celanese Corporation and American Can.
The Associates are organized into special project teams-some grouped
by industry and others by specific problem area-and are currently
engaged in field projects related to the seven APC objective areas.
After working for a period of time on assigned APC projects, the Associates
return to their firms with specialized productivity knowledge which
helps them in managing their own internal productivity improvement
programs.
Summary
The American Productivity Center is fully operational. Since its founding,
it has established a workable list of goals, objectives and strategies: it
has drawn together a staff of productivity specialists and a body of
productivity information; and it has begun to develop practical and
marketable products.
The APC realizes it cannot solve our country's productivity problem by
itself, but it is a beginning-a private-sector starting place to reduce
unemployment, fight inflation, provide capital, increase profits; improve
the American standard of living, and preserve the free enterprise system.
5
75
Founders
Operating Funds
Allen-Bradley Company
The Allen Group Inc.
Amex Inc.
American Can Company
American Standard Incorporated
Amsted Industries, Inc.
Anheuser-Busch, Inc.
Arcata National
Armstrong Cork Company
Arthur Andersen &Company
Atlantic Richfield Foundation
The Babcock &Wilcox Co.
Boise Cascade Corporation
Burroughs Corporation
Butler Manufacturing Company
Cabot Corporation
Castle &Cooke, Inc.
Caterpillar Tractor Company
Celanese Corporation
Chicago Bridge &Iron Company
Cities Service Company
Coca-Cola Bottling Co. of New York, Inc.
Continental Mlinois National Bank &Trust Company
Continental Oil Company
Conwed Corporation
The Cross Company
Crown Zellerhach
Cyclops Corporation
Dekalb AgResearch. Inc.
The Dexter Corporation
R. R. Donnelley &Sons Company
Eli Lilly and Company
Emerson Electric Co.
Field Enterprises, Inc.
First National Bank of Chicago
General Foods Corporation
General Motors Corporation
Gifford-Hill &Co., Inc.
Goldman, Sachs &Co.
Gulf Oil Foundation
Handy &Harman Foundation
Harsco Corporation
H. 1.Heinz Company
Honeywell, Inc.
International Business Machines Corp.
IC Industries, Inc.
Inland Steel Company
Institute for Continuing Studies, Inc.
International Multifoods
International Paper Company
Kraft, Inc.
Kuhiman Corp.
Lily Endowment, Inc.
Lucky Stores, Inc.
Lykes Corporation
McCord Corporation
Mead Corporation
Medtronic, Inc.
Melville Shoe Corporation
Memorex Corporation
Meredith Corporation
Herman Miller Inc.
David Milton Trust
Morrison-Knudsen Co., Inc.
Motorola Inc.
Murphy Oil Corporation
NL Industries, Inc.
Northrop Corporation
Overhead Door Corporation
J. C. Penney Company, Inc.
Penawalt Corporation
J. Howard Few Freedom Trust
Phillips Petroleum Company
Potlatch Corporation
Price Waterhouse &Co.
The Quaker Oats Company
Ralston Purina Company
Reading &Bates Offshore Drilling Company
1. B. Reynolds Foundation
The Riley Company
Rockwell International
The St. Paul Companies, Inc.
Simpson Timber Company
Southern Pacific Transportation Company
Standard Oil Company Ohio Corp.
Sun Company
Texas Gas Transmission Corporation
Texas Instruments, Incorporated
Touche Ross &Co.
TrausUnion Corporation
United States Gypsum Company
United States Steel Corporation
Universal Leaf Tobacco Co.
Varian Associates
Wells Fargo Bank
Weyerhaeuser Company
Capital Funds
The 1. S. Abercrombie Foundation
Albert Alkek
American General
M. D. Anderson Foundation
Brattes Construction Inc.
Cameron Iron Works. Inc.
Dresser Foundation, Inc.
Entex, Inc.
Ernst &Ernst
The Fondren Foundation
Gulf Consolidated Services, Inc.
Halbeuty, Michel T.
Halliburton Company
Haskins &Sells
Houston Clearing House Association
Houston Natural Gas Corporation
Hughes Tool Company
Lincoln Financial, Inc.
Oppenheimer &Co.. Inc.
Perry Homes, Inc.
The Prudential Insurance Company of America
Shell Oil Company
Weldon Weekley
WilsonoCrainlAnderson/Reynolds
76
i
Board of
Directors
Robert Abboud, Chairman, First National Bank of Chicago
I. W. Abel, Labor Consultant. Past President, United Steel Workers
John Biegler, Managing Partner, Price Waterhouse &Co.
Don C. Burnham, Officer, Director, Westinghouse Electric
Frank Cary, Chairman, International Business Machines
George A. Chandler, President, American Productivity Center
James L. Ferguson, Chairman, General Foods
C. Jackson Grayson, Chairman, American Productivity Center
John Kendrick, Professor, George Washington University
Donald S. MacNaughton, Chairman. Prudential Insurance Co.
Charles H. Pillard, President, International Brotherhood
i
of Electrical Workers
W. F. Rockwell, Jr., Chairman, Rockwell International
W. 1. Usery, Jr., Labor Consultant, Past Secretary of Labor
Glenn E. Watts, President, Communications Workers of America
John Whitehead, Senior Partner, Goldman Sachs &Co.
77
PRODUCTIVITY:
Whipping Inflation
Through Increased Output
An Interview with Dr. C. Jackson Grayson
47-106 0 - 79 - 6
78
j
PRODUCTIVITY:
, Whipping Inflation
Through Increased Output
An Interview with Dr. C. Jackson Grayson
A
HEATSUP, intensifying
INFLATION
the threat of federal wage-price
guidelines or outright controls, there's
one word that is getting increasing attention among business esecotives.
government officials, labor-management consultants, and economic
experts. That single word is prodoctivity-the measure of how much
output of goods or services is achieved
in relation to input of labor, materials,
and money.
The best answer to steadily rising
labor costs, economic authonties agree, is to improve productive efficiency
and boost output per hour. Unfortunately, the growth trend in the U.S. in
recent years has been in the opposite
direction. Productivity growth has
been going down, not up. According to
the Council of Economic Advisers, it is
not just a periodic slowdown, but a
significant decline that must be reversed if the nation is to attack inflation, provide more jobs, improve profits, and pave the way for solid business
growth.
What can be done to bring a turnabout? Can worker efficiency be improved in retail stores, sersice industries, corporate and association offices,
as well as on the factory production
line?
MANAGE-technical skills and good management
For answers, AsSOCIATION
MENTturned to Dr. C. Jackson Grayson, methods. Between 1944 and 1966, outJr., chairman of the American Pro- put per working hour grew by 3.2 perductivity Center with headquarters in cent per year. But from 1967 to 1977, it
Houston. Dr. Grayson is former dean of slowed to only 1.5 percent a year. On
the School of Business at Southern average, we've cut our productivity
Methodist University and was chair- gains in half. The U.S. productivity
man of the Federal Price Commission growth, in fact, is the lowest among all
from 1971 to 1973. While in the latter the major industrial nations of the
post, he saw that price controls were world, including Japan, West Gernot the answer to reducing inflation, many, Sweden, France, Canada, and
and he concluded that increased pro- Italy.
ductivity was the only effective way to
What has caused the slippage In the
deal with spiraling costs and prices.
In the interview that follows, Dr. American rate of productivity?
A whole batch of things, including
Grayson esplains in understandable
terms what the productivity problem government rules and regulations that
and
industry's efforts to hold down
can
be
attacked,
hamper
how
it
is all about,
how trade and professional associa- costs; a reduction in total capital intions can play a special role in helping vestment, in "real" terms, in many intheir members develop techniques for dustries, an influs of inexperienced
people into the labor force; and, finally,
productivity improvement.
lack of attention by management to
Dr. Grayson, just what has happened
production and technical skills at a
to productivity In this country In
time when foreign competitors have
recent years?
been concentrating on improving effiIts rate of growth has slowed alarm- ciency.
ingly over the past decade. We used to
be accustomed in this country to Dne all this have an effect on
steady, year-by-year strong growth in Iuslness costs and on consumer
output per hour as industry kept in- prices?
Definitely. It's no coincidence that
stalling modern machinery and
equipment and made the best use of over the past decade, while our rate of
0
79
productivity growth has been going
down, we have experienced unprecedented inflation and unemployment,
declining profits, lowered capital investment, and sluggish gains in the
"real" wages paid te workers.
When productivity growth declines,
it causes many problems. Inflation and
unemployment tend to accelerate. For
example, increased productivity helps
topullinflationdownbecausegainsin
the rate of output act asan offset to cost
increases,.
Aren't there someareas, though,
where it's sery dIfficult to get much
increase In productivity over and
abovewhat already has been.
attained?
Certainly. But in every industry,
some gains can be made. If an industry
"Wage and price
controls won't work,
because they don't get
to the fundamental
causes of inflation."
cannot make any gains, it will eventually go out of existence-and it should
gooutofesistence. In manycases, such
an industry will be picked up by
another nation. However, there are
many lines of business that can make
far larger gains than they are now making. I'm trying to get more firms to
realize the potentials they have for improvement.
Do you seeimprovement in
productivity as a way to avoid
mandatory wage-pricecontrols?
Definitely. In fact, it's the only way, I
think, that the private sector can marshal its resources to offer a better alternative than wage and price controls
imposed by the government.
Dr. Grayson, are you worried that the
present administration sooner or later
may resort to controls?
Yes President Carter has said that he
doesnot favor mandatory controls, and
his advisers and cabinet members say
that, too. But I see steps occurring
which tend to lead in the direction of
controls. People remember that President Nixon said in 1971 that he was
against controls, but we ended up with
them. If inflation should go up much
beyond its present rate, and stay there,
then the public will demand, and President Carterand the Congress probably
will institute, controls. I can tell you,
from my experience aschairman of the
Price Commission, that they won't
work.
One thing is training. In many cases,
by giving employees additional
training-or by retraining workers
whose skills have been outmoded by
new tools or machinery or new ways of
doing things.
A second important thing is motivation. That means convincing workers
that they have a stake in the success of
the enterprise. and that stepping up
their output will help them hold onto
their jobs and improve their real earnings, pareofwhichare now lost to inflation.
Finally, management must be prepared to give workers a share of productivity gains in the form of increased
pay and additional job responsibilities.
Why not?
Because they don't get to the fundamental causes of inflation. All they do
is act asan outside force to suppress by Doesthe bossor supervisor play a key
coercion the basic causes of rising role In spurring productivity gaIns?
Very much so. I've seencaseswhere
middle-management people and
supervisors are blocks to productivity.
One of the accusations by some businessmen is that it's the unions that are
causing us to lose productivity. I know
there are cases where unions impose
work restrictions and insist on certain
job rules. But I also know that management often imposes restrictions on
labor that make the workers inefficient.So I don't think we can assign the
bulk of the blame to either side. The
I
important thing now is to stop trying to
blame one another and realize that we
should be engaged in a joint enterprise
,,
of tackling the productivity problem.
i
A
_
Has the federal government been
doing anything to try to improve
productivity?
prices. That merely postpones a later
Yes, but its role has been pretty
blow-off. In the meantime, it causes much ignored. A National Center for
misallocation of capital, which goesin Productivity and Quality of Working
the wrong direction, because you're in- Life was created late in 1975 with
terfering with prices which in a free headquarters in Washington. It has
economy give signals on supply and produced some studies of value. But in
demand.
the main it has not lived up to the exControls breed more controls. They pectations and hopes of a great many
treat industry asa public utility. They people, and it is now being allowed to
cause people to acoid taking risks. So expire this year. Any organization in
the whole thing runs counter to what is the public sector inevitably is going to
normal business behavior.
flnd it difficult to get cooperation from,
and productivity data supplied by, the
So you come back to productivity as a private sector.
basic way to fight Inflation,...
Exactly. If you look at the other al- What about your own productivity
ternatives, nearly every one says the center: Dr. Crayson? How did it get
government should do something. started, and what are your aims?
In my work at the Price Commission,
That's not the answer. The only longterm answer is in the private sector, I saw the importance of using productivity
gains rather than controls to
and productivity is its chief hallmark.
fight inflation.And lalsoobserved that
What canmanagement do to
neither workers nor managers in a vast
encourage higher productivity?
number of firms in this country know
80
conferences, and workshops all across
the country. In those, we describe to
firms what we think are ways they
should consider improving their productivity, how they can organize a company productivity program of their
What happened?
own, how they can involve employees,
At the end of the year, I added up my how to motivate them and share gains
support and found that 75 corporations with them.
A second area concerns research on
and several foundations had pledged
$8.5million plus $1.5 million worth of productivity. Particularly, we are conpeople's time. That was enough for me centrating on ways to measure output
to decide to go ahead. In January of and methods for implementing pro1977,1 resigned my position at South- grams in various types of industries.
ern Methodist University to give full
The third aspect centers on publicatime to this project.
tions, in which we write up case
studies: Here's how the ABC Company,
What caused you to pick Houston as a for example, measures the prosite?
ductivity of its employees; here's how
A group of Houston businessmen felt the XYZ Company has organized a
that the center should be there. They company-wide improvement prosaid, "Ifwe were to build you facilities, gram; here's how still another firm has
free of charge, to house the center, used flexible working hours to boost
Has anything like this been done in
would you establish it In Houston?" It productivity.
other countries?
The fourth area includes advisory
was an offer that I couldn't turn down.
Yes, to a limited extent. I looked However, the location of the headquar- services-a program where members
abroad and found that Japan and West ters isn't the important thing. The of our staff will go to a firm and advise
Germany both had productivity cen- productivity problem isn't going to be them on how to get started.
ters. In each case they are large centers, solved at our headquarters. It's going
working actively with manufacturers to be done at individual plants and of- Have you recruited a competent staff
and other enterprises. Not insignifi- fices all over the nation. We're not a for that purpose?
Yes, an excellent one. We are buildcantly. those two countries have had think-tank. We're a nuts-and-bolts,
ing a permanent staff of experienced
some of the highest productivity gains individual-approach, product-level
people. In addition, part of our support
of any nations. The productivity cen- kind of operation.
from industry is in the form of manters didn't create all the gains, but they
What exactly do you offer companies
agement people on loan to us for a year
certainly helped.
that
are
willing
to
participate
in
your
or more. These associates bring to us
So I began calling for a center of a
program?
their practical business experience.
I
nature
to
be
set
up
in
the
U.S.
similar
The approach we're taking is four- They come from such diverse firms as
made speeches, wrotearticles, traveled
around the country trying to drum up fold. One aspect involves seminars, Gulf Oil, Weyerhaeuser, Honeywell,
Mead Corporation, Exxon Chemical,
International Moltifoods, and American Can. They are organized in project
Average Annual Increase in Productivity, 1966-76 teams, some grouped by industry and
some by specific problem area. They go
2
0
Percent
out into the field to tackle projects related to various APC objectives.
Japan
Do you charge for your services?
Yes, we have a scale of charges for
West Germany
M
seminars and publications that will
help to meet some expenses, and we
France
M
plan an active membership program to
supplement our contributions.
Italy
M
What sort of cooperation are you
getting from organized labor?
Sweden
M
In general, labor leaders are supportive of the idea of trying to improve
Canada
productivity. It's only the minority
that still views it as a management
Britain
M
trick for speeding up the production
line,forcingpeople toworkharderand
U.S.
I
destroying the union.
Data.Hale of Leer Slats
We have four labor leaders on our
board of directors. Their view is that
what productivity is; they've heard the
word, but they don't really understand
it.
I found, too, that few companies have
any sort of coordinated, ongoing program for improving output. Only a few
have any concept of the value of productivity measurement as a management tool. And Americans generally
aren't aware of the link between maximum output and the strength of our
free enterprise system.
For all these reasons, I left my Price
Commission job with the conviction
that productivity needed more attention. And I wanted to work at it in the
private sector because that's where the
responsibility lies and where there's
the greatest opportunity for improvement. I wanted a privately supported
center, funded by private organizations, to work with individual firms.
1
1
interest. When nobody responded, I
decided to do it myself. I spent a year
asking corporations if they'd contribute funds to an American Productivity
Center.
-I-I-I-p.~~~~~~~~~~~~~~~~~~~~~
81
"We're talking with I
several associations '
about setting up
programs that will, first
of all, seek to measure V
productivity in their
industries."
improving output is a way to preserve
both the anion and workers' jobs.
Are you actively seeking help from
trade and professional associations?
Yes. We have just set up a proposal
for joint programs with associations.
We recognize that associations offer a
unique resource in the area in which
we're working. We can benefit each
other. Each association has regular
and influential contact with dozens of
companies, hundreds of plants, and
thousands of decision-makers Associations can provide many services to
their members more economically
than can individual members working
alone. Finallv, as one business consultant has noted, "The fundamental purpose of most associations is to improve
the productivity of members-individually and collectively."
_
A
APC questionnaire to all of the association's members.
The resulting productivity statistics
and evaluation of performance will be
available toall the participating firms.
We are also talking to several other national trade and professional associations .
We are prepared to set op industrytailored briefings for association
members on how to start productivity
improvement programs in their own
companies. And we are ready to share
with associations our materials and
presentations on human resources development techniques, including quality of working life.
We realize the importance of coordinating our APC efforts with those of
other private sector organizations, and
associations are one of the key aspects
of that shared effort.
Do you encounter resistance from
association people or company
esecutives to share their methods for
Improving productivity? Is there a
An important activity is workingout tendency to say, "Well, we've got ways of measuring productivity, tak- samesecrets that we don't want
ing into account all the resources that anyone else to know"?
go into it - not only labor, but
Not one firm out of several dozen
materials, capitaland energy. Untilan that we've invited to Houston to date
organization measures its present has refused on that basis. We've had
productivity trends, it can't tell where such companies as IBM, Detroit Ediimprovement is needed.
son, Texas Instruments, Xerox, Beech
Many companies have told us they'd Aircraft, Northrup, and others. We've
like to know' how the productivity been most encouraged by the way leadlevels and trends in their plants com- ing companies in this country are compare with those of their competitors. ing in to describe their programs.
But up to now, a single, confidential
source for productivity measurement You mention Detrolt Edison. Many
knowledge simply hasn't been avail- people can understand how it's
able.
possible to boost output on an
In February of 1978, we began field assembly line, where tangible
work for our data collection and products are turned out. But what do
analysis service, working in conjunc- you do when It comes to a service
tion with the National Flesible Packag- business-an electric utility, a
ing Association. We are sending out an restaurant, a retail store?
What types of cooperative effort do
you envision between your center and
various associatiom?
Those enterprises need productivity
gains just as much as does the manufacturing sector. But many service
industries are resistant to the idea that
productivity concepts apply to them.
I'm trying to get the message across.
and it's an area where associations can
help spread the sord: It's equally tinportant io gei more productivity in the
service sector-not only for the companies but for the country's economic
future, because more and more of our
economy is shifting to services.
Admittedly. it's more difficult to
apply productivity concepts to
service-sector companies because of
the problem ofdefiningoutput. What's
the output of a doctor? Or an educator?
Or a waitress? Or a laseser? But that
sort of measurement, while difficult,
can and most be worked on, or we'll
continue to see productivity slide
backward rather than moving forward.
In regulated industries, especially, it's
vital to have productivity gains, because regulatory bodies are not going
to allow them to continue to raise
prices, particularly at present levels of
inflation. So the only way those indstries can continue to be profitable is to
make productivity gains.
You've been quoted as saying that
one of the biggest impediments to
productivity gains lies In the
corporate boardroom. What do you
mean by that?
Simply that management has given
scant attention to productivity in recentyears.They've neglected it infavor
of concentrating on such things as
market share, mergers, acquisitions,
and so on. They've tried to play the
earnings game while ignoring the supply side of their operations; and it's
that side, in the long run, that's going
to permit their survival. I'm trying to
draw more boardroom attention to the
need to concentrate no the productivity side of things.
Don't restrictive government
regulations tend to hamper
productivity improvement? Industry
has had to spend billions in recent
years on pollution controls,
occupational safety measures, and
similar programs that, while
desirable, don't contribute at all to
getting goods and services
produced...
Yes. I think we should take every
regulation that's now in effect, look at
it on a cost-benefit basis, and find out
how much it is contributing to inflation. Similarly, we ought to have every
82
proposednewactofCongressreviewed
for its impact on productivity.
Many individual businessmen have
spoken out against such productivitydestroyers, but often they speak in
abstractions. One role of our center
will be to speak collectively, with a
prestigious voice, building a public
awareness of the way restrictive
regulations-and management mistakes, too-destroy productivity.
The American Productivity Center
won't solve this pervasive national
problem by itself-no single thing
will-but it is a start, and that is what
Ea
we need today.
What's Needed to Close the Productivity Gap
The American Productivity Center is concentrating on seven key areas in
which industry can work to improve output. Here is how the center's
chairman, Dr. C. Jackson Grayson, Jr.. describes them:
Awareness. Organitations need to make employees and managers aware
of productivity's importance and the need for their involvement. "Myths,
mistaken impressions, and management inattention are holding us back."
Information. A central clearinghouse for information is essential: case
studies, manuals, books, films, tapes. "What little productivity information
we have is esoteric and incomprehensible to those who need to act on it."
Appraisal. Individual companies and industries need to find out where
they stand in relation to competitors, where their productivity problems
are, where they can improve.
Programs. Even the firms that recognize the importance of productivity
often have no program for improvement. Sustained, formal efforts are
needed, on a long-term basis, not as a one-shot, cost-cutting drive
Measurement. "This is the weakest link in the whole effort to boost
productivity." At the national level, information on measurement is woefully inadequate. At the industry or plant level, measurements-if they
exist at all-generally are superficial and misleading. What's needed are
measures for "total factor" productivity, counting not only labor, but capital, materials, and energy as well.
Human resources. Joint cooperative efforts by workers and managers are
necessary, not an adversary relationship that can be detrimental to each.
Employees need to be involved with incentive systems, with retraining
programs where necessary, and with motivational efforts. "Productivity
gains most be shared with workers."
Techniques. Literally thousands of ways to improve productivity exist,
but many firms know little about them.There has been ocentralforum for
exchange of ideas and methods. "We need to have documented data on
successes and failures, and to provide a source of contact for information
and assistance."
Further information about the American Productivity Center and its
programs can be obtained from Dr. Grayson at the center's headquarters,
1700 West Loop South, Suite 210, Houston, TX 77027. Phone: (713) 9617740.
Reprinted by permission from the October 1978
issue of ASSOCIATION MANAGEMENT. Copyright 1978 by the
American Society of Association Executives.
83
84
POLICY FORUM
Productivity:
A Call for Action
PRODUCTIVITY GROWTH 1966-1976
This productivity slowdown is one ofthe most significant
economic problems of recent years."
e
That stark sentence, almost buried on page 147 of the
1978 Annual Council of Economic Advisers Repod, should
be ringing alarm bells.
It is more than just a cyclical slowdown. Something tundamentat has happened. From 1947 to 1966. output per
man hour grew by 3.2 per cent per year, but from 1967-77, it
slowed to 1.5 per cent per year (which is even lower than
the usually quoted performance of the manufacturing sector, illustrated in the accompanying chart).
It is no coincidence that roughly in this latter period we
have also experienced unprecedented inflation and unemployment, falling profits and capital investment, and
sluggish real wage gains
No significant let-up is in sight. Costs are roing taster
than prices. Wage escalators are built into labor contracts.
Price escalation is built into torward sales Two successive
years of high federal deficits are planned.
Standard Keynesian stimulation of demand has
stimulated inflation even more, and without solving the unemployment problem or stimulating capital investment sutticiently. Severe fiscal and monetary restraint has reduced
output faster than inflation, and increased unemployment.
Income redistribution programs have focused policies on
allocation-on dividing the pie-instead of expanding it.
And regulation, public spending programs and taxes are increasing, driving prices further upward.
The tempo builds, therefore, for inaugurating "incomes
policies.
WAGE AND PRICE CONTROLS
President Carter calls for "voluntary restraint" by
business and labor. The Council on Wage and Price Stability is asked to undertake "an analysis of the outlook for
market conditions and cost trends in specific industries"
and "members of the Administration will participate in informat private discussions with firms or industry groups.
Shades of jawboning, arm-twisting and guidelines.
Lurking in the wings are mandatory wage and price controls.
President Carter has said that he does not favor mandatory controls. But people remember that Nexon said the
same thing in 1971. I inflation should rise tothe 8 per cent
mark-and stay there for a period of months-then the
American public will demand, and Carter and theCongress
will institute, controls. And I can tell you, from my experience as Chairman of the Price Commission, they won't
work.
492
NATIONAL JOURNAL 3/25/78
-
~~~~~~~~~
e
Belgiun
Derevari
Netherlands
~~~~~~~~~~~~~~France
-~~~~~~1-~~~~~~~~~~~
:
5
italy
-
~~~~~~~~~~~
o
i%
2%
~~~~~~~~~~~U
igo
~~~~~~~~~~~~
States
3%
4a%
5%
% 7%
rim
8%
10%
Soure U s Depurmentoi Lanb. bureauof Labor Stiuisiicn
All the proposed solutions have one thing in commongovernment intervention and direction of the economy.
Notably missing in all of them are (1) any real appreciation
of the private sectors role in solving national economic
problems, and (2) any real understanding of the role of
productivity, the historical strength of the private sector.
Yet it is in the private sector, where 80 per cent of our
goods and services are produced, that the battle will be won
or lost. Productivity is one of our most powerful weapons in
the fight against inflation and in the long struggle to reduce
unacceptable levels of unemployment. Gains in this sector
can bring tremendous benefits to the economy: an improvement of less than f per cent in output per employeehour can mean billions ofdollarsingross nationalproduct.
MANAGEMENT PRIORITIES
What is most urgently needed now is not more government intervention, but an awakening of theprivatesectorto
85
reassume the role it has gradually abdicated.
Programs and goals: While many firms agree that
For years now, too many of our nation's top business
productivity is important, most have no explicit program for
managers have largely ignored productivity and have been
improvement. Some give periodic pep speeches on
| ,playing
the gameof moneyanddemandmanagement Key
productivity. Some initiate cost cutting drives. Most
measures have involved return on equity Snot return on
programs die as start-stop efforts. Firms need to create
assets), with emphasis on acquisition, merger and tax
sustained, formal efforts toward productivity improvement
manipulation. Laurels, bonuses, and CEO slots have been
with detailed goals, objectives. strategies, assignments.
going to financial, accounting and marketing specialists,
data gathering systems, monitoring and follow up
with less attention to production and technical skills.
Management inefficiencies have crept in. as score-keeping
Measurement: Measurement is the weakest link at both
has been not on productivity, but on increasing capacity,
the micro and macro levels. At the national level, the data
marketshare points, profitability, and price leadership. Even
are woefully inadequate for public policy analysis of causes
leading business schools preparing management leaders
of the productiviy slowdown, or analysis of the impact of
of the future have all but dropped production and producproposed public policy alternatives. Al the plant, firm or intivity courses in favor of behavioral science, accounting
dustry level, most firms rely on only financial and profitand finance courses.
/
ability figures and have few real productivity measures. And
Meanwhile, foreign competitors have been concenwhatmeasuresthereareeveninleadingfirmsaretypically
trating on efficiency and gaining steadily In a growing
superficial and even misleading Virtually none have
number of industries-sbipping, steel, television manufacmeasures for "total factor" productivity-productivity of
turing. footwear-we are already in serious trouble. In
labor, capital and materials.
others-computers, autos, electronics-the warning
signals are there. Professors Jorgenson and Nishimizu of
Labor/Management Both labor and managementgain
Harvard and Princeton recently estimated that "by 1973
from productivity irrprovement. Yetrecentyearshaveseen
technology atthe aggregatelevel inJapavooasvesIrzghtlry ,agrowing adversary relationship detrimental to each. The
ahead of that in the US"
relationship is often structured so that employees havethe
incentive not to cooperate-threatened job security, no
THE KEY AREAS
gain sharing, poor management aid poor working environAwareness: Too often, productivity is mistakenly treated
ment. Labor and management can work together on
as a code word for speed-up, layoffs and stop watches.
programs for improved productivity Restraints can be
Others treat it as something applicable only to heavy inreduced, and opportunities opened up. Some firms and industry, blue collar workers or industrial engineers. Myths,
dustries are already doing this with productivity teams.
mistaken impressions and management inattention are
quality of working life programs and gain-sharing
holding us back. We need educational programs to inagreements.
crease labor and management awareness of productivity's
importance and its benefits-not in abstract, economic
Techniques: There are literally hundreds of ways to imtheoretical terms, but intermsof where it reallycounts: jobs,
prove productivity, and new ones are created daily, in this
paychecks and profits.
countrv and abroad. Thewaste is that many firms know liffl
Intormnatlon: What little productivity information we have
is typically esoteric and incomprehensible to those who
need to act on it, It is buried, scattered and, for practical purposes, inaccessible. A central clearinghouse reference
service of productivity information is needed: case studies.
manuals, books, films, tapes-in short, a specialized
productivity information center.
Appraisal: Individual plants, firms and industries need to
undertake a comprehensive productivity 'audit" to determine their level of productivity, their productivity problems
and opportunities. They need a thorough inside and outside
evaluation of their productivity measurement systems,
communication systems, incentive systems, productivity
organization, accounting systems, capacity utilization and
labor/management cooperation.
about these techniques. Improvement occurs inanotherindustry, in another country, andmany firms have no way to
share in the ideas. Ideas are sometimes not even
transferred within the same firms. We need to have
documented data on successes and failures, and to know
who to contact for information and assistance.
TheAmerican Productivity Centerwas brought into being
one year ago to help industry and labor focus on these key
areas thatwill make productivity improvement possible. We
are all nowpaying the cost for having ignored productivity
for too long
C. JACKSON GRAYSON JR.
CHAIRMAN
AMERICAN PRODUCTIVITY CENTER
AMERICAN
PROOUCTIVTY
CENTERBOARDOFDIRECTORS:
RoberIA.Abboud,Chaimaoat
trweBoadFirstNational
Bankof
Chicago. 1.W. Abel, labor consultant.fanmerPresident, United SteeWorkersof Ameica, John C. Slegler. Managing Partner,Pice
waterhouse
&
Ce,;DonaldC. Burnham.
Director-Officer,
Westinghouse
ElectricCorp. FrankT. Cary,Chairman
or tre aoard.IBM;
a ere. A' Chandler,President,American ProductivityCenter, James L. Ferguson. Chairman,General FoodsCorporation, C. Jackson
Grayson, Jr..Chairman,
American
Productivity,
Center;Dr. John W.Kendrick. Protessmot
fEconomics, GeorgeeWashington
Univerity
DonaldS.11,1c1haughton.
Chairman
andChiefEaecuive
Officer'Prudential
I nsuarace
Co; Charles
H.Pillad. President.
International
BrOtherhood
of Electrical Workers,Willard F. Rockwell,Jr., Chairman of theBoard, Rell
Iterational. Witiam J.Usery. labor
cansuftant.formerU.S.Secretary
ofLabor; leaneE. Watts.President.
Ccommunications
markersorAmecica:
JohnC.Whtlehwad,
Senior
Partnom,
Golderan,Sachs&Ca.
NATIONAL JOURNAL 3/25178 493
-
0
86
THE AMERICAN PRODUCTIVITY CENTER
The American Productivity Center was established in February 1977 to provide American business
and industry with a major resource for the achievement of significant gains in productivity.
Services provided to individual companies or industry groups include information, research and
development, education and training, and assistance in the design and implementation of appropriate
productivity measurement and improvement programs.
The Center is a non-profit organization supported by private contributions, principally from companies
and foundations. It is governed by a board of directors of prominent leaders of American business and
labor.
Arrangements for briefings and further information on the Center and its programs may be obtained
from: The American Productivity Center, 1700 West Loop South, Houston, Texas 77027. Telephone:
(713) 961-7740,
87
EXHIBIT C
_
A
_C 1700WestLoop South *Suite 210 *Houston, Texas 77027 *713-961-7740
_
_
American
Productivity Center, Inc.
November
28,
1978
Mr. Alfred E. Kahn
Chairman
Council on Wage and
Price Stability
c.-
726 Jackson Place, N.W.
Room 4025
Washington, D.C.
Re:
FLZ.
20506
Proposed Voluntary Standards
for Noninflationary Wage and
Price Behavior, 43 Fed. Reg.
51938
MM-m~
C
9
.
"
,,,r~,,,Ad A51938
^<>-,
^-
(Nov. 7,
1978)
Dear Chairman Kahn:
The American Productivity Center ("APC") herein
submits its comments in response to the Council on Wage
and Price Stability (PCOWPS") proposal to establish
voluntary standards for noninflationary wage and price
proposal was published in 43 Fed. Reg.
behavior.
The
Price
(Nov. 7, 1978) and invited comments to be submitted
by December 2, 1978.
The APC is a privately funded non-profit organization dedicated
to improving productivity and the quality
It is the largest private,
vof working life in America.
non profit, non-partisan organization in America working
vw~wtz~r
with labor and management in the productivity area.
*
E,,,,,,,
aS'...-..
-c--FwZ
:
With
its independence and expertise, the APC is in a unique
tposition to provide an impartial assessment of the effect
withe proposed wage-price standards will have on productivity.
Therefore, the APC has carefully studied these standards
with regard to their probable implications for productivity,
88
Mr. Alfred E. Kahn
November 28, 1978
Page Two
and respectfully offers the following findings and modifications. */
FINDINGS
As proposed, the COWPS wage-price standards could
seriously curtail some of the most effective productivity
This would be contrary to
improvement programs in America.
the goals of the President's Anti-Inflation Program and to
the statutory authority pursuant to which the standards
are promulgated.
As authority for promulgating wage-price standards,
the COWPS relies primarily on Sections 2(c), 3(a)(4), and
3(a)(5) of the Council on Wage and Price Stability Act,
12 U.S.C. S 1904 note. See 43 Fed. Reg. at 51952 (S 705.1
Section 3(a Tm) of the Act states in part
Authority).
that COWPS shall "focus attention on the need to increase
productivity in both the public and private sectors of the
economy."
The central importance of productivity to a lasting
solution to inflation, to an increasing standard of living,
and to decreasing unemployment has been recognized many
times by government, business, and labor leaders. The
President, the Federal Reserve Chairman, the Comptroller
General of the United States and the Chairman of COWPS
have all stressed the high priority of increasing productivity.
In order to further the statutory policy cited as
enabling authority, and to be consistent with established
national policy and with the public interest, COWPS wageprice standards should encourage rather than hamper efforts
to improve productivity. The following proposed modifications will remove impediments to productivity now contained
*/ Staff with expertise in anti-inflation programs were
asked to review all suggested modifications for their
consistency with a controls program.
-2C-
89
Mr. Alfred E. Kahn
November 28, 1978
Page Three
in the wage-price standards without increasing the
regulatory burden, or reducing the effectiveness of the
program.
The modifications also are designed to be consistent with the objectives of the program, and to fit
into the proposed standards with minimum redrafting.
MODIFICATIONS
Proposed Modification of Section 705A-4
Profit Margin Standard
Add:
To the extent that an improvement in profit
margin can be demonstrated to be directly
attributable to an improvement in productivity
it will be in compliance with this standard.
Rationale
This standard acts as a disincentive to productivity improvement efforts and as an incentive to increased
inefficiency.
In some cases it would even prohibit productivity improvement.
For example, a bank compelled by
the government's monetary policy to increase interest
rates would automatically be in violation if it substantially increased its productivity.
As modified, this standard would act as an incentive for increasing productivity and decreasing costs.
It would not open any loopholes and would encourage voluntary compliance.
It would decrease regulatory burden,
regulatory lag and compliance costs by decreasing the
number of exception requests.
Section 705A-4 as Modified
705A-4
Profit Margin Standard. A company which
does not achieve the price deceleration standards in
705A-1,2, and 3 will be considered to be in compliance if
its program-year profit margin does not exceed its profit
margin base.
If product lines excluded under parts 705A-6
(i) (1) and 705A-6 (i) (3) account for more than 75 percent
90
Mr. Alfred E. Kahn
November 28, 1978
Page Four
of program-year dollar sales volume and there is no
reasonable accounting method capable of establishing a
separate profit margin for the nonexcluded product lines,
the company is excepted from the preceding profit margin
criterion for compliance. To the extent that an improvement in Profit margin can be demonstrated to be directly
attributable to an improvement in productivity it will be
in compliance with this standard.
Proposed Modification of S 705A-9
Undue Hardship or Gross Inequities
Add:
or negative productivity impact.
Rationale
In its current form, this section does not allow
for exceptions where the standards inadvertently and unintentionally act in a manner inconsistent with maintaining
Without modification, it could
or increasing productivity.
destroy productivity in specific instances and embodies a
generally negative attitude toward productivity improvement.
The additional language, while not weakening the
standards, will provide a necessary safeguard against
hampering productivity and will help to create a positive
atmosphere for productivity improvement programs. It will
also act as a stimulant to these efforts by highlighting
the Council's concern that its standards not be detrimental
to productivity.
Section 705A-9 as Modified
Undue Hardship or Gross Inequities. The
705A-9
Council on Wage and Price Stability may except a company
from the application of the price standard, make adjustments to the base rate of price change, or alter application of the profit-margin standard to avoid extreme situations of hardship or gross inequity or negative productivity
impact.
-4C-
91
Mr. Alfred E. Kahn
November 28, 1978
Page Five
Proposed Modifications of Section 705B-6
Pay-rate Increases Traded for ProductivityImproving Work-Rule Changes
Delete:
contractual
Change:
alter to improve
Add:
practice
Rationale
In its present form, this section would bring many
progressive and necessary productivity efforts to a complete standstill and undo recent progress in this area.
Recent programs have tried to dispel the erroneous and
detrimental beliefs that productivity only involves the
"blue collar" worker, and that productivity only means
In fact, productivity includes
working harder and faster.
all workers, and improvements come from working more efFurthermore, productivity improvement comes
fectively.
not only from improvements in labor productivity, but also
This "total
from capital, energy, and materials inputs.
factor" approach requires that all employees share the
responsibility for productivity improvements and should be
provided appropriate incentives.
The present standard, by allowing pay above the
seven percent limit only for contract labor and only for
changes in work rules, inhibits efforts to stress total
Rather, it fuels the erroneous
factor productivity.
assumption that productivity comes only from squeezing
more from workers, and would have many undesirable effects:
Iould
prohibit many productivity gainsharing plans, such
it
as Scanlon'Plans; */ it would be detrimental to labormanagement cooperation; and it would largely prohibit inIn
centives, direct or indirect, to non-contract labor.
short, this section is discriminatory, unfair and unjust
to all non-contract labor.
*/ For a more detailed explanation of productivity gainsharing programs such as the Scanlon Plan, see the attachment entitled Productivity Gainsharing Plans.
-5C-
92
Mr. Alfred E. Kahn
November 28, 1978
Page Six
This sort of unfairness erodes public support for a program that is entirely dependent upon such support for success.
As modified, Section 705B-6 will exert a positive
influence by providing recognition of and incentive for
It will not
productivity improvement by all employees.
It is non-inflaweaken the standard but strengthen it.
tionary in every sense and will improve support of and
compliance with the pay standard and with the entire antiinflation program.
Section 705B-6 as Modified
705B-6
Pay-Rate Increases Traded for ProductivityIn determining compliance,
Improving Work-Rule Changes.
that part of a pay-rate change that is in return for changes
in eontractual work-rules and practices that improve proIn
ductivity will be deducted from the pay-rate change.
order to comply in this manner, it must be demonstrated that
the cost reductions generated by the work-rule-practice
change are equal to or greater than the excess of the payrate change over the pay standard.
Proposed Modification of S 705B-7
Undue Hardship or Gross Inequities
Add:
or negative productivity impact.
Rationale
Same as given above for S 705A-9.
Section 705B-7 as Modified
705B-7
Undue Hardship or Gross Inequities. The
Council on Wage and Price Stability may grant an exception
from the application of the pay standard or may make appropriate adjustments in the standard to avoid extreme situations of hardship or gross inequity or negative productivity
impact.
-6C-
93
Mr. Alfred E. Kahn
November 28, 1978
Page Seven
Proposed Additions to S 705C
DEFINITIONS.
Productivity - The Bureau of Labor Statistics
productivity definitions, where applicable, should be used.
Work Practices - 'Work practices" are the activities
and processes associated with the performance of a specific
Such practices can be identified in
job or group of jobs.
contractual agreements, employee manuals, policy manuals,
etc., or developed informally over a period of time and
accepted by employees and management as "standard" or past
practice.
Rationale
In the proposed standards, the terms "productivity"
and "work practices" are omitted from the definitions in
Since the meaning of these terms will be
section 705-C.
crucial to determining compliance for many companies, they
should be defined.
CONCLUSION
The APC strongly urges COWPS to adopt the above
suggestions and is prepared to aid and assist the Council
in any appropriate manner.
For further information, or specific requests,
please contact Michael S. Lang at 713/961-7740.
Sincerely,
C
Jackson
Chairman
Michael S. Lang
General Counsel
Enclosure
cc:
APC founder companies, Members of Congress
-7C-
47-106 0 - 79 - 7
94
ATTACHMENT:
PRODUCTIVITY GAINSHARING PLANS
Productivity gainsharing programs are based on three
principles:
1.
The philosophy that every employee can make a
significant contribution to the effectiveness of
the group in which he works by sharing his ideas
for improving the way the work gets done.
2.
A means for that employee to have his ideas heard
and evaluated by other employees and managers who
can help refine and implement the new process.
3.
A financial agreement in which employees and the
company share the results in productivity gains
according to a pre-determined formula.
Several hundred companies, ranging from small operations of 25 or 30 people to major corporations employing
thousands of people, currently have these plans or are
exploring the possibility of implementing one.
Successful
programs report impressive productivity gains, sometimes
as high as 30% to 40%.
These gains result from more
effective utilization of materials and energy as well as
improved product quality and production.
The Scanlon Plan is a well-known variety of this
approach.
Under a Scanlon plan, the productivity bonus is
determined by calculating the ratio of total labor cost to
the sales value of production--a figure generally called
the base ratio--and then applying this ratio to the calculated sales value of production for a given period.
If
actual labor cost has been less than the calculated costs,
the difference represents a savings shared by workers and
owners in a pre-determined ratio.
The bonus calculation is made monthly, and the bonus
(if any) is paid in a separate check as soon as possible
in the following month.
The Scanlon bonus is divided
between the company and the employees, typically 25% and
75%, respectively.
Each employee's share is calculated as a percentage of
the total payroll of included employees for the month
(including overtime), and the percentage is announced.
Each
employee receives a bonus check representing that percentage
of his or her total pay for the month.
These plans have been implemented in both unionized and
-8C-
95
-2-
non-unionized work places, and usually include not just
contractual, but all of the employees in an operation-management, direct labor, indirect labor, engineering,
research and development, and office and clerical staff.
Section 705B-6 assumes that any practices and work
rule changes that result in productivity improvement must
be contractual and negotiated as if they were collectivebargaining issues.
In fact, productivity gain-sharing
programs may or may not be a part of the collective-bargaining agreement.
In unionized organizations, the plan
is usually covered by a memorandum of agreement between
the union and company rather than being a section of the
formally negotiated contract.
As written, the guideline
does not address changes in non-contractual work rules and
practices that improve productivity.
This improved labor
productivity results from the many cost-saving suggestions
introduced by employees covered by the plan.
This guideline must be rewritten as suggested to allow
these productivity gain-sharing programs to continue and to
encourage other companies and unions to explore this approach to productivity improvement.
-9C-
96
~~EXHIBIT
Sa
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A- CongreoSIOnal 'Record
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PROCEEDINGS AND DFD,'TES OF THE 92d
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g201.59
CODE OF FEDERAL RPUIA7tONt
1 37351
Productivty Incentive program.
1S735.051
(a) Existing Prndacirby iaextive Program. A product wity Incentive program (as defined in paragraph (d) of this section) in existence,
or pooed for installation and coneunicated to employees. prior
to November 14, 1971,will he allowed to operate according to its
ternssaThus
ttributble to the operation of such a
roam
mas_ eoe ee1rom ae ustmtnt computtions pursuant to
1201.57(j). This paragraph shall apply to productivity incentive
programs on either a plant-wide or less than plant-wide basis. In the
caseof a substantial revision of such a program the provisions of
paragraph(b) or (e) of this section
(whichever is applicable), shall
apply.
I13735101
(b) NMmor rsed procslmtiaity imaeistii progrus onsa plaxt-side
bais. Increases
attributable to the opertion of a new or substantially
revised existing pLant-wide productivity incentive program (as defined
in paragraph (d) of this section) may be excluded from adjustment
computations puruant to § 201.57(j) if(I) Within 30 days of the installation of such a program, or revision thereof, or within 30 days of Junt 22 1972.whichever is later,
the employer has filed with the Pay Board a certification of such installation or reision which shall indude a full description of the program and (if applicable) its revision, and
(2) Incresses under such program, or revisions thereof, actually
reflect and are directly related to increases in productivity.
(13735.15J
(c)Net or retised Productity incentv Program ensless than a
laide basis. If. on less than a plant-wide basis, the installation
of a new productivit incentive program (as defined in paragraph (d)
of this section) or the installation of changes to an existing productivity incentise program which would substantially revise the terms
of such program, would cause the annual aggregate wage and salary
increase of an appropriate employee unit to exceed the maximum
permissible annual aggregate. increases attributable to the operation
of such program may be exeluded from adjustment computations
pursuant to J 201S.S7ji: provided. That increases under such program.
or revisions thereof, actually reflect and are directly related to increases
in productivity. Prior to the installation of such a program or the
implementation of revisions thereto, or within 30 days of June 22, 1972.
whichever is later, the employer shall provide the Pay Be-d *1% a
description of such program and shall certify to the Board that the
program, or revisions thereto, will substantially meet criteri appropriate for such plans or practices. Among the factors which may be
considered sry that the plan or practice-
a
14M
M v P. R. 12M (i
I& 19M
(I) Provides employees fhe expectation of a level of earnings
above baserates which will vary in relationship to changes in productivity, but which will not result in increased unit labor costs for the
employer;
(2) 1s designed to provide earnings oppoartnities sufficist to
motivate the participants;
(3) Contains standards o performince and provisions forrevil
such standards to reftect changes in equipment, methods, quality
requirements and other factors related to the bais for standards
development;
(4) Contains guarantees of wages and earnings for such contingencies as down-time for reasons beyond the control of participants
and for nonstandard work: and
(S) Defines the employees included and their relationship to
increased productivity.
"3).201
(d) Praertiity incentivre rfbeg djfxse
For the purposes of
this part, the term "productivity incentive program" means a plan or
practice which establishes a formal system vhereby, in accordance
with predetermined formulas, wage and salary payments to an
employee or a group of emplovees increase as the measured productivity of such employee or group increases; provided, that where a
single plan or practice is plnt-rside and includes all or substantially
all of the employees in a plant or firm, payments may be based on
the measured increase in productivity for such plant or firm as a whole.
[I 373S.251
(e) Discrotinnae.. 11 a productivity incentive program is discontinued and such action results in an increafe in wages and salaries
to the employees affected. the employer shall certifi to the Pay Board
within 30 days of discontinuance that such action was taken in good
faith and not for the purpoe of circumventing the intent of the
economic stabilization program.
Excerpted by The Eddy-Rucker-ltickels
Conmpny, 4 Brattle Street, Cawmridge,
MIssachusetts 02138 --- Specialists
in the design and guidance of plantwide productivity sharing incentIves.
98.
EXHIBIT E
February, 1979
POSSIBLE INDUSTRY TASK FORCES
Industry
Objective
1.
Banking and Insurance
To discover ways to measure and
improve productivity in key industries with high public interest
'High labor intensity
Increasing competition
*Difficulty of defining output
2.
Coal Mining
To determine specific barriers to
improving industry productivity
and bow each barrier can best be
overcome
Major impact from OSHA
regulation
*Heavy labor factor--labor
saving technology major issue
'National need for energy
sources important
3.
Manufacturing (a subset)
To select a subset (or several)
in the manufacturing sector to
examine several productivity
impacting factors:
'Computerated manufacturing
*Capital productivity
*Guaranteed job security/income
'Alternative work schedules
'Incentive systems
4.
Footwear
To examine the international
competition position of the
footwear industry
'Fragmented industry
'Obsolete equipment
'Impacted by imports
'Resistance to change
5.
Machine Tool
To determine whether the international competitive position of
our machine tool industry has
deteriorated and why, particularly
from the standpoint of product
innovation and cost competitiveness
'High importance for productivity
in other industries.
'Heavily dependent on capital
market health, economy
'Highly impacted by imports
'Significant technology factor
99
Industry
Objective
6.
Steel
To examine recent trends in international competitive position of
our steel industry. Pinpoint major
reasons.
7.
Public Utilities
To determine best means to improve
capital and labor productivity of
utility industry
'Major capital factor
'Technology change important
'Impacted by government regulations
'Capital project management key
nationwide issue
'Key to energy sufficiency
8.
Medical Equipment
To determine key means to improve
industry productivity
'High technology factor
'Fragmented industry
'Important factor in health care
delivery improvement
'Impacted by government regulation
9.
Construction
To examine key determinants of
industry productivity by comparing
high-productivity project results
vs. low-productivity project
results; determine why high productivity is not achieved for all projects.
10.
Pharmaceuticals
To examine international competitive
position of our pharmaceutical
industry from a productivity standpoint to determine cost/benefit of
U.S. approaches to product research
development, testing, and introduction.
11.
Textiles
To determine the key means of improving industry productivity and,
in turn, the international competitive
position of U.S. textile industry
'Heavy focus on capital recovery
'Labor saving technology and its
use are major factors
100
INDUSTRY PRODUCTIVITY TASK FORCES
Objectives
(1)
To create a mechanism where the key leaders from
business, labor, and government who can affect
productivity in an industry are brought together
in a constructive atmosphere for discussion,
involvement, and cooperative efforts to seek
improvement.
(2)
To obtain action from the task forces, not just
discussion and reports.
(3)
To focus national (and in some cases, international)
attention on some productivity problems in key
industries.
-E3-
101
A SUMMARY OF THE IDEA
The idea is to organize industry productivity task
forces composed of representatives from labor, business,
and government to seek improvement in productivity in
selected industries in the nation.
The mechanism for accomplishing this is the creation
of task forces that will be organized, operated, and
The
followed-up by the American Productivity Center.
goal is to seek improvement of productivity by identification of sources and obstacles to productivity in that
particular industry, by seeking understanding of the needs
of each of the groups, and by searching for solutions that
can be accepted and implemented.
These task forces will be initiated through an initial
meeting to bring together the leaders, followed by separate
task forces that work on identified problems over a one to
two year period with direction, progress reports, and periodic meetings supervised by the American Productivity Center,
together with the Task Force Chairman.
The reasons for approaching the productivity problems
of industries in this way are:
(1) Declining productivity growth is a serious problem for many industries,
(2)
and in some industries,
productivity is actually declining.
Present methods of seeking solutions to productivity improvement are not working well in many of
Labor, management, and governthese industries.
ment have often drifted into antagonistic, formalized positions from which only miniscule
progress can be made.
-E4-
102
(3)
A private sector Center has a greater opportunity
to bring the parties together, for many private
sector organizations will not accept further
government intervention and direction.
(4)
A structured approach, organized and followed-up
over a long period of time, has more chance of
progress than confrontation over a bargaining table
or in government administrative proceedings.
While some "task forces" can degenerate into
(5)
nothing more than discussion groups, the structure
followed here is designed to minimize that possibi(6)
lity.
The results are never certain.
Perhaps no progress
can be made. But what is the alternative? Often
it is a continued stalemate or a continued decline
with parties wanting negotiating mechanisms but
having none.
-E5-
103
INDUSTRY PRODUCTIVITY TASK FORCES
I.
STRUCTURE
A.
American Productivity Center organizes and
administers the program
B.
Task Force Chairmen
1.
Labor
a.
b.
2.
Management
a.
b.
3.
II.
III.
IV.
One current president of a union
One retired officer of a union
One current CEO or President
One retired CEO or President
Government
Appropriate officials
-
PARTICIPANTS
* Companies
Industry Associati4:ons
* Unions
Academia
* Government
Media
FORMAT
A.
Initial meeting (approximately two days)
B.
f
Creation of task forces, each designated to tackle
one or more major issues with representatives from
each of the groups on each task force.
C.
Follow up meetings, progress reports,
final reports
INDUSTRIES
*
*
*
*
Steel
Coal
Railroads
Trucking
*
*
*
*
*
Forest Products
Apparel
Construction
Health
Retailing
-E6-
* Footwear
* Food Processing
* Printing
* Education
* Shipping
* Housing
104
INDUSTRY PRODUCTIVITY TASK FORCE
The
Industry Productivity Task Force will
have three principal objectives:
' Open discussion on issues relating to productivity
enhancement with people who must participate in
any change.
' Create an agenda for action and research.
Encourage innovative demonstration projects or
changes which may improve productivity.
* Seek action.
In order to have maximum effectiveness,
the task force
study must have the following features:
' It must be rigorously organized in advance of outside participation so that the task force effort
will not run down of its own momentum.
Target goals and target products must be clearly
designed in advance so that principal efforts can
be expended on developing specific substantive
issues rather than on process and procedures.
Time schedules must be set and precisely regarded
so that several levels of effort will mesh while
enthusiasm is maintained at a high level.
Principal substantive work efforts will be carried
out by small groups of industry,
labor and govern-
ment experts with the assistance of the APC staff
and others.
The results of these small group efforts
will be extensively reviewed by a large number of
industry experts, who through their ex post review
and comment will indirectly participate in the task
force.
Action must be the end goal.
-E7-
i05
TASK FORCE ORGANIZATION
The task force effort should be carried on at several
different organizational levels.
There will be:
1) APC
staff, 2) Senior task force, 3) Working task force, 4) Outside consultants.
General responsibilities are sketched in
this section.
APC Staff
The APC staff will direct the task force effort.
The
staff will structure all task force efforts in advance so
that little possibility will exist for deviation from a short,
direct, output-oriented course.
Agendas, report outlines,
papers dealing with specific empirical issues should be
prepared in advance of each work session by the APC.
Papers
prepared at the working task force level should pass through
the APC staff to the Senior Task Force for final approval.
The staff should serve in this conduit capacity as an
editorial, refining, and polishing agency.
Senior Task Force
The Senior Task Force will consist of senior representatives of labor,
industry management, federal officials,
industry associations and academics.
will serve the following functions:
The Senior Task Force
1) Plan and.approve the
coverage of the Task Force report; 2) Recommend representatives for each of the Working Task Force groups.
In some
cases, these representatives may be persuaded to volunteer
direct staff support; 3) Review and approve the final output
of the Working Task Force groups; 4) Make whatever recommendations or certifications the entire Task Force may arrive at.
Working Task Force
Several Working Task Force groups will be established.
Each one would be organized around areas which corresponded
to the principal topical divisions of the final Task Force
-E8-
106
report.
Each group will consist of junior representatives
of labor unions,
industry management and the federal govern-
The task force members should be able to devote full
ment.
time during two to three concentrated work periods to the
effort.
Each Task Force work session will be organized in
advance and participants prepared to arrive at a final
written output.
Each work session will be given a running
start in the form of working papers on specific topics
prepared by outside consultants or assembled from the available literature.
Working Task Force members should come to
sessions prepared to dispute specific points of view,
to
present empirical information, or to assert specific positions.
The Task Forces will be divided into subgroups of two
or three members each which will be assigned a topic for
detailed exploration.
Each subgroup will have an appointed
secretary who will be responsible for drafting a rough
position on the assigned topic.
These rough working papers
will be ayproved and refined at full meeting of the Task
Force.
Outside consultants can be called in to extend argu-
ments and to develop empirical evidence for positions taken
by the working task force.
Outside Consultants
When appropriate, outside consultants will be called
upon to do research, to prepare papers, and to lend
facilitating assistance when helpful.
-E9-
107
EXHIBIT F
PRODUCTIVITY ANALYSIS AND STRATEGY SYSTEM (PASS)
The American Productivity Center is planning to create
a "Productivity Analysis and Strategy System," hereafter
referred to as PASS.
PASS will collect productivity data from individual
establishments,
analyze productivity levels and trends, make
diagnostic analyses, indicate possible areas for corrective
attention,
and also allow managers to explore strategic
options themselves.
The output of PASS will be useful to various groups:
(1)
Managers in companies
(2)
Industry associations
(3)
Researchers in universities,
research organi-
zations
(4)
Staff of the American Productivity Center
Proper steps will be taken to preserve confidentiality
of data for individual firms, to control access to the data,
and to observe all anti-trust regulations.
Such a collection of productivity data, together with an
analytic and strategic capability,
does not now exist.
The
closest analog is PIMS, but this system does not collect
certain data necessary for productivity analysis, nor does
the system have some of the same goals as PASS.
108
PASS OPERATING PLAN
I.
OBJECTIVES
1.
2.
Assemble a data base reflecting productivity
strategy experiences of a group of participating
companies.
Conduct a research program on that data base to
discover variables that govern (a) productivity
levels (b) other outcomes of strategic productivity actions, and (c) outcomes of changes in the
3.
business environment on productivity.
Conduct an applications program to make the findings
4.
of the research available to participating companies
on a form that they can use.
Carry out other activities--publication, education,
service to participants, study of productivity
methods, impact of governmental regulations.
II.
CONFIDENTIALITY
Information entrusted to the Center by the Members is
held under strict confidence and a program of data
security prevents the possibility of leakage among
members, companies or to outsiders.
III.
MEMBERS
Any business organization can be a Member, provided
it subscribes to the objectives of the Center and the
conditions of Membership:
Contribute data to the data base
Respect data security measures
* Restrict PASS findings, reports, to internal
company use
* Designate a representative (and an alternate) to
act in a liaison capacity to the Center
Pay a pro-rata share of the cost of operating PASS
-F2-
109
PASS OPERATING PLAN (cont.)
IV.
STAFF
The staff will consist of people with diversified
backgrounds:
business experience,
business planning,
economic research,
industrial engineering, computer
utilization, and productivity expertise.
This staff will be supplemented by selected researchers
located at different institutions, and occasionally by
service firms on contract from the Center.
V.
DISSEMINATION
The resources, findings, and reports of PASS are
available only to the companies contributing data.
However, there will from time to time be selected
publications directed at the well-being of the economy
at large in areas where the Center can make a useful
contribution.
VI.
DATA BASE
The unit of observation in PASS is an establishment.
An establishment can be a division, product line, or
The establishment should
occasionally an entire firm.
sell a distinct set of products or services to an
identifiable group of customers, in competition with
a defined set of competitors, and where a meaningful
separation can be made of revenues, operating'costs,
investments, and output.
Eventually, the data base will grow to where there are
characteristics of market environments, the state of the
competition, the strategy pursued, and the operating
results obtained for each establishment.
Standardized forms will be used to collect the data.
The forms are designed to break the required data into
simple elements that can readily be assembled from
-F3-
47-106 0 - 79 - 8
110
PASS OPERATING PLAN (cont.)
financial or physical data records, or that can be
estimated if there are not specific identifiable
records.
Time and effort required to complete a set of forms
will depend on the state of the business records in a
firm.
Companies with good systems will typically
require two to three man days to complete the forms;
others will require about four days.
VII.
RESEARCH AND DEVELOPMENT
The research portion of PASS consists of a continuing
analysis of experience reflected in the data base, to
discover the empirical relationships that determine
what strategy, under what conditions, produces what
results.
These factors are incorporated in a set of productivity predicting and profitability predicting models
that assign to each factor its proper weight, judging
from experience in the data base.
The models also
indicate how the impact of each productivity determining
factor is conditioned by other inputs.
The models are designed to aid the assessment of
strategic moves.
An assumed change in one or several
productivity influencing factors can be analyzed to
determine the productivity and profitability consequences both during the time that the change is being
executed, and after it has been completed.
VIII.
FEEDBACK TO MEMBERS
Members receive three kinds of feedback from the
Center:
1. Reports on the general principles of productivity
strategy disclosed by analysis of the data base
-F4-
-
t
ill
PASS OPERATING PLAN (cont.)
2.
Specific reports on each establishment the company
has contributed to the data base
3.
Access to computer models in which the general
strategic principles are incorporated in a manner
useful for strategy planning and simulation, plus
instruction and counsel in the interpretation and
use of these resources.
IX.
MAJOR REPORTS
1. Productivity Reports
Productivity reports specify the productivity index
that is "normal" for the establishment given the
characteristics of the market,
tion,
competition, posi-
technology, and cost structure.
It reports whether this establishment is the kind
that normally achieves 4% productivity, judging
by the experiences of other establishments with
similar characteristics.
It also identifies the
major strengths and weaknesses of the establishment
that account for the high or low index.
2.
Strategy Sensitivity Report
This report is a computational pretest of several
possible productivity strategy moves in the
establishment.
It indicates the normal short and
long term consequences of each move, judging by
the experiences of other establishments making a
similar move,
from a similar starting point, in a
similar establishment environment.
It will specify
the productivity impact likely to be achieved by
along with the associated
projected changes,
investment and cash flow.
This report is used by upper level managers and
-F5-
112
PASS OPERATING PLAN (cont.)
planners, for evidence of potential effects of
broad moves in cost-effectiveness,
and pricing recovery.
productivity,
It is used by middle
level managers for evidence of the potential effects
of specific action in such areas as programs to
improve relative product quality, changes in capitallabor ratios,
improvements in capacity utilization,
investments in R & D, etc.
3.
Optimum Strategy Report
This report suggests a combination of several
strategic moves that promises to give optimal
It presents an
results for the establishment.
opinion for any of several different measures,
such as productivity indexes, cost-effectiveness
indexes, pricing recovery indexes,
cash flow,
X.
return on assets,
etc.
USES OF PASS REPORTS
1.
To provide a common language for the discussion
of productivity strategies.
2.
To generate questions that should be asked about
an establishment.
3.
To nominate promising future establishment strategies
4.
for detailed exploration.
To estimate the future consequences of specific
strategies.
5.
To suggest details of strategy execution that
usually succeed.
6.
To screen specific establishments for possible
7.
To estimate the overall productivity and profitability levels that constitute normally expected
acquisition, disposition, or reorganization.
performance for an establishment with a particular
profile.
-F6-
113
PASS OPERATING PLAN (cont.)
8.
9.
To identify the strengths of an establishment on
which future stragegy can build, or the weaknesses
that future strategy should aim to correct.
To propose several optimal input combinations,
given certain external factors.
XI.
CONFIDENTIALITY
1.
All dollar values are rescaled by the establishment
contributing it.
They multiply the information
by an arbitrary disguise factor known only to
that establishment, prior to entry into the data
base.
2.
The business is not identified as to the nature of
the products or market represented.
The sole
identification of an establishment is also coded.
3.
The identity of the parent is also coded.
Access to the data base is limited to researchers
working on approved projects, and to the extent
4.
that they have a need to know.
Representatives
of Members have access to the "sanitized" version
of the data base, from which any possible means of
indirectly identifying companies and businesses
have been removed.
They may not retrieve data on
individual establishments, other than their own,
even in the concealed form.
5.
Members may recall their data, in part or in total,
at any time on a 30 day notice.
6.
All information contributed to the Center is the
responsibility of the Chairman-of the Center.
The
Chairman establishes an operating procedure for the
secure handling of the data, and delegates selected
control with direct accountability to him.
-F7-
114
EXHIBIT G
PRODUCTIVITY RESEARCH NEEDS
I.
II.
III.
IV.
I.
MEASUREMENT
SOURCES/OBSTACLES
TO GROWTH
ADJUSTMENTS TO CHANGE
PRODUCTIVITY,
GROWTH, AND CYCLES
MEASUREMENT
1.
Industry Data
Better measures and more experimentation are needed
for many industries in the private sector:
ample,
construction, railroads,
steel,
for 'exfootwear,
coal,
health.
2.
Quality and Mix Change in Output
Quality and mix changes should be taken more fully
into account in measures for manufacturing and
services,
3.
e.g. health.
Measures of Capital and Other Inputs
There is need for further research on conceptual
issues:
capital stock,
output of services,
relation
between capital consumption depreciation and obsolescence; the use of proxy measures such as energy.
Entrepreneurship deserves attention for its role in
shifting from one production function to another.
4.
Company Measurement
Data collection by individual companies would provide
not only information valuable to these firms,
but also
insights into the dynamics of change, e.g. the influ-
115
ence of capacity utilization, the length of runs, and
technical and managerial innovations.
5.
Total Factor Productivity
Measurement techniques need to be created that will
examine output in relationship to all input factors-labor, capital, energy, and materials.
6.
Inter-Firm and Inter-Industry Comparison
Data should be collected by products, by firms and by
industries so that productivity comparisons can be
made inside industries and between industries to
study sectoral shifts.
7.
International Comparsions
International comparisons of productivity for individual industries should be computed, on a comprehensive
or multifactor basis,
as well as on a man-hour input
basis.
8.
Productivity in the Household
With the concept of the family as producers of utilities
becoming more widely accepted, research should be
addressed to the concept of the stock of educational
capital and the role of education in efficiency in
consumption.
II.
SOURCES OF PRODUCTIVITY GROWTH
1.
Innovative Process
Plant and company studies of innovation and R & D are
needed to understand mechanisms for translating R & D
activity into marketable products.
-G2-
116
2.
Effect of Incentive Systems
The long term effects of wage and salary incentive
systems need to be studied to determine their effectiveness.
3.
Motivation and Productivity
More study is needed to measure the relation between
productivity, job satisfaction, motivation and hours
of work.
4.
Productivity Programs in Foreign Countries
There is need to study the efforts made by government
and industry in foreign countries to improve productivity.
5.
Effects of Investment
Studies should be undertaken in different industries
about how new technology is incorporated in new
investment.
6.
Management Strategies
Data and models are needed so that the effects of
various management strategies can be tested and varied.
7.
Rate of Technological Innovation
Relationships among productivity, character and rate
of technological innovation, and age of industry need
to be examined to test whether the rate of innovation
suffers a retardation as the industry exploits the
technological breakthrough that gave rise to it.
-G3-
117
8.
Tax System
Information is needed about the implications for
productivity of changes in tax incentives such as
investment tax credits for physical capital, training
and research, accelerated depreciation, and capital
gains.
9.
Quality of Working Life
Research needs to be done to understand what quality
of working life means and what programs are successful.
Also, research is needed to study the relationship
between quality of working life and productivity
improvement.
10." Government Regulations
Studies of the impact on productivity caused by
government regulations are needed in all areas of
influence.
III.
ADJUSTMENTS TO CHANGE
1.
Displacement
Longitudinal as well as cross sectional studies are
needed of the forces which determine who gets displaced,
how displacements take place, and the events that
determine reemployment of displaced workers.
2.
Management Processes
The decision-making process in managing adjustment to
change needs research on such items as the criteria
used in the assessment of manpower and community impacts
of change, and an evaluation of the effectiveness of
various adjustment mechanisms.
-G4-
118
3.
Early Retirement
Studies are needed on the results of experiences of
workers who take early retirement,
including patterns
of labor market behavior and income heeds, subsequent
employment
4.
and productivity.
Cost of Adjustment
There should be studies of the social costs of technological change to estimate the amount
to industry,
5.
government,
chargeable
and society.
Collective Bargaining
Concrete examples are needed of adjustments to technological change under collective bargaining,
in both
the blue and white collar field.
6.
Training and Retraining
Information is needed on:
numbers and variety of
private training programs,
types of curricula offered,
who conducts them,
the characteristics of effective
programs compared to ineffective programs.
PRODUCTIVITY,
IV.
1.
ECONOMIC GROWTH, AND CYCLES
Cyclical Changes
Studies should extend existing work on the pattern
and causes of cyclical fluctuations in output,
input,
productivity, and rate of capacity utilization,
including the reasons why costs rise faster than
prices, the influence of international competition,
and differences among plants and industries.
I
LJ_-
119
2.
Counter Cyclical Policies
Research
is needed on policies that would induce or
promote countercyclical behavior of productivity and
costs,
especially in slowdowns that develop during
expansions.
3.
Regulated Industries
More needs to be known about differences in productivity growth between regulated and non-regulated
industries
and how regulation influences efforts to
improve productivity.
-G6-
120
EXHIBIT H
CAUSES OF THE PRODUCTIVITY CRISIS
There is little question that the USA productivity
growth rate has slowed and that it is a fundamental--not
just a cyclical--change.
Between 1948 and 1965,
productivity growth in
the private nonfarm sector averaged 2.6% per year.
In 1965
to 1973, it averaged 2.0%, and from 1977 to 1978 it averaged
0.6%.
These figures,
together with other evidence, indi-
cate that the slowdown in productivity is not just a temporary aberration and provides accumulating evidence that the
underlying trend is probably considerably less than 2.0% per
year.
In fact,
the 1979 Economic Report of the President
states the CEA's forecast
for a productivity growth of only
1.5% annually over the next five years:
1979-1983.
That, combined with labor force trends, is projected
to lead to only a 3% annual real growth over the same five
year period.
This is not a happy economic forecast for the
health of this nation in any of its dimensions--inflation,
unemployment, balance of payments, foreign competitiveness,
social dividends,
gloomy forecast.
and standard of living.
It is indeed a
121
Why?
Why has this occurred?
A frightening answer is that no one is really sure
why.
Of course,
there are suspicions, and some evidence.
Everyone has his pet theories.
But the leading researchers
largely confess that while they have some estimates of
various contributions to the slowdown, most are still puzzled.
That fact,
in and of itself, should be enough to
spur an enlarged productivity effort.
It is too important a
variable and influence on policy to be left in such a state
of relative ignorance.
The list of candidates for causes of the slowdown
are:
(in no particular order)
'
'
'
'
'
'
'
'
'
'
'
'
'
'
Lagging capital investment.
Lagging R&D and technological change
Negative influence of government regulations
Required environmental investments
Age-sex change mix in the workforce
An increasing shift from agriculture to other
sectors
Drags from major low productivity areas--construction, mining, and other
Higher energy prices
Worker alienation
Decreased management and labor attention to productivity
A series of accidental shocks to the economy
Stop-go economic policies that create uncertainty
about the future
Inflation
Wage-price controls and standards
Work rule restrictions
The truth is that it is probably not any one item
on the list, but a combination of several.
There are also
items on the list that interact with one another.
For example,
governmental regulations slow innovative R&D, thereby slowing
-H2-
122
technological change,
thereby slowing capital investments,
etc.
Among my own candidates for leading causes are:
' Government regulations
Lagging capital and R&D investments
* Labor & management inattention
* Inflation and stop-go economic and incomes
policies
Capital Investment
Has capital investment slowed?
How much of the
slowdown is attributable to lagging capital investment
relative to labor?
What policies would be most effective
in stimulating capital formation and investment?
First, there is little doubt that capital investment
is important to productivity improvement.
Most productivity
analysts agree that a significant portion of the nation's
productivity growth stems directly from technological improvement; and such improvements, in turn, are necessarily based
on capital invested for industry.
Only by devoting a signifi-
cant share of current production to replace, modernize, and
expand capital can we hope to maintain productivity growth.
Though the emphasis is typically on physical capital,
intan-
gible capital formation and investment in people (human
capital) are increasingly important in our inevitable shift
to an information-knowledge oriented society.
It is unfortunately a fact of life that the rate
of capital formation and investment for our industrial plants
has dropped off significantly during the past four years.
During the decade or so prior to the 1974-75 recession,
fixed
real nonresidential capital investment had averaged a little
-H3-
128
,,
,
more than 10.3% of real GNP.
During the past four years, however,
ment has averaged an anemic 9.8% of real GNP.
fixed investThis differ-
ence may not sound very large at first glance, but look at
the facts:
If the past 10.3% average investment had continued
through 1978, an additional $32.6 billion would have been
expended on productivity-improving new and more efficient
plants and equipment,
together with expanded plant capacity
where feasible.
It seems clear that the rate of capital investment
has declined in the past few years, that the productivity of
capital has also declined, and that the real rates of return
to capital have declined.
Reasons for reduced capital produc-
tivity are numerous--government mandated capital investments
in nonproductive areas, less productive technology available,
poor management, an aging capital stock, higher energy costs.
The same is true for Britain,
where the problem is not so
much the amount of capital available, as it is the productive
use of the capital.
Another indication of the capital problem is the
decline in the capital/labor ratio.
The change in this ratio can occur for many reasons,
and its exact impact on productivity is not certain.
This
ratio grew at an average annual rate of nearly 3% between
1948 and 1973, and since then,
the growth of this ratio has
declined more than one percentage pqint.
It is probably not
accidental that this period also coincides with the productivity slowdown.
-H4-
124
What policies should be changed to stimulate the
productivity of capital?
The most common suggestions are expansion of the
investment tax credit to include construction of new plants,
accelerated depreciation allowances for tax purposes, more
flexibility and slowed timetables for investments in environmental, health, and safety standards, and fewer restrictive
government regulations.
It is likely that all of these would have some
favorable impact, but perhaps the greatest long term assistance would be reduction in the overall corporate tax rate,
reduction in inflation, and stability in economic policies.
Capital investments are long term commitments--bets on the
future--and corporations will hedge their bets, regardless
of the added stimulus, until they are certain about the
economic environment of the future.
R&D and Technological Innovation
Another related contributor to the slowdown is
lagging R&D expenditures.
It is not R&D per se that results in improved productivity, but its results:
technological
innovation.
The
majority of technological innovation results from basic and
applied R&D, and it is the changed level and kind of R&D in
recent years that is of concern to our future productivity.
Indications of our technological slowing are:
The overall USA patent balance with other major
nations has declined almost 47% from 1966 to 1975.
The number of USA patents granted to foreign
residents has more than doubled in the last
-H5-
125
15 years, with the two countries most active
being West Germany and Japan.
* US technological innovations that can be termed
"breakthroughs" declined from 36% in 1953-59
to 16% in 1967-73.
* While the USA percentage of GNP devoted to R&D
has been declining, the same percentages in
Japan and West Germany have been increasing.
Furthermore, while the percent of USA research
funds devoted to national defense has been about
51%, Japan has devoted 2%, and West Germany 11%.
The same questions asked about capital are relevant
for R&D:
What
is happening to R&D expenditures?
of the slowdown in attributable to R&D change?
would be most effective to stimulate R&D?
How much
What policies
For what sectors?
And as with capital, the evidence is not firm as to
the exact relationship between R&D and productivity growth,
but most research indicates a relationship.
John Kendrick, one of the nation's leading productivity researchers, believes strongly that this has been one
of the major contributors to the slowdown, contributing as
much as one-fourth of the retardation, embodied in both the
human and nonhuman factors of production.
A 1977 Commerce Department report stated that
technological innovation was responsible for 45% of the
nation's economic growth from 1929 to 1969.
Other researchers
have shown that companies in high technological growth areas
have consistently shown greater productivity gains, had more
price reductions, and given more people jobs.
The ratio of R&D to output reached 3.0% in 1964-its peak--but has since dropped to 2.2% in 1978.
-H6-
47-106 0 - 79 - 9
Much of
126
the research is in military and space-related research, some
of which is transferable to the private sector productivity
improvement, but much is not.
Private industry has provided about 1% of GNP for
R&D for a long period of time.
Though the amount of private
R&D has not dropped dramatically, the kind of R&D has changed.
Many firms report that they have been forced by
government regulations to shift part of their R&D efforts
to compliance with government regulations and away from productivity improving basic research.
This will be difficult
to turn around rapidly, for firms have had to hire a different
set of researchers.
Another cause is that some managers report that
they have shifted their R&D (and capital investments) to
lower-risk,
shorter term projects to reduce uncertainties
due to government regulations, inflation, and stop-go
economic forecasts.
All of this adds up pretty clearly that our rate
of technological innovation is slowing and particularly so
relative to our principal competitors.
As with capital, there are recommendations for
direct help to R&D through extending coverage of the 10%
investment tax credit to include R&D, increased basic research,
special R&D subsidies to industries with productivity problems
and foreign competitive inroads,
and stepped-up government
sponsored R&D in the private sector.
These would undoubtedly have some effects, but
the greatest help could come from across the board measures--H7-
127
general corporate tax cut, reduction of double taxation of
dividends, reduction of inflation, stability in the economy,
and amelioration of governmental regulations negatively
impacting productivity-improving R&D.
Technological innova-
tion may just as well be served not by "more" R&D, but the
right kind of R&D,
together with improved diffusion and tech-
nology transfer.
Government Regulation
At the top of many people's agenda for the cause
of productivity slowdown is the amount, kind., and scope of
government regulations.
How much has it slowed productivity?
regulations are most detrimental?
What specific
What can be done?
People are quick to indicate where government has
harmed their productivity,
but it should be remembered that
government also aids productivity through providing a framework for orderly processes of business, maintenance of law
and order, and maintaining an infrastructure such as roads,
rivers, bridges,
etc.
If anyone thinks that this contribu-
tion is negligible, let him assess the impact on productivity
of the turmoil in Iran.
That aside, the evidence is strong that government
regulations have slowed down our productivity growth.
Probably the most publicized and authoritative
study is that of Denison, who attributed an annual slowdown
of 0.4% in our productivity growth from 1973 to 1976 because
of governmentally mandated environmental,
regulations.
health, and safety
As he and others have also pointed out,
-ii8-
this is
128
only the cost side, and ignores the benefits that accrue
to society through improved air, water,
health, and safety.
In analyzing regulatory impact,
a division should
be made between economic and social regulation.
regulation,
Economic
such as in energy or railroads inhibits efficiency
of allocation by restricting resources from flowing to those
uses that have a high demand value.
There is little question
that these economic regulations negatively impact productivity.
Social regulations, such as OSHA and EPA,
are more
complicated, although they too reduce productivity.
They inhibit productivity growth because of added
costs of compliance in the form of management
time, added
accountants and lawyers, delay in decision making and
implementation of projects,
added uncertainty in capital
commitments, and direct specification of how the standards
are to be met, rather than specifying performance levels and
leaving it to the private sector to find the most productive
means.
We truly do not know whether the costs of social
regulation outweigh the benefits, but it is likely to be
true,
especially because of the hurried timetables of recent
years, the ways that the regulations were written, and the
absolute neglect of any productivity impact analysis.
More than 72% of the firms responding to a 1977
GAO survey in the private sector said that altering government regulations and restrictions would be a desirable and
effective way to contribute to productivity improvement.
What should be done?
-H9-
129
One important recommendation is that all new and
existing regulations should be required by legislation to
have a productivity impact analysis.
Regulation is an area
fully controlled by government and can only be changed by
government.
A federal productivity focal point should promote
the identification, development, and adoption of broad
acceptable regulatory reform proposals and productivity
test criteria, with participation from the regulators
themselves, public interest groups, the regulated, and
others.
The idea of a regulatory budget, as proposed by
some, could also be a part of this process and should be
studied for implementation.
As for which regulations impact productivity the
most, detailed studies are not available.
The Business
Roundtable has been conducting a study for about a year
to calculate the costs of regulation to a selected sample
of firms.
That study should be helpful.
Their respon-
dents indicated that the agencies that added the most
costs were OSHA, EPA, EEOC, IRS, and in some firms, DOE.
However, more work is urgently needed to study
productivity impacts at the individual firm level, at the
industry level,
and across the economy.
Such micro studies
should have been made earlier but with our productivity
problem reaching alarming proportions,
these studies are
now urgently overdue.
One special sub-sector that should be singled out
-HlO-
130
for early and special relief from excessive regulation
are the small and medium sized businessmen, who do not
have the staffs, funds,
of regulations.
nor time to comply with the myriad
Not only does excessive regulation hurt
these individual firms, their over-regulation stifles
small firm innovation, and aborts potential start-ups
that would help the nation.
One small businessman, George Lockwood in California, reported that "meeting the demands of 42 different
federal, state, regional, county, and municipal government
agencies has taken at least half my time."
away from his job,
That's time
he says, as "chief scientist, chief
engineeer, chief financial officer, and general manager."
1
His story is repeated all over the nation.
Management and Labor
Another area leading to the productivity slowdown
is a lack of relative attention by labor and management
to productivity in recent years.
It is not that managers or employees are of poorer
caliber.
But for various reasons,
they have not paid much
attention to productivity in recent years.
Too many of
the business leaders have largely ignored productivity in
favor of more attention to money management, acquisitions,
government regulation, market share, tax compliance, and
manipulation.
Labor leaders have been more concerned with
added fringes, protection against inflation and division
1.
Houston Post, January 28, 1979, p. 2A
-Hll-
131
of the pie.
Neither management nor labor is "wrong."
/
Nor is this a broad scale indictment of all management and labor, for there are clearly many who have active
productivity programs and work very hard to improve their
record, particularly in the manufacturing sector.
How-
ever, this is not the case for many firms in the nation,
particularly in the service and government sectors where
many of the organizations have simply neglected productivity for a variety of reasons--social, political,
and
economic.
They simply have not kept their eye on one of the
most important variables of all--improved productivity.
The same is true of government in its fiscal and monetary
policies:
more concerned with demand management and
redistributing the pie,
instead of supply, management,
incentives, and productivity improvement.
Though this brief review of probable causes is not
complete,
it constitutes a list of the most likely contri-
butors in recent years.
More r search is needed in both
the private and public sector
to understand the causes
more clearly and to create p ograms that turn the productivity crisis into opportunity.
-H12-
132
Senator BENTSEN. Mr. Grayson, that sounds like pretty sage
advice and you have certainly hit a responsive chord with me
because you know of my concern about productivity.
I started hearings 4 years ago on capital formation and we have
been able to get some modest interest and make some modest
headway.
This subject is one which will take a while to get in the consciousness of all of the people who should be rightly concerned
about it.
Mr. Carlson, we are glad you were able to get your tractor
through the rest of the crowd. We are glad to have you here, please
proceed.
STATEMENT OF JACK CARLSON, VICE PRESIDENT AND CHIEF
ECONOMIST OF THE CHAMBER OF COMMERCE OF THE
UNITED STATES, ACCOMPANIED BY HARRY McKITTRICK,
DEPUTY DIRECTOR, PRODUCTIVITY CENTER
Mr. CARLSON. Thank you, Mr. Chairman.
I was not threatened with being plowed under but the taxicab
driver was threatened and we wound up coming on the subway.
I will insert my prepared statement for the record.
Senator BENTSEN. That is fine.
Mr. CARLSON. There is no doubt productivity has slowed, not just
in a particular industry, although some have gone down much
faster than others and we are much worse off than other countries
around the world.
I think it is important as Jackson Grayson referred to the fact it
is important to fight inflation but it is important for the well-being
of the people of this country overcoming this upward spiral.
The lower average productivity in the last decade has resulted in
the average American household receiving $3,700 less in personal
income. If the rate continues to go as people are forecasting like
ourselves-Senator BENTSEN. Let me have those numbers.
Mr. CARLSON. The $3,700 is referred to in table 4 of my prepared
statement.
The fact that productivity is 1.5 percent during the last 10 years
versus 3.3 percent means the average household in this country is
having available to consume $3,700 worth of goods and services.
That is a personal income measure.
If we make no changes in the figure, the forecasts that most
people have for productivity growth is what we have had in the
last 10 years unless there is a marked change, and we will lose
$4,800 per household during the next 10 years if we do nothing.
That is in addition to what we have already lost. So, it really comes
home to roost in every one of our lives.
Clearly, one can see the inflationary impact and we try to show
it in some of our agencies as others have. The causes of slower
growth have been documented by scholars in the field, such as
John Kendrick and Edward Denison.
We have a table which shows the slowdown as they have identified it. The Council of Economic Advisers has come forth with a
section on productivity and they, too, identify similar causes.
133
We have conducted a survey of business leaders, and in my
prepared statement I have a summary of it. We asked them for the
reasons for the slowdown of industry. They identify the same reasons as identified by scholars and the Council of Economic Advisers.
I would take note that Federal regulations were No. 1 on their
list in a given factor as well as take note of another one and that is
they identify business attitudes and worker attitudes as rather
important.
Inasmuch as attitudes are important because improvements in
terms of outcomes can come from management, worker or any
other; and because it is an attudinal factor, it has an opportunity
for leadership because leadership can set up a climate one can be
concerned about productivity and, therefore, national leadership is
important from the Congress, the President, those of us who have
responsibilities in particular sectors.
Everyone else agrees with the slow growth in capital formation.
We are slow compared to other countries and slow in relationship
to needs other than productivity, increasing factors such as our
social objectives.
On the capital side, we have had an increase of effective tax rate
during the last 10 years from around 41 percent up to about 55
percent last year, our latest estimate. The reason for the effective
increase has been the role of inflation upon the valuation of inventory and valuation of capital costs and recovery at last in relationship to replacement costs.
It is interesting to note Congress took a step forward of $4 billion
tax relief for corporate investment but that was total and more
than offset by the fact that replacement costs in relationship to
depreciation allowances increased by more than $4 billion and,
consequently, at the time the deliberations were going on in Congress, the tax code, because of inflation, wiped out all of the benefits.
It is interesting to note the legislation passed in the last Congress has been the most productivity inhibiting legislation in any
congressional or Presidential leadership I know of.
What seems good on other criteria, increases in taxes and farm
price support, clear act amendments, et cetera, more than offset
the tax relief that was provided with the tax relief legislation that
helped to increase productivity and consequently reduce productivity and investment and employment during the last 3 years so
business as usual is leaning toward more limitation through policy
on the growth of productivity.
We also take note of growth in regulatory agencies has been at
the rate of 28 percent this year in terms of their funding and the
President proposes 14.42 percent. Those are the two highest priority areas by amount of money that the President is proposingmuch higher than defense.
In talking to the administration-I am sure Mr. McIntyre can
comment on this-there is no aggregate amount of how much has
been proposed in terms of outlays in appropriations or authorizations, I should say, for regulatory authorities.
Yet, this is identified by everybody as one of the reasons for
slowing down productivity growth.
134
The Federal Government's response to slow productivity growth
has been recognized in the President's Economic Report, even
though this is a good economic report, at least the Council report is
a good one, shows considerable scholarship and education.
The President displays benign neglect in his report by following
the reasons for the weakening of productivity are complex and not
fully understood.
He does not recognize the need for leadership in this area. The
President disbanded the National Productivity and Quality of
Working Life Center, the only place in Government where declining productivity growth was comprehensively considered.
The token creation of an anemic Federal Council on Productivity, consisting solely of Federal employees with other full-time jobs,
hardly responds to the need for leadership and commitment, and I
understand they have met only once to consider this rather critical
problem which has lost $3,700 per average family in the past 10
years.
In terms of recommendations, if we are to overcome our largely
self-inflicted decline in productivity growth, we must treat the
causes of the decline.
HIGH EMPLOYMENT
AND NEAR CAPACITY UTILIZATION OF ENERGY
Clearly, maintaining high employment and economic growth
without accelerating inflation-demand pull-through appropriate
fiscal and monetary policies is necessary. Economies of scale are
rather important in increasing productivity growth.
The Federal Government, with business and labor, and consumer
leaders, must provide leadership to improve the general climate for
productivity growth. Improvements in risk taking innovation, removal of barriers to efficiency, are all necessary functions of public
and private officials. Such an approach can produce more goods
and services for the benefit of everyone. It is an all-win situation.
This is not a trade-off at least over the longer run.
Enactment of tax relief as percentage for business investment
was suggested by the Council of Economic Advisers in their report.
We have given an example: Lowering the useful life of equipment
from 11 to 9 years and increasing the investment tax credit by 2
percentage points beginning in mid-1980 need not affect the Federal deficit significantly in fiscal year 1980 but could by the end of
1982 increase productivity by 1.5 percent and by 3 percent by
1985-or 0.5 percent higher annual productivity growth rate.
We have a table showing our analysis on that.
Also, tax relief should be provided to spur private sector investment in new developments and applied research. Risk-taking and
innovation is now discouraged by high taxation. The Federal Government has taken steps to reverse the decline in basic research;
now encouragement must be provided to bring the bright idea to a
usable technique embodied in new physical technology, such as
new and more efficient equipment.
The huge growth of regulations as an important tool of Government policy-the others being spending, taxing, and credit-is accompanied by very little political accountability or responsibility.
I
135
The Congress enacts a bill giving the objectives of public policy
and turning over the responsibilities for establishing particular
policies or regulations to narrow administrative bureaus of the
executive branch, with organization heads that remain in the position for about 2 years.
Sometimes the law will be quite specific and rigid about goals or
timing; often the agency will have wide discretion. These bureaus
have promulgated and are promulgating the largest mass of costly
and productivity-limiting public policy in the history of the United
States.
This is being done in most cases without any explicit acceptance
of these regulatory policies by an elected official of the Federal
Government. I am talking about my own experience, Mr. Chairman, in government and not only people running these areas now.
Typically, a bureau chief promulgates these regulations without
clearance from the President or from the Congress. The decisions
add up to huge resource reallocations, but there is no system for
making the decisions in light of the expected effects. This is government without proper representation or accountability.
The problem is so bad that the President does not even know the
total sum of additional funds he gives in the form of budgets to
regulatory agencies. He readily identifies in his budget message the
total for spending, the total for taxing, and even the subtotal for
tax expenditure but he has no idea as to the total for regulations.
It is, therefore, not surprising to find out that the growth of
regulatory authorities has proceeded at a much faster pace than
the growth of Federal taxes and spending. Even the less rapid pace
of Federal taxing and spending is bringing forth a taxpayers revolt
as illustrated by proposition 13 in California.
For-example, the President proposes to increase the regulatory
budgets by 44 percent between 1978 and 1980, either indicating his
highest priority or greatest ignorance. As identified by scholars
such as Professor Murray Weidenbaum, the increase in regulatory
capability and resources is magnified twentyfold in terms of additional costs imposed upon industry and State and local governments. Moreover, this high increase in agency capability and in
costs ultimately borne by the American consumers and workers is
done with the least amount of representative government or accountability.
I would like to draw a parallel, and a contrast, between the
decision process on Federal regulatory activities and that on Federal credit activities.
The following points have been advanced by the administration
in support of its proposal for control by the President and Congress
of Federal credit activities; while these same points are applicable
to regulatory activities, no similar control proposal is being offered:
(a) They are a large and growing means of meeting objectives of
Federal programs;
(b) There is no established mechanism for regularly and closely
reviewing total Federal activity;
(c) Hence, there is no way to consider the resource allocation
implied by those plans; and
136
(d) For the Government to foster efficiency in the allocation of
economic resources-in the economy as a whole, it must exercise
better and more systematic control.
- The same arguments can be made even more forcefully for looking at the regulatory side as a whole.
At a minimum, the President should be required to submit to the
Congress each year, total outlays and appropriations he proposes
for regulations and regulatory authorities.
Second: He should be required to include, to the extent available,
the costs and benefits associated with such expenditures recognizing that such estimates will be subject to considerable improvement as more and more are attempted.
Third: The legislative branch should also be held accountable
and responsible by enacting a provision that Congress can veto
proposed new regulation.
Fourth: Sunset provisions should be established for all Federal
regulations, and legislative reauthorization of programs should
only occur after a legislative benefit and cost analysis has been
performed on the major regulations.
Fifth: The President and the Congress should establish capability
for evaluating the impact of proposed regulations subject to congressional veto and subject to Presidential review.
The beginnings of the capability exist in the Council on Wage
and Price Stability and the staff of the Council of Economic Advisers and perhaps in the Congressional Budget Office.
Sixth: Any evaluation of regulations should include a review of
ways to achieve the agreed social objectives at the least cost. Productivity inhibiting engineering requirements or specifications of a
particular piece of equipment or technology should be replaced
with performance requirements allowing for new technology, equipment, techniques, and innovations.
Seventh: We would find it unacceptable for the President (as
some now argue and as is argued in some current litigation) to be
in a position where officials whom he selects and who serve at his
pleasure, may be able to exercise regulatory powers and not be
subject to the President's policy control. Presidential policy control
is an essential element to achieving political accountability and
representative government.
Eighth: The Congress should begin by slowing down the doubledigit growth of Federal regulatory agencies now.
The capability for evaluating impacts of regulations should be
strengthened and be in a separate Executive Office entity during
the initial 5-year period. After the 5-year experience, the need for a
change in the organization or structure should be considered.
In the Congress, the beginnings of some capability resides in the
Congressional Budget Office and perhaps in some legislative committees. In time the skill mix of the staff should reflect a capability
to measure the benefits and costs of proposed regulations.
While public policy must remove the barriers to the growth of
productivity, American business can and will do more to improve
productivity. In order to carry out this commitment the National
Chamber established a Productivity Center last October with the
following objectives:
Evaluate trends and policies influencing productivity growth;
137
Identify public policies that reduce productivity growth and recommend changes to public officials;
Encourage business leaders to review how they can increase
productivity in their own companies and in cooperation with workers and consumers.
We plan to achieve these objectives in full cooperation with State
and local Chambers of Commerce, trade associations, and productivity centers across the country, including the very best of the
productivity centers that Jackson Grayson heads up.
Thank you very much.
Senator BENTSEN. Thank you very much.
[The prepared statement of Mr. Carlson follows:]
PREPARED STATEMENT OF JACK CARLSON
Stimulation of Lagging Productivity Growth
I am Jack Carlson, Vice President and Chief Economist of the Chamber of
Commerce of the United States. I am accompanied by Harry McKittrick, Deputy
Director of the National Chamber's newly created Productivity Center. On behalf of
the National Chamber's 80,000 members, we greatly appreciate the opportunity to
present our views on the serious problem of slower growth of productivity, to
recommend some policies to improve productivity growth, and commit American
business to continue working to accelerate the growth of productivity in the future.
SLOWER PRODUCTvIT
GROWTH
There is no doubt that productivity growth within the United States has slowed
(Table 1).
TABLE 1.-LABOR PRODUCTIVITY GROWTH, 1948-78
[Percent
change
peryear]
Sector
1948to 1955 1955to 1965 1965to 1973 1973to 1977 1977to 1978P
Private business economy ........................
Nonfarm.................................................
Manufacturing ........................
Nonmanufacturing..........................
3.4
2.7
3.3
2.4
3.1
2.6
2.9
2.4
2.3
2.0
2.4
1.7
1.0
.9
1.5
.6
0.4
.6
2.5
-. 3
XPreliminary.
Note.-Data relate
tooutput
perhourpaidfor,forallpersono.
of Economic
Advisers,
p. 68.
as found
in the 1979Annual
Report
of theCouncil
Department
of Labor,
Bureau
of Labor
Statistics,
Source:
The slower productivity growth has occurred in every sector of the U.S. economy
(Table 2).
TABLE 2.-PRODUCTIVITY GROWTH BY INDUSTRY, 1950-77
[Percent
change
peryear]
Industry
Agriculture.............................................................................
Mining....................................................................................
Construction ..........................................................................
Manufacturing: .
Nondurable....................................................................
Durable........................................................................
Transportation........................................................................
Communication.......................................................................
Utilities..................................................................................
1977output
share
to 1965 1965to1973 1973to1977
(percent)] 1950
2.9
1.5
4.3
4.9
4.3
3.4
3.6
1.9
-2.1
3.0
-6.1
.3
9.9
14.4
3.9
3.2
2.3
3.2
2.5
3.0
5.3
6.1
3.3
2.2
2.9
4.6
3.5
2.2
1.2
1.0
6.7
.2
138
TABLE 2.-PRODUCTIVITY GROWTH BY INDUSTRY, 1950-77-Continued
[Percentchangeper yearJ
1977output
share
(percent)
Industry
1950to 1965
1965to 1973 1973to 1977
Trade:.....................................................................................
3.4
-. 8
2.6
7.3
Wholesale......................................................................
2.1
.8
2.3
10.0
Retail............................................................................
2.3
.2
15.4
1.6
Finance, insurance, and real estate ................................
-. 3
1.7
1.2
12.0
Services.................................................................................
.1
.4 12.5 .5
..........................................................................
Government..
All industries:................................................................
1.1
2.7
2.0
100.0
Current weights...................................................
1.1
1.9
2.6
................
.
Fixed weight (1977 output weights) ..................
because
ofrounding.
Detailmaynot addto 100percent
for all persons.
Note.-Growth datarelateto outputperhourworked
of the
as foundin the 1979AnnualReport
of Economic
Advisers,
Analysis)andCouncil
(Bureau
of Economic
Source:Department
of Commerce
Advisers,
p. 71.
Council
of Economic
The decline in productivity growth is most obvious in the United States compared
to other Western industrialized countries, particularly in the manufacturing sector
(Table 3).
TABLE 3.-PRODUCTIVITY IN MANUFACTURING, 1960-76
[Average
annualpercentchange]
1966-76
v00000
Country
1960-76
1960-66
1966-76
196066
2.2
-45
4.0
2.9
United States .................................
-16
3.3
3.7
3.1
United Kingdom .................................
3.5
-19
4.3
3.8
Canada...................................................................................
+76
4.3
2.9
5.1
Switzerland............................................................................
+5
5.5 5.7 5.8
..................................................................................
France..
5.2
-20
5.7
6.5
Sweden..................................................................................
5.3
- 21
6.7
5.8
Italy .................................
-3
6.0
5.8
5.9
Germany.................................................................................
+32
7.4
5.6
6.7
Netherlands '..........................................................................
8.1
+62
6.8
5.0
Belgium 1...............................................................................
+48
5.4
8.0
7.0
Denmark................................................................................
8.9
+1
8.9
8.8
Japan .................................
*1960-75.
estimates,
Note.-Data for 1976arepreliminary
January
1979
Research,
Officeof Economic
YorkStockExchangeo
as foundin the Neon
of Labor,
Bureau
of LaborStatistics,
Source:
U.S.Department
publication.
The lower average productivity of the last 10 years compared with the average of
the previous 20 years has resulted in a great loss of human physical welfare, higher
poverty and less opportunity. The average American household now receives $3,700
less income (Personal Income) for better housing, food and clothing, savings for the
future and tax payments for government services as a consequence of the decline in
productivity. If the trend is not reversed, the average American household will lose
$4,800 more income in 1988 (Table 4).
139
TABLE
4.-Loss of household income from slower growth during last 10 years
and forecast for next 10 years
Average productivity growth 1948-68 (percent) .............................................
Average productivity growth 1968-78 and forecast for 1978-88 (percent).
3.3
1.5
Loss in productivity growth....................................................................
1.8
Resulting loss of household income in 1978 ....................................................
$3,700
Additional loss if slow growth continues to 1988 ...........................................
$4,800
Higher labor costs are closely tied with higher business costs and with consumer
prices. This has been true during the recovery from the 1975 recession (Table 5).
TABLE 5.-CHANGES IN WAGES,
PRODUCTIVITY, AND UNIT LABOR COSTS
IN NONFARM BUSINESS AND
CONSUMER PRICES,
1975-78
[Annualpercentchanges]
Inflation
Compensation
Output
per
Unit
perhour
hourworked
labor
worked (productivity) costs
1975 ........................
1976 .................
1977 ......................
1978 .......................
9.9
8.4
8.1
9.4
1.9
3.5
1.3
0.6
Nonfarm
Consumer business
Price
Index implicit
price
inflation
deflator
7.8
4.7
6.7
8.8
9.1
5.8
6.5
7.7
.
10.6
5.4
5.9
7.0
Col.I minus
col.2 equals
col.3.
Source:
U.SDepartment
ofLabor,
Bureau
ofLabor
Statistics.
Also, slow growth in productivity undoubtedly led to higher wage demands, labor
costs and inflation than workers may have expected from official estimates (Table
6).
TABLE 6.-Situation during 1978
Percent
Administration estimate of consumer price inflation (January 1978) .......
Growth in real income based on historical experience (1948-68)................
5.9
Compensation increase................................................................................
Actual productivity growth (private, business sector) ...................................
Labor costs inflation (unit labor costs).............................................................
Increase in consumer prices...............................................................................
9.2
0.4
8.7
7.8
3.3
CAUSES OF THE SLOWER GROWTH
The causes of the slower productivity growth have been analyzed by several
scholars, including Professors John W. Kendrick and Edward F. Denison (Table 7).
140
TABLE 7
Sources of Productivity Growth 1948-1977
(U.S. Domestic Business Economy)
1948-1966 1966-1973 1973-1977p
ib)
(c)
(a)
(Percentage Point Contribution
to Growth Rate)
Technological Progress
1.4%
0.6
+ Changes in Labor Quality
+ Changes in Quality
0.0
of Land
+ Capital and Labor
Mobility
0.8
+ Changes in Output
0.4
Growth
+ Net Government Impact
0.0
+ Other N.E.C.
-0.5
1.1%
0.4
0.8%
0.7
-0.1
-0.2
0.7
0.3
0.2
-0.1
-0.6
-0.3
-0.3
-0.4
Average Annual Rate of Growth
= Total Factor Productivity
2.7%
1.6%
0.7%
Change Between Periods
1966-1973
1973-1977
vs
vs
1948-1966
1948-1966
(a)-tb)
(a) - (c)
(Percentage Point Contribution
to Change in Growth Rate)
-0.3%
-0.2
-0.5%
+0.1
-0.1
-0.2
-0.1
-0.5
-0.2
-0.1
-0.7
-0.3
-0.1
+0.1
Change in
Average Annual Rate of Growth
-1.1
-2.0
p = preliminary
N.E.C. = Not Elsewhere Classified.
Source:
Professor John W. Kendrick, George Washington University,
as found in The New York Stock Exchange, Office of Econonic
Research, January, 1979 publication.
141
The President's Council of Economic Advisers devoted several pages in their latest
Annual Report describing the causes of the slowdown in productivity growth (pages
67-91):
Slower growth of investment
. . .analytical studies estimate that (the growth in the capital stock) could well
have reduced productivity growth by up to one-half of a percentage point per year
from earlier trends.
Increase in social regulations
Increased economic and social regulation has aggravated the productivity slowdown in a number of ways.
In addition, important indirect costs are generated by social regulation. The
implementation of new regulatory statutes is often associated with considerable
litigation and uncertainty which tends to reduce innovation and investment. Moreover, some regulations specify or suggest the technology to be used to meet new
standards, rather than prescribing a level of performance to be attained. As a
consequence, innovations that could meet the standards at lower cost are not
encouraged.
. . .the direct costs of compliance with environmental, health, and safety regulations may have reduced by (0.4) percentage point from annual growth of output
relative to inputs since 1973.
. . .from 1950 to 1965 labor productivity in mining grew 4.3 percent per year, but
since 1973 it has declined at an annual rate of 6.1 percent. In the late 1960s and
early 1970s stringent mine safety laws began to take effect. . . . regulation has
undoubtedly been very costly in terms of real output per hour worked.
In the utilities sector, growth in output per hour worked fell successively from 6.1
to 3.5 to 0.2 percent per year in 1950-65, 1965-73, and 1973-77. While a number of
influences have been at work to reduce productivity growth in this industry, the
increase in environmental regulation had an important bearing.
Increase in employment of women and teenagers
Productivity growth has also been reduced by a dramatic shift in the age-sex
composition of employment.
Research and development
Some have suggested that a decline in the intensity of research and development
in the United States may be a significant cause of the productivity slowdown.
Others
Little of the 1965-73 decline in private nonfarm labor productivity or the further
reduction in 1973-78 seems to stem from shifts in the industrial composition of
employment.
Some suggest that the oil embargo of 1973-74 and the subsequent quadrupling of
oil prices had an adverse impact on productivity growth. However, it is difficult to
find a mechanism by which an oil crisis could have such an immediate and severe
effect on the economy.
Business leaders have also identified causes for slowdown in productivity growth
(Chart 1).
47-106 o - 79 - 10
142
CHART 1
rauses
.or Slowdown
C
or,''<2
;Left
,~s,''R
0 10
...i1,',.'.
I1
Percent
20 30 40
l
1
50
60
70
l
l
lI
lde
,.i
4
.'I
~Very
Right Side
80 90 100
Important
Important
i
I
I
95 Federal Regulations
-*1
.21
>i-I.
pic;odutivi*ty Growth R t§.
w
~
r
86 General Business Climate
i2
=
-
83 Worker Attitudes
81 Welfare and Unemployment Benefits
Ia
78 State Government Regulations
74 Inadequate Investment
73 Labor Union Activity
68 Capital Gains Taxes
=
63 Inadequate R &D
a
62 Corporate Income Taxes
@ 62 Management Attitudes
I
3
59 Workers Skill Levels
59 Energy Cost
54 Local Government Regulations
54 Personal Income Taxes
Slow growth of capital
Professors Kendrick and Denison, the Council of Economic Advisers Annual
Report, and the survey of business leaders all identify the importance of new capital
formation, which embodies the latest in technological progress, cost-reducing techniques, diffusion of techniques across the country, the movement of capital to
growth areas, and lowering cost of compliance with Federal regulations.
Unfortunately, fixed capital formation as a percent of the U.S. output is lower
than in the past and lower than any major Western industrialized country (Table 8).
143
TABLE 8
Fixed Formation
Capital
Japan 33.0
as a Percentage
of Gross
Domestic Product
1961-1976
Australia 25.5
\
West Germany 24.3
.99
'C.~~
,-
~~~~~~~~~~~~~~~~~~~~~~~~
_e
-.
4 -:
'kCahadla-222,
.~ ^
~~e;'Ita~~~~l'l<
- •$ffi4¾
2m.0.' United Kingdom 18.6
United States 17.8
Source:
Cover of National Chamber's Report:
"Public Policy and Capital Formation."
144
This is understandable when it is realized the effective corporate tax rate on the
real income of U.S. corporations has been increasing during the last 10 years (Table
9).
INCOME l OFNONFINANCIAL CORPORATIONS, 1967-78
ONTHE REAL
TABLE 9.-EFFECTIVE TAXRATE
taxrate
Effective
onrealcorporate
(percent)
income
Year:
ineffective
Increase
taxratedueto
and
profits
in Consumer inventory
Chanre
of
understatement
Index
Price
depreciation
overyear)
(year
2.9
4.2
5.4
5.9
4.3
3.3
1967 .........................
1968 ........................
1969 ........................
1970 ........................
1971 ........................
1972 ........................
41.2
46.6
50.2
52.8
50.9
46.5
1973 ........................
52.1
6.2
1974 ........................
1975 ........................
1976 ........................
1977 ........................
1978 .54.9
71.8
52.1
52.7
51.8
11.0
9.1
5.8
6.5
7.8
- 1.2
- 0.1
1.4
3.3
3.6
2.4
9.4
30.3
12.3
11.6
10.7
12.8
valuation
inventory
ofCommerce's
withtheU.S.Department
corporations
of non-financial
istheprofits
corporations
of non-financial
income
l Real
tax
profits
stateandlocalcorporate
is theratioof thefederal,
income
taxrateonrealcorporate
Theeffective
adjustments.
consumption
andcapital
(times100).
totheirrealincome
corporations
ofnon-financial
liability
to
of liability
the ratio
minus
adjustments
consumption
andcapital
valuation
withinventory
to profits
taxliability
profits
Theratioofcorporate
profits
(times100).
unadjusted
-Estimates.
Center
andPerspective
Trends
States,
oftheUnited
ofCommerce
andChamber
Analysis
ofEconomic
Bureau
ofCommerce,
U.S.Department
Source
The small $4 billion tax relief for encouraging corporate investment has been
more than fully offset by inflation-induced understatement of capital consumption
allowances in comparison with replacement costs during the time the tax bill was
debated and enacted.
In fact, all major economic legislation enacted in the last Congress caused less
investment for subsequent years. This was true for increases in minimum wage,
social security taxes, farm price supports, and clean air amendments. These increases more than offset tax relief to stimulate investment. They also caused loss of
employment (Table 10).
145
TABLE 10
UNITED STATES
ACTUAL AND POTENTIAL rIPACT ON INVEST~fTNT AND EMPLOYMENT
OF THE CARTER ADMINISTRATION S PROPOSALS AND
CONGRESSIONAL ENACTMENT OF 1977 AND 1978 LEGISLATION (1)
at
-8 I a Inv
I
I
3
1
I
3l
…
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..--------..
c r~ousc Sties
Sq77us
Illipup
ot
(
(3
b)
oflal
Socorito
…
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Tares
|3I.'
) PoreS 2c t~
35) Gejnea) Ply 33973)
Atr ).od sandeil>
36clean
>3 .,
nelbl
oi fk
(93 latlosal Poersy Pollc<i3>
310) Fedoral Po, (1933 )
(11) total C
Cross Ispact 040
05
(12) Total fet Inac
Fs
__-------_____________I
-I
slo)>) or L oss)-)
3
00
3
3
3
3
3
1
-1837-----9
81
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3
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-61
l
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206
303
303
3001
3 -605 -3.230 -I3.63 -3.83) -1.926 1
2-56
-34
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-64
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_1
-50
-6
-3
-323
7
1
_1
0
0
-24
31H
-12
-162
-75
0
5s
-3
-367
60
6
-2
-196
-123
-i
-2
-190
-292
3
1
09 3
6 3
-2 3
302
6
-2
-203
-130
3 3
-300
-305
-503
-1.104
-309
-110
-3 30
-l1D
-330
-320
-1
-209
-60
-229
-233
-309
-323I
0
32
23
-75
2 G0
3
3 305
-01
-91
0
-5 1 1 -300
-3 3 3-302
-320
-199
3
3
3
0
0
3 -251 -1,484
3 3________
-363 -920
___9
42
50
1
3
406
60
-353
-2,305 -2.673 -3.938
3,490 -1.602 -2.988
_149
02
-Z. 8
(I
I
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-33
-2
-3
0
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-21
-20
(303 PotentIal Cross Ispacto
(19)3 otentlal Vet Ispooti71
I-39
I -20
-206
-95
1
I
I
(Io Change in Ieoels of eco.oelo
"Iln
y.
<2> Based on loot tat Iserpre-attoo prior no
plans oubitno-d by scot-local gooersssnce
'3d lnclodos oatural3 as dsregolacton.
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-5
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(10) Cossoon Itus
(35) Cango Preference
(36) Alslokands
clbrsol
(333 Crude Oil Tao
Chambser of Coseros
I
20
-55
LECGILST100"rOPOSED
OR
S PPOPTOED
90M NOT
0n
Trosoak
__
0
____~~~~~~~~~~~~~~~~~~~~~
SOURCEfU0.
I
_
34
-4
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(*--130-15
(9
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(9 39
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at
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.
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-56
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-202
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-62
-3 3
-58
3 13 -200
-68 1 1 -81
-345
-220
:4>
050
6o
07>
oorcast and Sorey (enter.
models of Dots Resources.
-536
-
3.I
3
3
3
0
0
-109
0
-202
31
-305
-5
-150
-143
-6
-620
-212
-68 -13723
-93
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-352 -3,007
0
-703
-3A
-3.402 -4.042 -7.337
-0,99 -2 618 -5 38
o-s 3) through (201
So. of
Ad]ustseon of
_o-313 for oneriuppiog poicies.
SIs of roes 3
through 3101 and 133) throngh (17).
Adjostent of ron (30) for oosrl~apping policiea-
Asspnioss aud sodelblnohy nr. Jack Ca1nsoad Ceorge
oo
and Chase Econoseclos
oasooit=e.
Similarly, all sources identify that Federal regulations have been a key reason for
declining productivity growth. Understandably, this is so because the $5 billion
spent on regulatory agencies is leveraged to cause about 20 times that figure
additional costs on private industry and state and local government, which, if
passed on to consumers of taxpayers is equivalent to an average decline of about
$1,400 for each American household. Moreover, the President has set the growth of
regulatory capability as his number one priority by increasing the regulatory
agency budgets faster than any other area (Table 11).
TABLE 11.-FISCAL YEAR
1979 BUDGET
AND FISCAL YEAR
1980 PRESIDENTIAL BUDGET PROPOSALS
Fiscalyear 1979
estimate(percent)
Regulatory agencies....................................................................................
Defense......................................................................................................
Average of areas........................................................................................
............................
6.6
9.4
Fiscalyeaf 1980
Presidential
proposal(percent)
14.2
9.2
7.7
FEDERAL GOVERNMENT RESPONSE TO SLOW PRODUCTIVITY GROWTH
The President and some members of the Congress, including the members of the
Joint Economic Committee, recognize the problem of slow productivity growth but
the government is doing very little to increase productivity. The President displays
benign neglect in his Economic Report: "The reason for the weakening of productivity growth . . . are complex and not fully understood."
Official Federal actions reflect lack of leadership. Both the President and the
Congress disbanded the National Productivity and Quality of Working Life Center,
the only place in government where declining productivity growth was comprehensively considered. The token creation of an anemic Federal Council on Productivity,
146
consisting solely of Federal employees with other full time jobs, hardly responds to
the need for leadership and commitment. Based upon the importance of changing
attitudes of workers, managers, and public officials, leadership is a very important
missing ingredient.
RECOMMENDATIONS FOR PRODUCTIVITY GROWTH
If we are to overcome our largely self-inflicted decline in productivity growth, we
must treat the causes of the decline.
High employment and near capacity utilization of energy
Clearly, maintaining high employment and economic growth without accelerating
inflation (demand pull) through appropriate fiscal and monetary policies is necessary.
Change in attitude
The Federal government, with business and labor and consumer leaders, must
provide leadership to improve the general climate for productivity growth. Improvements in risk taking innovation, removal of barriers to efficiency, are all necessary
functions of public and private officials. Such an approach can produce more goods
and services for the benefit of everyone.
Tax relief to increaseproductivity-enhancing investment
"Enact tax relief designed to strengthen incentives for business investment," is
wisely suggested in the Council of Economic Advisers Annual Report. For example,
lowering the useful life of equipment from 11 to 9 years and increasing the investment tax credit by 2 percentage points beginning in mid-1980 need not affect the
Federal deficit significantly in fiscal year 1980 but could by the end of 1982 increase
productivity by 1.5 percent and by 3 percent by 1985 (or 0.5 percent higher annual
productivity growth rate) (Table 12).
ALLOWANCES AND INVESTMENT TAX
TABLE 12.-ECONOMIC IMPACT OFLIBERALIZED DEPRECIATION
CREDIT
[Mid-1980to 19851
1985
1982
Increase in productivity (percent):
Level.................................................................................................
Rate .0.5
Increase in net capital stock:
Dollars (billion)................................................................................
Percent..............................................................................................
Increase in employment..............................................................................
Increase in household disposable income (1979 dollars) ...........................
Change in Federal receipts:
Dollars (billion)................................................................................
Percent..............................................................................................
1.5
3.0
0.5
$14.8
1.8
182,000
$126
$35.1
3.3
150,000
$254
$7.2
1.1
$10.5
1.2
States.
of the United
of Commerce
SourceChamber
Tax relief to increase research and development
Also, tax relief should be provided to spur private sector investment in new
developments and applied research. Risk-taking and innovation is now discouraged
by high taxation. The Federal government has taken steps to reverse the decline in
basic research; now encouragement must be provided to bring the bright idea to a
usable technique embodied in new physical technology, such as new and more
efficient equipment.
Regulatory policy to enhance productivity
The huge growth of regulations as an important tool of government policy-the
others being spending, taxing and credit-is accompanied by very little political
accountability or responsibility. The Congress enacts a bill giving the objectives of
public policy and turning over the responsibilities for establishing particular policies
or regulations to narrow administrative bureaus of the Executive Branch, with
organization heads that remain on the position for about 2 years. Sometimes the
law will be quite specific and rigid about goals or timing; often the agency will have
147
wide discretion. These bureaus have promulgated and are promulgating the largest
mass of costly and productivity-limiting public policy in the history of the United
States. This is being done in most cases without any explicit acceptance of these
regulatory policies by an elected official of the Federal government. Typically, a
bureau chief promulates these regulations without clearance from the President or
from the Congress. The decisions add up to huge resource reallocations, but there is
no system for making the decisions in light of the expected effects. This is government without proper representation or accountability.
The problem is so bad that the President does not even know the total sum of
additional funds he gives in the form of budgets to regulatory agencies. He readily
identifies in his budget message the total for spending, the total for taxing, and even
the subtotal for tax expenditure but he has no idea as to the total for regulations. It
is, therefore, not surprising to find out that the growth of regulatory authorities has
proceeded at a much faster pace than the growth of Federal taxes and spending.
Even the less rapid pace of Federal taxing and spending is bringing forth a taxpayers revolt as illustrated by Proposition 13 in California.
For example, the President proposes to increase the regulatory budgets by 44
percent between 1978 and 1980, either indicating his highest priority or greatest
ignorance. As identified by scholars such as Professor Murray Weidenbaum, the
increase in regulatory capability and resources is magnified 20-fold in terms of
additional costs imposed upon industry and state and local governments. Moreover,
this high increase in agency capability and in costs ultimately borne by the American consumers and workers is done with the least amount of representative government or accountability.
I would like to draw a parallel, and a contrast, between the decision process on
Federal regulatory activities and that on Federal credit activities. The following
points have been advanced by the Administration in support of its proposal for
control by the President and Congress of Federal credit activities; while these same
points are applicable to regulatory activities, no similar control proposal is being
offered:
(a) They are a large and growing means of meeting objectives of Federal programs,
(b) There is no established mechanism for regularly and closely reviewing total
Federal activity,
(c) Hence, there is no way to consider the resource allocation implied by those
plans,
(d) For the government to foster efficiency in the allocation of economic resources
. , in the economy as a whole, it must exercise better and more systematic
control.
At a minimum, the President should be required to submit to the Congress each
year, total outlays and appropriations he proposes for regulations and regulatory
authorities.
Second, he should be required to include, to the extent available, the costs and
benefits associated with such expenditures recognizing that such estimates will be
subject to considerable improvement as more and more are attempted.
Third, the legislative branch should also be held accountable and responsible by
enacting a provision that Congress can veto proposed new regulation.
Fourth, sunset provisions should be established for all Federal regulations, and
legislative reauthorization of programs should only occur after a legislative benefit
and cost analysis has been performed on the major regulations.
Fifth, the President and the Congress should establish capability for evaluating
the impact of proposed regulations subject to Congressional veto and subject to
Presidential review. The beginnings of the capability exist in the Council on Wage
and Price Stability and the staff of the Council of Economic Advisers and perhaps in
the Congressional Budget Office.
Sixth, any evaluation of regulations should include a review of ways to achieve
the agreed social objectives at the least cost. Productivity inhibiting engineering
requirements or specifications of a particular piece of equipment or technology
should be replaced with performance requirements allowing for new technology,
equipment, techniques, and innovations.
Seventh, we would find it unacceptable for the President (as some now argue and
as is argued in some current litigation) to be in a position where officials whom he
selects and who serve at his pleasure, may be able to exercise regulatory powers and
not be subject to the President's policy control. Presidential policy control is an
essential element to achieving political accountability and representative government.
148
Eighth, the Congress should begin by slowing down the double-digit growth of
Federal regulatory agencies now.
The capability for evaluating impacts of regulations should be strengthened and
be in a separate Executive Office entity during the initial 5-year period. After the 5year experience the need for a change in the organization or structure should be
considered.
In the Congress the beginnings of some capability resides in the Congressional
Budget Office and perhaps in some legislative committees. In time the skill mix of
the staff should reflect a capability to measure the benefits and costs of proposed
regulations.
THE NATIONAL CHAMBER AND PRODUCTIVITY
While public policy must remove the barriers to the growth of productivity,
American business can and will do more to improve productivity. In order to carry
out this commitment the National Chamber established a Productivity Center last
October with the following objectives:
Evaluate trends and policies influencing productivity growth;
Identify public policies that reduce productivity growth and recommend changes
to public officials;
Encourage business leaders to review how they can increase productivity in their
own companies and in cooperation with workers and consumers.
We plan to achieve these objectives in full cooperation with state and local
Chambers of Commerce, trade associations, and productivity centers across the
country.
Senator BENTSEN. In the last session of the Congress I introduced
six regulatory bills and was able to get three of them passed, and I
have three along this line on cost effectiveness and the other on a
regulatory budget.
That is tough to get a handle on but I think that is one we have
to work out. We put a limitation on how much these agencies can
spend each year, but I think it is time we put a limitation on how
much they can make people spend each year, so we know and
understand the economic impact that is being passed on to all of
the consumers of this country.
Mr. CARLSON. I think that is the way to go and clearly moving in
the direction of operation rather than ignorance being clearly the
way to go.
Senator BENTSEN. In view of the comments you have made in
your prepared statement, I would like you to take a look at the
bills I and Congressman Brown have introduced and see if you
fellows don't want to add your support to them.
Mr. CARLSON. We would be pleased to do that. In principle, the
direction in which you are going is one we can all applaud. We will
look at the specific provisions and and provide a letter back to you.
Senator BENTSEN. We want more than rhetoric. We want reality.
It is going to require a lot of support from all segments.
I made a point earlier-either of you might comment on it-is it
possible to reduce inflation to 7.4 percent as the President has
stated if productivity increases by only 0.4 percent and unit labor
costs go up by 8.1 percent?
Are those contradictory?
Mr. GRAYSON. I will give my own answer.
Unit labor costs, generally speaking, track very well with price
increases unless profit margins are going to suffer around the
country.
I think there is no way to hold inflation down to the level
forecast unless productivity is better than what is now forecasted.
149
Senator BENTSEN. We have a contradiction there in the President's forecast.
Mr. GRAYSON. Yes; there is.
Furthermore, let me add when the wage and price standards
program was calculated, assumptions were made wages would rise
about 71/2 percent because of the 7 percent standard, plus one-half
percent due to other added costs-social security, et cetera.
Prices were set one-half percent below the base period to yield
53/4 percent price increases. A little arithmetic will show that the
assumption built into the wage and price standards is that productivity will rise this year 13/4 percent. That is built into the mechanism. It is not spelled out. That is implied by those two figures.
One and three-fourths rise, therefore, is the implicit productivity
forecast and yet, last year, we were only able to eke out four-tenths
of 1 percent across the country.
Mr. CARLSON. I would agree with that analysis. Our forecasts
show a late forecast. The administration assumes in its guidelines
and I would say it is impossible to achieve the objectives even
though American business is trying to do its part and where it has
discretion in keeping down the growth of prices.
Senator BENTSEN. According to the Economic Report of the President, by the end of 1983, output per hour will be only 71/2 percent
higher than at the end of 1978. That compares with a 17 percent
gain over 5 years which would be obtained at the 3.2 percent
annual rate of productivity growth achieved in the two decades
after World War II.
This means that some of the hopes and dreams of our people are
not going to be fulfilled. It means that a lot of the poor who
thought they were going to be able to break out of poverty are not
going to be able to break out.
Doesn't that lead to social strife-some serious economic implications for our political system?
Mr. CARLSON. I would certainly agree with you it does dash
expectations if they were based on historical growth and output per
man-hour. Just the time period you are talking about, if in fact we
were going at the historical level that we had for a 20-year period,
1948-68, 1½/2 percentability into these numbers are somewhat less
than that.
The average household by 1983 would be receiving over $2,000
worth of additional income at the higher productivity level. With
$2,000, you can do an awful lot on an average increase in terms of
individual households, in terms of overcoming poverty, in terms of
upward mobility, in terms of any group effort such as environmental quality or whatever else we may desire.
Clearly, it cuts down our options by growing less.
Mr. GRAYSON. I would like to supplement that, Mr. Chairman.
I made some calculations looking simply at what would have
happened if we had maintained our productivity growth rate of 3.2
percent from 1947 to 1967. Though I don't have it on a per household figure, real GNP would be about $265 billion higher in the
year 1978.
That is a fantastic figure. These are real dollars that could go for
social dividends for improving the health and welfare of the
Nation, for helping the poor, for higher wages and for fighting
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inflation. It is not just rhetoric. It is a real figure that gets right
down to the household.
Some people say that productivity improvement can only be a
half of a percent or 1 percent. And since we are dealing with
inflation of 9 and 10 percent, we would be reducing inflation by
only 1 percent if we improve productivity by 1 percent.
That would be true in the first round but as you accumulate that
increase over a period of time, you will bring down inflation rapidly. A calculation done by William Freund of the New York Stock
Exchange shows the arithmetic of how a slowing of productivity
growth can ratchet inflation up rapidly, and how, on the other side,
it can bring inflation down rapidly by increased productivity.
Senator BENTSEN. I think this next question is obvious, but I
want it in the record.
Is the problem of the lack of increase in productivity a problem
that primarily concerns management, or is it an issue that also
concerns labor, and are labor leaders concerned that higher productivity could lead to higher unemployment?
Mr. GRAYSON. It must concern management and labor. Labor
probably has the most at stake. Three-fourths of our national
income is in the form of compensation of employees.
Senator BENTSEN. How do you respond when they say you will
replace workers on the production line with a machine and get
greater productivity?
Mr. GRAYSON. I have heard that concern many times and the
record clearly shows that increased productivity results in more
jobs.
In 1977, a Department of Commerce study extensively showed
that the highest employment growth areas were in the industries
with the highest productivity. It is unquestioned in some cases that
where there is immediate productivity improvement there may be
some job dislocations.
One of my arguments to business and labor is that we must take
care of those employees through improved retraining, new training,
job skills, job adjustment assistance, et cetera.
In my view, labor has just as much at stake as management, and
we have on the board of directors of the American Productivity
Center several labor leaders who agree with this.
Mr. CARLSON. In the prepared statement, we have the example of
increasing productivity through increasing investment. You not
only increase the investment and output of each worker so that in
this case we have household income going up by $254 by an increase in the depreciation allowance which is more liberal and also
the investment tax credit, an increase by 150,000, the number of
jobs available in your economy.
So, clearly, except for the fictional problems we are talking
about, we could talk about adding jobs, not reducing jobs as we go
to a higher productivity level.
Senator BENTSEN. You were talking about a disaggregated approach, to try to get a better definition of where the lack of
productivity is taking place so we can attack it better.
Studies we have seen say the slowdown of overall productivity
can be accounted for by the collapse of productivity in certain
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specific sectors-construction, mining, utilities, and wholesale and
retail trade.
According to staff calculations, in the decade 1967 to 1977, productivity in construction and mining declined by nearly 2 percent.
Productivity in utilities grew by only 2 percent, while productivity
in wholesale and retail trade grew by less than 2 percent.
Do you have any explanation for those figures, and what would
be the policy implications?
Mr. CARLSON. Inasmuch as I had responsibility years ago in the
Government for the coal industry and also for the health and
safety of miners in that industry, I have to admit that the Government regulations were the primary cause for the decline in the
productivity in the mining industry.
Senator BENTSEN. We had to do some things there, didn't we?
Mr. CARLSON. Clearly, the health and safety regulations were not
adequate but also clearly we have some bad regulations even in
that important area that we should clean out and overhaul which
we are not doing.
In the utility industry, we have had heavy regulations and that
is the primary cause for slower growth coming to this industry
which has been noted for high productivity in the past.
So, government regulations, some of it good and some of it bad
has had an impact upon productivity growth in those two areas.
Senator BENTSEN. Do these regulations retard the building of
new utility plants?
Mr. CARLSON. Also the delays. We are aware of the nuclear
delays but there are delays on other new plants and there are new
regulations. Some add not one bit to the health and safety of the
workers or the communities in which they reside. They turn out to
be unnecessary delays and costly delays that lower productivity.
Senator BENTSEN. Last week Chairman Miller of the Federal
Reserve Board testified. He stated that accelerated depreciation
allowances are the best policy for stimulating investment.
How would you rank accelerated depreciation, the investment
tax credit, depreciation allowances based on replacement costs, and
cuts in corporate tax rates as measures to modernize the productivity capacity of this country?
Mr. CARLSON. I think the order you read them is a responsible
order. Whether the depreciation is accelerated or close to replacement cost, accelerated gives it a little more front-end loading along
with the tax credit as having the most stimulative and immediate
effect.
Mr. GRAYSON. We need the short-run stimulus in some cases, but
I think overall, we have to take a long-run view, for it is a long-run
problem.
We have to look at the top and bottom. We have to dig deep if we
are going to solve these problems.
Mr. CARLSON. Mr. Chairman, the latest report we have from the
Commerce Department shows that the gap between capital cost of
recovery allowances and depreciation allowances and recovery
costs is now nearly $20 million, so some modest improvement
would close that gap where it is accelerated depreciation or reform
of the depreciation system itself would be very, very useful.
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I think some people have an understanding that some improvement needs to be made in that area, let alone wise from an economic standpoint.
Senator BENTSEN. I have had some concern about trying to use
replacement cost. You may run into a lot of very practical problems in that regard. In fact, I believe that the Secretary of the
Treasury, or one of our other witnesses, testified that, with replacement cost depreciation, people might have a tendency to hold on to
old assets.
Mr. CARLSON. The practicality is you will not be able to capitalize
your capital cost system to have enough to replace your equipment.
Consequently, some improvement in the economic life for depreciation purposes is a useful direction to go and thereby you don't
need to get into as you have identified some of the indexing problems trying to match up replacement costs with the depreciation
allowance.
Senator BENTSEN. Mr. Grayson, you have charged that the President's wage-price guidelines could seriously curtail some of the
most effective productivity improvement programs in America, because productivity gains may be counted as offsets to pay increases
only for labor under union contracts.
About one-fourth of the labor force is unionized.
Could you elaborate on that criticism? Would it be administratively unfeasible to broaden this?
Mr. GRAYSON. In fact, there was an amendment in 1971 to the
economic stabilization program which said productivity had to be
taken into consideration in setting pay standards. If we are going
to continue today's standards without allowances for productivity
improvements, we are going to destroy incentives for productivity
programs, some of which are already being hurt by these current
standards.
I submitted written comments to COWPS to this effect. If we
allow exemptions only in the union area, as it is now written, it
hurts the nonunion areas not covered by this particular exemption.
Also, it does not permit the formation of new productivity plans.
Some specific examples-there is a Houston welding firm which
can't install an improvement program because they don't have a
past record.
There is another firm, James Berry Valve Co., making certain
control valves for atomic subs. They can't exceed the standard on
the wages from their productivity program if they go over their
base period.
In other words, what we are doing by these standards is freezing
the ability and incentives for firms to improve something that is
vital to this Nation. The wage/price guideline is holding them back
at this point.
Senator BENTSEN. Do you have a comment on that, Mr. Carlson?
Mr. CARLSON. No, I agree with that. I think that is the drift as
we go down into the wage and price areas. Also, we have noted in
Great Britain, if in fact they do not take into account productivity,
they have this freeze which affects technology.
But it is difficult to administer any program, monetary or voluntary, in calculating product improvements. Consequently, the effect
of most of our experience on the wage and price guideline side has
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been to encourage productivity when we have had wage and price
guidelines or mandatory controls.
Mr. GRAYSON. Some firms have told me, they are not going to
slow down their productivity improvement program, and they are
going to violate the guidelines because they don't believe it is in
the best of interests of their country or their firm.
I hate to see that they feel they are violators of the guidelines.
Senator BENTSEN. Let's discuss a group very much in the news
this morning. Productivity in agriculture increased between 1946
and 1977 by approximately 500 percent, an extraordinary increase.
Yet, the net income for the farmer today, after inflation adjustments, is less than it was in 1946.
Now, why is that? I want you to help me answer some of the
questions I am going to have to answer later this afternoon.
Mr. CARISON. I still have to make it back downtown. Clearly, one
of the great success stories of this country has been an increase in
productivity in agriculture. Some of that is attributed to wise
public policy. The fusion of technology in the agriculture section
and some of the R. & D. stimulus that has come from some of the
grant colleges and industries in this area.
Agriculture is still a very competitive part of our economy. Most
of the R. & D. in investments and productivity occur outside the
industry by the suppliers, certainly those who provided the tractors
that the farmers are now using, as we see around the industries,
are much more efficient pieces of equipment than 5, 10, 15, 20
years ago. And that has been a major factor. Most of the R. & D.
has been done off the farm with the automobile industry providing
that input.
Because of the competitiveness, because the R. & D. is being
handled elsewhere, because there has been a desire to reduce the
excess labor that was thought to be needed on the farm and,
therefore, attracted into the city, the incomes on the farms have
not been excessive in the past, but quite frankly speaking, given
the improvements that occurred this last year, we have over a 25percent increase in the income of farmers.
There is enough to attract farmers in many areas to continue
with their business. There is a tradeoff that has to be looked at. If
you have additional farm price supports, that is cost-push inflationary and to what extent is an adequate level of income to farmers
producing the food that we need and also what is inflation, and
excessive value judgment on you and other Senators?
Senator BENTSEN. Do you want to comment on that, Mr. Grayson?
Mr. GRAYSON. I essentially agree with that. They should know
that they are not alone in this problem of real *income gains.
If you look at the after-tax real income gains for the average
worker in this country, they have not risen. I don't know the exact
number of years-but for some 11 or 12 years true earnings have
gone up. But take away the effects of inflation and taxes, and what
the worker has left to take home leaves him also in a bad lot. So
the farmer needs to compare himself with others to realize this is a
national problem and not just his problem alone.
Senator BENTSEN. We are talking about the Bureau of Labor
Statistics for measuring productivity. What do you think of the
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procedures that are used by the Bureau of Labor Statistics for
measuring productivity in the private sector?
Mr. GRAYSON. The Bureau of Labor Statistics is probably one of
the most competent organizations I have run across in the Government. They have an extremely good group.
My suggestion is that they be given a broader charter, more
funds, in order to improve what they are doing. Their budget is
now $3.1 billion, but in several areas they need to expand their
work because we need the data.
One, they need to look at total factor productivity instead of just
output in man-hours. We need to look at inputs of capital, materials, and energy. We use the output per man-hour as sort of the
surrogate for all of those and we don't see the interaction or
contribution of all of these other inputs. They ought to start
moving toward total productivity.
Two, we need to begin to look at more industries than we now
analyze. The Burea of Labor Statistics only publishes about 60 to
70 industries. We need to expand that to include the 400 industries
we have around the Nation. We need to have more data on nonproduction type employees because we are expanding the number of
employees in that category.
We need to have more studies on the service sector than we now
have data for. That is the growing sector of the economy.
There is a whole series of recommendations from the National
Research Council. They have already formed their recommendations which are now in the hands of GAO and will shortly be
coming to Congress.
I recommend adopting many of these which would strengthen
the statistics we badly need.
Mr. CARLSON. I would agree with that assessment, but I think we
should add to the qualifications and the spending of that agency.
Senator BENTSEN. Let's try to break this productivity slowdown
into three factors-give me your opinion as to how much is attributable to each.
One of them is insufficient capital formation-you just told me
the numbers on it. The second is insufficient research and development. The trend is excessive government regulation.
Mr. GRAYSON. I will give you my views. I have looked at the
figures computed by Ed Denison at Brookings and John Kendrick
at George Washington University, who, together with a number of
other researchers, have been trying to calculate the causes of slowdown for a period of time.
They all have a list of candidates and each one has his own
estimates. But I will give my views.
Tangible capital investment contributes approximately 20 percent to productivity growth. We also get improvement from R. & D.
and other forms of intangible capital improvement-education and
training-which improves the quality of labor and creates intangible human capital. Together, these contribute anywhere from 20 to
50 percent.
The range of our ignorance in this area is enormous.
There is the area of technological advance which includes the
quality of management, and the ability to mix the various input
factors. These are changes caused by utilization of capacity and by
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changes in the economy. Then there is also the measure of ignorance or the residual, which is simply what is left over and unexplained.
In that area would probably go how much government regulations have impeded productivity. It is about time we started to
calculate that. It can't be done by one swift calculation. We need to
accumulate the data by the budgetary process, by industry studies,
and by getting down to where the firms are impacted.
Until we do that, we won't know what policy changes we need in
order to change the productivity gains.
Mr. CARLSON. I would just add to that that capital formation,
where you buy a piece of equipment, not only provides more equipment with a given technology per worker, but it can also include
improved technology. So, it is a more efficient piece of equipment
than the one before.
Also, by having more capital formation, the mobility of capital is
an area not growing so fast, so depreciation capital moving into
somewhere else is also tied up with the capital formation.
So, I would say on the capital side, the largest amount that can
improve your productivity from- increased R.- & D. is part of that
R. & D. has to be embodied in terms of human beings and better
techniques they have to work with as part of their brainpower or
mechanical capability or embodied in physical capital, new equipment.
So, your R. & D., to be effective, sometimes has to come back in
the form of human capital.
On the regulation side, I was interested to note the Council of
Economic Advisers recognizes 4.4 percentage reduction in the productivity rate has been due to regulations.
That does not include the changes in the use of the public lands
which has been identified by other scholars as a reason for productivity going down and Government regulations have affected that.
Also, Government regulations have affected the pace at which
technological advances can occur by how much investment can
occur, people holding back because they feel they may not be in
compliance with the regulation. So, at least you have. Four percentage point drops in about 11/2 percentage points, drop in productivity of roughly one-fourth that they identify, and other categories
would be higher.
In overcoming that, I would like to stress the capital front is doable as well as the attitudinal. If people are more conscious of the
need to increase output per man-hour or manage public officials,
that can help considerably too, because the attitude has been in the
opposite direction in the last decade.
Mr. GRAYSON. Mr. Denison has calculated just the direct costs in
the environmental, safety, and health areas. What we don't calculate are the added costs going on daily in terms of added staffs in
the private sector, the uncertainties, and the delays.
There is the tendency of a lot of businessmen to postpone or put
investments into low-risk activities. In the end, I suspect the
impact Denison calculated is short of what the real number is.
Senator BENTSEN. Has there been a trend in recent years for
American business to stress short-term investments and research
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activities, rather than long-term studies that can give us more
major breakthroughs in technology?
Mr. CARLSON. Yes, I dare say the trend has been in both the
public and private sector, and investing in equipment and shortlived equipment has been more pronounced and in major plant
expenditures or expansion. And in the public sector, we moved
away during the last 5 to 10 years, away from basic research and
more in applied and most of it in development even in the areas of
the public sector.
There is good reason for that. It is a riskier environment out
there and the return for taking that risk is lower than now.
Mr. GRAYSON. A lot of the R. & D. is being put on the defensive
measures to be sure firms are complying with the regulations.
Senator BENTSEN. What do you fellows think about the National
Productivity Council's role in improving productivity?
Mr. GRAYSON. I made a few statements in my opening remarks
that I don't think the current National Productivity Council will
get the job done.
Senator BENTSEN. Is the Council doing anything?
Mr. GRAYSON. They had one meeting on December 11, and I
understand no further meetings are scheduled at this point. I am
sure they will meet again, sometime. But at that meeting, concern
was expressed about the problems and the discussion ranged over
several topics. But again, no action, no comprehensive program, no
funding, no staff-all of the key variables that I view as being
important to making something happen.
OMB is certainly an excellent agency. No question about it. One
of my recommendations is that the focal point for the administration be in OMB, as a program responsibility.
I know this would be new. OMB does not normally have program
responsibility, but there is no reason why they couldn't have as
their responsibility a reconstituted National Productivity Council.
You can take what is on paper and give it the authority, the funds
and the staff and have it become the focal point for the administration.
As now structured, I do not think that will get the job done.
Senator BENTSEN. Mr. Carlson.
Mr. CARLSON. I share the same conclusion and also the same
support for the current Director of OMB.
I also think, in addition to what Jackson Grayson just said, we
need to have a tie-in to the private sector through advisory committee arrangement or some other tie-in with management. And
labor and perhaps some other groups, including State and local
governments, if in fact we are going to provide comprehensive
leadership for this effort to improve productivity growth and I
think we should.
The fact is it is a great disappointment not to take the shell that
existed before with the Productivity and Quality of Life Center
that existed to go ahead and use that to make it productive, and
getting on with the leadership role.
Mr. GRAYSON. As chairman of the American Productivity Center,
I would be most happy to work with them. I am meeting with Mr.
Granquist later on today to offer my support in whatever areas
157
they want to work. I think we need both public and private sector
cooperation.
Senator BENTSEN. We were talking about R. & D. and Government support through tax incentives to industry, yet some public
interest groups strongly oppose this, saying that R. & D. has to be
directed; otherwise, industry will come up with spending to develop
synthetic potato chips or something else.
How do you answer that one?
Mr. CARLSON. Most of the research activity in this country is a
derived demand from objectives that consumers want to pursue,
and many of those objectives have been because a particular price
of transportation or something else they wanted was particularly
high which created an incentive for business to find a lower, less
costly form of transportation, or whatever other objectives consumers wanted to pursue.
Once you remove basic and applied research from the wishes of
consumers away from the marketplace, in fact, you are going to
have research that will not have any application, a supply-push
approach only to basic or applied research is inadequate.
Consequently, I would argue, yes, there is room for public pur-
poses and applied R. & D. and development for that purpose, but
also there is a crying need for that larger part of the economy that
is in the private sector.
Our tax laws tend to discourage investment in private R. & D.
because the rate of return is so far-the return is so far down the
road that the taxation effect occurs very early on and the discouragement occurs early on and the tax occurs early on. And, consequently, there is not adequate investment in the research area.
Senator BENTSEN. I am on the Finance Committee. I am sympathetic to trying to find a way of encouraging R. & D. But, it is
difficult to define R. & D. to avoid serious abuse, and have some
things that you and I might not think of as R. & D., and yet might
be so charged, to try to take advantage of the tax incentive-do you
have any idea how that could be tied down?
Mr.
CARLSON.
I think the improvements made last year in the
capital gains side, when you do recognize the benefits of applied
research, developments, new technology, new product and the selling of that product and the returns coming from it are not so
heavily taxed was a move in the right direction and tends to help
that longer time process that occurs from the applied research
being made and the payoff that comes from it.
I think there can be identified other provisions in the tax bill
that could be somewhat pinpointed to encourage private sector R.
& D. We would be pleased to recommend some to you.
Senator BENTSEN. I would like to see some. I think that with
capital gains, there is such a delayed result, that I question how
much motivation results from that. I would like to see ways to
further define R. & D. so we would not have a lot of abuses in the
utilization of an incentive.
Mr. CARLSON. It has been somewhat disappointing because your
committee, in the past, and in the House and both bodies have
given the Secretary of the Treasury, in some areas, the authority
to reduce the depreciation life of certain investments that could be
categorized in the R. & D. category. And the Treasury Secretary
47-106 0 - 79 - 11
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has not used that authority, so there is already some discretion in
the tax law which is not being used. And I am sure there are some
additional provisions that could be used and we would be pleased to
make some recommendations.
Senator BENTSEN. It is difficult to distinguish between true innovation and some minor product innovation, for example, going back
to tailfins on cars.
Mr. CARLSON. You will always have the problem of something
being of value to one person and not another, where a person may
be willing to buy a product, where you and I might think it has
excessive gadgetry on it.. You will always have that difficulty in
trying to draw a fine line. It will be difficult, I agree.
Senator BENTSEN. I thank you very much.
Our next witness, Mr. McIntyre, is scheduled for 11 o'clock. He is
having a little trouble budgeting his time, apparently.
We have Mr. Van Doorn Ooms, Assistant Director for Economic
Policy, Office of Management and Budget.
Would you come forward, please.
We understand the Director is on his way, subject to traffic.
Do I understand you are prepared to present the testimony?
Mr. OoMs. Yes, Senator Bentsen. I would be pleased to give the
Director's testimony.
Senator BENTSEN. Why don't you do that in the interest of time.
Speak directly into the mike so we can all hear you. State your
name and position for the record please.
STATEMENT OF HON. JAMES T. McINTYRE, JR., DIRECTOR,
OFFICE OF MANAGEMENT AND BUDGET, ACCOMPANIED BY
VAN DOORN OOMS, ASSISTANT DIRECTOR FOR ECONOMIC
POLICY
Mr. OoMs. Mr. Chairman, my name is Van Doorn Ooms, Assist-
ant Director for Economic Policy at OMB. I would like to read the
prepared statement of the Director of OMB, which is as follows:
We welcome this opportunity to discuss the President's 1980
budget with you. I understand that my colleagues-Fred Kahn,
Mike Blumenthal, and Charlie Schultze-have testified before this
committee at other times.
I know that Secretary Blumenthal and Chairman Schultze have
discussed the administration's fiscal policy and economic objectives
with you in detail. I would like to discuss this subject briefly before
turning to other aspects of the budget.
As we began to prepare the 1980 budget last year, we faced the
harsh reality of accelerating inflation. Continued reports of good
economic news, such as gains in employment and industrial production, seemed to be offset by almost daily reports of higher rates
of inflation.
The proposals in this budget reflect the President's belief that
our most important domestic priority is to bring inflation under
control. We simply cannot be content to live with rates of inflation
as high as those we have experienced recently. No other economic
problem is so acutely felt by the American people.
Inflation is terribly corrosive of social values. It intensifies the
struggle over shares of a slowly growing economic pie. When economic standards are no longer reliable, all of us focus more atten-
159
tion, too much attention, on maintaining our economic status. The
preoccupation with economic security through higher wages and
higher prices becomes acute.
We must reduce the rate of inflation. However, the fiscal policies
of the administration attempt to avoid an abrupt-and unnecessary-swing to extreme restraint. A recession would bring, at best,
slight and temporary relief from high inflation, relief that would
come at the expense of the unemployed.
The fiscal policy in the budget, instead, applies moderate additional restraint to the economy, slowing down growth to ensure
that shortages and supply bottlenecks do not add to inflation. The
best way to prevent a recession, and its high social costs, is to avoid
the boom-and-bust cycle of fiscal policies.
In the longer term, this is the only prudent course. In combination with the wage and price standards, and with additional compliance induced by real wage insurance, this fiscal policy will
permit a gradual reduction in the rate of inflation. A recession
would not only cause great hardship, it would also retard investment activity and reduce productivity growth. A boom-and-bust
cycle now would only make fighting inflation more difficult in the
years to come.
Senator BENTSEN. Mr. McIntyre, would you like to carry on with
your presentation?
Mr. MCINTYRE. Thank you, Mr. Chairman.
I had planned to submit my prepared statement for the record
and just make some comments on the highlights of it.
Senator BENTSEN. I will take your entire prepared statement into
the record and you may proceed as you wish.
Mr. MCINTYRE. I would like to apologize to the committee. I had
a little trouble getting here this morning.
Senator BENTSEN. One of the previous witnesses said he was now
plowed under and I see you have worked your way out of it.
Mr. MCINTYRE. Mr. Chairman, inflation is a long-term problem.
It requires in my judgment long-term solutions. We must be prepared to apply restraint to the economy for an extended period so
that the rate of inflation comes down gradually. This fiscal policy
should not be rapidly reversed. The rates of inflation that we have
shown in the budget for 1979 and 1980 are far too high to be
satisfactory.
The performance of the economy in the final months of 1978 has
convinced me that we can continue moderate growth with a policy
of restraint. The economy is fundamentally strong, and it will
respond favorably to slower inflation.
The budget has been described as "lean" and "austere," and I
would like to suggest four ways to demonstrate that restraint:
First, if you look the growth in outlays, you will see that the
growth in total outlays has been significantly reduced. This budget
provides for outlays of $531.6 billion in 1980, 7.7 percent more than
in 1979. This is a somewhat slower rate of growth than the 9.4percent increase between 1978 and 1979, and significantly slower
than we have experienced over the past 5 years when outlay
growth averaged 12 percent per year.
The proposals in this budget reduce the percentage of gross
national product and income spent by the Federal Government
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from 22.6 percent in 1976 to 21.2 percent in 1980. If continued
restraint is exercised, we would expect that share to decline further in future years.
A third way to look at the degree of austerity in the budget is to
look at the measure of the relative impact of fiscal policy is provided by the high-employment budget margin. Decreases in the
high-employment deficit reflect a fiscal policy that is moving in the
direction of restraint. The 1980 budget shows reductions in the
high-employment deficit of $8 billion in 1979 and of $15 billion in
1980.
The fourth and final way I would like to suggest to this committee is that it look at the budget and compare it with the current
services budget estimate for 1980. The administration's current
services estimate, including projections of programs under existing
law and the changes that would occur as a result of changes in the
number of eligible beneficiaries without any changes in law,
amounts to $536.1 billion in 1980. As we put this budget together,
$11.6 billion in proposed program reductions below the current
services level were partially offset by $7 billion in proposed increases.
The net reduction below the current services level amounts to
$4.5 billion in 1980. This is the first budget since the current
services concept has been in general use that does not provide-I
repeat, "does not provide"-an increase over the current services
level.
Let me emphasize that our method of computing the current
service figures does not include any inflation increases for discretionary or nonindexed programs. Inclusion of an inflation adjustment for these programs would bring the total spending reduction
to about $12 billion.
By any of these measures, the President's 1980 budget provides
the restraint that is appropriate to current economic conditions.
To achieve the required fiscal restraint, while at the same time
meeting our most important national needs, the 1980 budget was
subjected to a thorough and painstaking review. This budget reflects the President's view, repeated in his state of the Union
message, that Government can be both competent and compassionate. That view was expressed in the direction that I received from
the President to protect programs that truly help the disadvantaged and to reduce or end programs that are not effective. I
believe that this budget complies with that directive.
The discipline imposed by the 1980 budget is not arbitrary. This
budget provides better discipline over Federal spending by: (1) Recommending the reduction or elimination of lower priority programs; (2) proposing improvements in existing programs to make
them more effective; (3) providing adequate resources for the
higher priority programs, such as assistance for the disadvantaged;
(4) reorganizing, consolidating, and targeting Federal activities; and
(5) reducing and eliminating wasteful practices.
Mr. Chairman, you have asked me to comment on the economic
assumptions in the budget and the relationship of the budget policy
in relation to them. The short-range assumptions represent a forecast of how the economy will respond over the next 2 years, not
161
only to budgetary policies proposed by the President for 1979 and
1980, but to the President's anti-inflation program.
The long-range assumptions for 1981 to 1984 are not forecasts.
They are projections of the economic performance that would be
required to reach the 1983 goals of 4-percent unemployment and 3percent inflation stipulated by the Humphrey-Hawkins Act, given
necessarily uncertain projections of labor force and productivity
growth.
The short term unemployment and inflation assumptions for
1979 and 1980 are consistent with the recognition that substantial
further reductions in unemployment require that we first bring
inflation under control. The likelihood of achieving the sustained
economic growth required to reduce unemployment while inflation
remains high is very small.
The economic assumptions for 1981-1984 represent very ambitious goals in that they would require simultaneously reducing
inflation and unemployment very substantially. As the HumphreyHawkins Act indicates, these goals are unlikely to be achieved
through aggregate fiscal and monetary policies alone. It will require a substantial reduction in structural unemployment. The
administration is pursuing several strategies toward that end.
In the near term, we will continue to spend large amounts on
programs that seek to reduce structural unemployment. Some
470,000 training and work experience opportunities are being
sought for the economically disadvantaged under CETA title II-A,
B, C and title III. Public service employment, with over $4.9 billion
in 1980 outlays for an average of 546,000 jobs, is being targeted
more toward the structurally unemployed. Outlays of over $2.1
billion for special employment programs for youths are requested,
including funding of a wide range of carefully devised research and
demonstration programs to help us begin to understand this especially serious aspect of the structural unemployment problem.
The administration will soon propose a welfare reform program,
to take effect by 1982, that will emphasize incentives for permanent, unsubsidized employment for welfare recipients.
Perhaps most importantly, 1979 marks the implementation of
two new efforts that signal the overall turn toward a direct attack
on the problems of the disadvantaged. These are (1) the private
sector initiative in CETA title VII that will finance a new partnership between government and private business, to enhance placement of the disadvantaged by all CETA and Employment Service
activity; and (2) the targeted jobs tax credit which provides a
special incentive for the employment of disadvantaged persons,
particularly youth between the ages of 18 and 24. Both programs,
proposed by this administration, are especially relevant to the concern expressed in the Humphrey-Hawkins Act that primary emphasis be given to the enlargement of employment opportunities in
the private sector of the economy.
As you are well aware, the Federal Government has been spending billions on structural programs since the early sixties. We are
constantly learning how to spend more wisely in this area, but we
clearly still have much more to learn before we can say with
confidence that anyone knows precisely how to substantially
reduce structural unemployment in a noninflationary way and
162
accelerate progress toward the goals established in the HumphreyHawkins Act.
Mr. Chairman and members of the committee, the President has
made proposals that will reduce the rate of inflation and dramatically improve the prospects for the development of the American
economy in the coming decade. This is part of building a new
economic foundation.
We need the consent of the Congress to begin to build this new
foundation. We will be actively working with the authorizing committees to adopt legislative proposals that both increase program
effectiveness and reduce the Government's burden on the taxpayer.
All the Members of the Congress will be called to judge the President's budget recommendations. I urge that you endorse them.
Mr. Chairman, that concludes the highlights of my prepared
statement and I would like the entire statement to be submitted
for the record.
Senator BENTSEN. That will be done.
[The prepared statement of Mr. McIntyre follows:]
PREPARED STATEMENT OF HON. JAMES T. MCINTYRE, JR.
Mr. Chairman and Members of the Committee, I welcome this opportunity to
discuss the President's 1980 budget with you. I understand that my colleaguesFred Kahn, Mike Blumenthal and Charlie Schultze-have testified before this Committee at other times.
I know that Secretary Blumenthal and Chairman Schultze have discussed the
Administration's fiscal policy and economic objectives with you in detail. I would
like to discuss this subject briefly before turning to other aspects of the budget.
As we began to prepare the 1980 budget last year, we faced the harsh reality of
accelerating inflation. Continued reports of good economic news, such as gains in
employment and industrial production, seemed to be offset by almost daily reports
of higher rates of inflation.
The proposals in this budget reflect the President's belief that our most important
domestic priority is to bring inflation under control.
We simply cannot be content to live with rates of inflation as high as those we
have experienced recently. No other economic problem is so acutely felt by the
American people.
Inflation is terribly corrosive of social values. It intensifies the struggle over
shares of a slowly growing economic pie. When economic standards are no longer
reliable, all of us focus more attention, too much attention, on maintaining our
economic status. The preoccupation with economic security through higher wages
and higher prices becomes acute.
We must reduce the rate of inflation. However, the fiscal policies of the Administration attempt to avoid an abrupt-and unnecessary-swing to extreme restraint.
A recession would bring, at best, slight and temporary relief from high inflationrelief that would come at the expense of the unemployed.
The fiscal policy in the budget, instead, applies moderate additional restraint to
the economy, slowing down growth to insure that shortages and supply bottlenecks
do not add to inflation. The best way to prevent a recession, and its high social
costs, is to avoid the boom-and-bust cycle of fiscal policies.
In the longer term, this is the only prudent course. In combination with the wage
and price standards, and with additional compliance induced by real wage insurance, this fiscal policy will permit a gradual reduction in the rate of inflation. A
recession would not only cause great hardship, it would also retard investment
activity and reduce productivity growth. A boom-and-bust cycle now would only
make fighting inflation more difficult in the years to come.
Inflation is a long-term problem. It requires long-term solutions. We must be
prepared to apply restraint to the economy for an extended period so that the rate
of inflation comes down gradually. This fiscal policy should not be rapidly reversed.
The rates of inflation that we have shown in the budget for 1979 and 1980 are far
too high to be satisfactory.
163
The performance of the economy in the final months of 1978 has convinced me
that we can continue moderate growth with a policy of restraint. The economy is
fundamentally strong, and it will respond favorably to slower inflation.
The fight against inflation will not be waged by fiscal restraint alone. The wage
and price standards are essential to the anti-inflation policy. These standards provide a basis for assessing the consistency of wage and price decisions with the
national goal of lower inflation.
The public response to the standards so far has been encouraging. However, I
believe that the Congress can improve compliance by passing the President's proposal for real wage insurance. This is an innovative proposal that is both fair and
simple. It will increase the effectiveness of the wage and price standards and is a
major part of the President's anti-inflation program.
The deceleration of inflation indicated by the standards is essential for continued
prosperity. Fiscal restraint will thus result largely in lower inflation and only
modestly in lower growth. Employment and real income will be higher if businesses
and workers abide by the standards than if they do not.
This budget is lean and austere. I suggest four ways to demonstrate that restraint:
The growth in total outlays has been significantly reduced. This budget provides
for outlays of $531.6 billion in 1980, 7.7 percent more than in 1979. This is a
somewhat slower rate of growth than the 9.4 percent increase between 1978 and
1979, and significantly slower than we have experienced over the past five years,
when outlay growth averaged 12 percent per year.
The proposals in this budget reduce the percentage of gross national product and
income spent by the Federal Government from 22.6 percent in 1976 to 21.2 percent
in 1980. If continued restraint is exercised, we would expect that share to decline
further in future years.
Another measure of the relative impact of fiscal policy is provided by the highemployment budget margin. Decreases in the high-employment deficit reflect a
fiscal policy that is moving in the direction of restraint. The 1980 budget shows
reductions in the high-employment deficit of $8 billion in 1979 and of $15 billion in
1980.
Finally, I would like to compare this budget with the current services budget
estimate for 1980. The Administration's current services estimate, including projections of programs under existing law and the changes that would occur as a result
of changes in the number of eligible beneficiaries without any changes in law,
amounts to $536.1 billion in 1980. As we put this budget together, $11.6 billion in
proposed program reductions below the current services level were partially offset
by $7.0 billion in proposed increases. The net reduction below the current services
level amounts to $4.5 billion in 1980. This is the first budget since the current
services concept has been in general use that does not provide an increase over the
current service level. Let me emphasize, that our method of computing the current
service figures does not include any inflation increases for discretionary or nonindexed programs. Inclusion of an inflation adjustment for these programs would
bring the total spending reduction to about $12 billion.
By any of these measures, the President's 1980 budget provides the restraint that
is appropriate to current economic conditions.
To achieve the required fiscal restraint, while at the same time meeting our most
important national needs, the 1980 budget was subjected to a thorough and painstaking review. This budget reflects the President's view, repeated in his State of the
Union Message, that government can be both competent and compassionate. That
view was expressed in the direction that I received from the President to protect
programs that truly help the disadvantaged and to reduce or end programs that are
not effective. I believe that this budget complies with that directive.
The discipline imposed by the 1980 budget is not arbitrary. This budget provides
better discipline over Federal spending by:
Recommending the reduction or elimination of lower priority programs;
Proposing improvements in existing programs to make them more effective;
Providing adequate resources for the higher priority programs, such as assistance
for the disadvantaged;
Reorganizing, consolidating, and targeting Federal activities; and
Reducing and eliminating wasteful practices.
The changes proposed for public employment programs provide a good example of
the priorities and choices established in the budget. As the economic recovery has
progressed, there are more jobs being created in the private sector and less need for
countercyclical employment programs to assist those who were unemployed as a
result of the 1974-1975 recession. At the same time, structural unemployment
among minorities and the disadvantaged remains too high. The program proposals
164
in this budget redirect the CETA jobs program toward those who are most in need,
the structurally unemployed.
Uncontrollable programs have not been exempt from scrutiny. For example, a
number of adjustments are being proposed to the social security program that would
result in savings of about $600 million in 1980, $1.6 billion in 1981, and $2.9 billion
in 1982. The features being proposed for change are largely special benefits that
predate such programs as supplemental security income and the basic educational
opportunities grants program. These provisions are now generally duplicative, and
they can be more carefully targeted under the newer programs. Moreover, the
changes move the social security system back in the direction of a retirement
program directly related to work experience by eliminating some special benefits
that are unrelated to past worker and employee contributions.
Similar scrutiny was given to developing the budgets for other Federal programs:
In national defense, the increases in funding are carefully directed to maintain
our security and that of our NATO allies.
Programs for the disadvantaged received special attention, as a result of which
there was a retargeting of some programs and an overall increase in the level of
funding for these programs taken together.
To provide for the Nation's energy needs, funds were carefully allocated to reduce
duplication and to provide us with a long-term reduction of our dependence on
foreign energy sources.
Basic scientific research received enhanced support to increase the Nation's productivity and to invest in our technological future.
Preparing this budget has reminded us once more of the vast demands placed on
our resources and the limited means we have to satisfy them. Having to face the
dilemma of providing for essential national needs while restraining the Government's role in the economy forced us to develop principles for resolving this dilemma. Those that the President developed are:
We have an obligation to manage with excellence and to maintain proper priorities within the budget totals that are consistent with sound economic policy.
The budget must be kept within the bounds of appropriate economic policy. In
today's world, economic policy calls for restraint.
The Government has no resources of its own; the only resources it can use are
those that it collects from the taxpayer. We have an obligation to use these resources prudently.
Government action must be limited to those areas where its intervention is more
likely to solve problems than to compound them.
Mr. Chairman, you have asked me to comment on the economic assumptions in
the budget and the relationship of the budget's economic policy to them. The shortrange economic assumptions for 1979 and 1980 represent a forecast of how the
economy will respond over the next two years, not only to the budgetary policies
proposed by the President for 1979 and 1980, but to the President's anti-inflation
program. The long-range assumptions for 1981 to 1984 are not forecasts. They are
projections of the economic performance that would be required to reach the 1983
goals of 4 percent unemployment and 3 percent inflation stipulated by the Humphrey-Hawkins Act, given necessarily uncertain projections of labor force and productivity growth.
The short-term unemployment and inflation assumptions for 1979 and 1980 are
consistent with the recognition that substantial further reductions in unemployment require that we first bring inflation under control. The likelihood of achieving
the sustained economic growth required to reduce unemployment while inflation
remains high is very small.
The economic assumptions for 1981-1984 represent very ambitious goals, in that
they would require simultaneously reducing inflation and unemployment very substantially. As the Humphrey-Hawkins Act indicates, these goals are unlikely to be
achieved through aggregate fiscal and monetary policies alone. It will require a
substantial reduction in structural unemployment. The Administration is pursuing
several strategies toward that end.
In the near term, we will continue to spend large amounts on programs that seek
to reduce structural unemployment. Some 470,000 training and work experience
opportunities are being sought for the economically disadvantaged under CETA
Title II-A,B,C and Title III. Public service employment, with over $4.9 billion in
1980 outlays for an average of 546,000 jobs, is being targeted more toward the
structurally unemployed. Outlays of over $2.1 billion for special employment programs for youths are requested, including funding of a wide range of carefully
devised research and demonstration programs to help us begin to understand this
especially serious aspect of the structural unemployment problem.
165
The Administration will soon propose a welfare reform program, to take effect by
1982, that will emphasize incentives for permanent, unsubsidized employment for
welfare recipients.
Perhaps most importantly, 1979 marks the implementation of two new efforts
that signal the overall turn towards a direct attack on the problems of the disadvantaged. These are (1) the private sector initiative in CETA Title VII that will finance
a new partnership between government and private business, to enhance placement
of the disadvantaged by all CETA and Employment Service activity; and (2) the
targeted jobs tax credit which provides a special incentive for the employment of
disadvantaged persons, particularly youth between the ages of 18 and 24. Both
programs, proposed by this Administration are especially relevant to the concern
expressed in the Humphrey-Hawkins Act that primary emphasis be given to the
enlargement of employment opportunities in the private sector of the economy.
As you are well aware, the Federal Government has been spending billions on
structural programs since the early 1960s. We are constantly learning how to spend
more wisely in this area, but we clearly still have much more to learn before we can
say with confidence that anyone knows precisely how to substantially reduce structural unemployment in a non-inflationary way and accelerate progress towards the
goals established in the Humphrey-Hawkins Act.
Mr. Chairman and Members of the Committee, the President has made proposals
that will reduce the rate of inflation and dramatically improve the prospects for the
development of the American economy in the coming decade. This is part of building a new economic foundation.
We need the consent of the Congress to begin to build this new foundation. We
will be actively working with the authorizing committees to adopt legislative prow
sals that both increase program effectiveness and reduce the Government's burden
on the taxpayer. All the Members of the Congress will be called to judge the
President's budget recommendations. I urge that you endorse them.
Similarly, I ask that you support the other proposals that the President has made.
Real wage insurance will enhance the prospects for winning the fight against
inflation. It is an important and innovative new weapon in our anti-inflation arsenal. Those who dismiss it easily should be asked how they would stop inflation.
The President will make proposals for reform of the regulatory system and for
substantial deregulation of the surface freight transportation system of the country.
These proposals will be important in the fight against inflation and will need your
support.
Slowing inflation will require the cooperation of all Americans. The President and
his Administration can lead, but they alone cannot reduce inflation. I believe that
the American people will cooperate, and I have confidence that the Congress will
make restraining inflation paramount in their consideration of these proposals.
Mr. Chairman, this concludes my formal statement. I would be pleased to answer
the Committee's questions.
Senator BENTSEN. We have been having full attendance on this
committee until today. I assume the membership has had some of
the same problems in getting here, not because of any lack of
interest, because they are very much concerned about the President's budget and the economic issues facing us.
Let's turn to getting inflation down to 7.4 percent and productivity dropping to 0.4 percent and labor unit costs going up 8.1 percent. Do you have a contradiction in those figures? If so, what are
the implications? They don't seem to add up to me.
Mr. MCINTYRE. Let me start off by saying that I am very concerned about the lack of productivity in this country. It has been
going down rather rapidly in the past several years and it is the
problem that causes us some great concern.
I am not certain that we know the answers to getting productivity turned around in the short term. However, that is not at all
intended to mean that we are not seeking ways to get productivity
turned around.
Senator BENTSEN. Let me ask about that. Last fall the President
called for the formation of a National Productivity Council and you
are chairman of it. What have you done about it?
166
Mr. MCINTYRE. First of all, we held a meeting in December. We
have established three task forces.
Senator BENTSEN. Do you have a staff?
Mr. MCINTYRE. We have a staff we have borrowed from the
various agencies.
Senator BENTSEN. Is there a staff allocated to that Council that
they have under their control, dedicated to this effort?
Mr. MCINTYRE. There is not a separate staff employed by the
Council. The Council does have a staff that has been selected from
respective agencies and has been asked to work on the Council's
activities.
Senator BENTSEN. I don't see how you are going to accomplish
much unless you have people there dedicated to that purpose without all of the conflicting requirements that they have. I am deeply
concerned about this issue. I just hope we just don't go to rhetoric
on it, but we try to work toward final solutions.
Mr. MCINTYRE. I have a deep and abiding interest in this. It is
not an issue relegated to rhetoric. We have taken some specific
actions in the administration. Let me mention a couple of them
before this Council was actually created.
First of all, in the Federal sector, which we can't overlook, we
have 2 million employees, including the Postal Service.
Senator BENTSEN. I would hope you wouldn't.
Mr. MCINTYRE. We have to focus on the Federal sector, which is
one on which we have the most control. The previous Congress
passed the Civil Service Reform Act which I think can do probably
more than any other single action of the Congress and the administration to provide for improvements in Federal employee productivity. We are making a major effort to implement the new law right
now.
We have given implementing civil service reform highest priority
in the administration.
A second thing that we are trying to do, as we go through the
budget process, is to improve technology that will provide for possible improvements in productivity. To that end, we have recommended real growth in the budget in basic research and development. It is not as much as we would have liked to have recommended, but when you consider that this entire budget represents
a rather austere approach to funding Federal agencies, and when
you consider that fact and the fact that we have actually provided
for real growth in basic research, then I think that is another good
example of evidence of the administration's commitment to doing
things to increase productivity.
Senator BENTSEN. Let me ask you, will changes in productivity at
the Federal level show up in the index? Is there an assumption
that the increase in productivity at the Federal level is zero?
Mr. MCINTYRE. Let me ask Mr. Ooms to address that.
Mr. OoMs. Mr. Chairman, it is certainly true our measures of
inputs and outputs in the Federal sector are not such that they
will necessarily reflect the types of productivity increase that we
might-Senator BENTSEN. We should be measuring the Federal Government along with the rest of the economy and decide whether we
are really making some headway or losing ground.
167
Mr. OoMs. That's right. Mr. Chairman, it is not as easy to measure service sector output as in the Government as it is to measure
the widgets, gadgets, automobiles, and other identifiable items produced in the manufacturing sector of the economy.
So there are some conceptual problems as well as practical problems in attempting to measure these things.
Senator BENTSEN. Mr. Director, I have introduced legislation
concerning revenue sharing for the States. That is about $2.25
billion. How in the world can we justify revenue sharing for the
States when the Council of Governors Research Center estimates
for 1979 indicate that not one of them is going to have a deficit,
and we turn around, hopefully with a $29 billion deficit, with some
predicting $40 billion? How can we talk about adding to the surplus of the States?
Mr. MCINTYRE. Mr. Chairman, that is a very good question. That
is a question I examined when we put the budget together.
As you know, the Revenue Sharing Act is authorized through the
end of fiscal 1980. We expect to address the issue of general revenue sharing in the coming months and make proposals to the
Congress. We are required by law to recommend reauthorization by
May of this year, according to provisions of the Congressional
Budget Act.
We are looking at that issue in the administration and will have
our recommendations to you at the appropriate time. Let me tell
you why I did not recommend amending the law and taking out
revenue sharing in the 1980 budget. It was an issue that we seriously considered, but since Congress had already acted on that law,
and since we would have to come back up this year with our
recommendations on whether or not that law should be amended
or whether it should be continued in its current form, or whether it
should be just let go and not be reauthorized, we felt that was the
appropriate time at which to address the issue.
In my judgment, had we come up with an amendment to the
general revenue-sharing law, taking out the States' portion or the
entire amount, we would have been subjected to some criticism
about gimmicks in the budget. I tried to make sure that any
proposals that we made with respect to legislation were proposals
that we really felt we could get and we felt we could fight hard for
and accomplish this.
Senator BENTSEN. Mr. Director, I think that is one we have an
excellent chance of getting, and I don't think it has anything to do
with accounting practices. I think it is a good point and one which
has an excellent chance of passing in the Congress. All the opposition I have heard is from the hired lobbyists for the Governors. I
have not yet heard from the Governors and I am not sure that I
will, but I think you will see a lot of support from Governors.
Mr. MCINTYRE. I think you will find some support from the
Governors, but if it came to the administration and we took advantage of that type of savings in this budget, we would be subject to
questioning on the Hill about it. At least that was my judgment,
particularly since the law itself authorized-Senator BENTSEN. You talked about cutting back on the social
security benefits. You know, I have walked up that hill before and
I will tell you it is pretty steep.
168
Mr. MCINTYRE. When speaking of the social security benefits, we
are talking about a $115 billion program. We are talking about
changes in the benefits that have a good programmatic basis because there are other programs in the Government that would
cover the same individuals who would be affected by these benefit
changes. We have proposed benefit changes that would reduce
outlays by $600 million, which is about one-half of 1 percent of a
$115 billion program. These are very minor changes in comparison
to the total and, more important, changes that duplicate other
Federal Government programs.
Senator BENTSEN. Let's get back to this question of revenue
sharing with the States and your concern about having come up
with a budget and being charged with gimmickry. Now you have it
proposed. You had it proposed by a member of the Senate Finance
Committee, by the chairman of the Joint Economic Committee and
I don't think you would be charged with gimmickry if you just
supported it.
Mr. MCINTYRE. We will look at that in the administration and
tell you what our position is.
Senator BENTSEN. My 10 minutes have expired.
Congressman Brown.
Representative BROWN. I don't know whether I should be on your
side or his side, so I will pick a side of my own and go from there.
I don't notice much in your prepared statement about tax receipts, what you anticipate as receipts. How much have tax receipts increased between the 1978 and 1979 fiscal years? Do you
have any estimate of that?
Mr. MCINTYRE. We have a place in the budget where we actually
give you the percentage increases.
Representative BROWN. I know it is in the budget, but it is not in
your prepared statement and you did not address yourself to that
in your testimony.
Mr. MCINTYRE. The actual level of budget receipts was $402
billion in 1978. We expect receipts in 1979 to be $456 billion and
$502.6 billion in 1980. Then in the years of 1981 and 1982 the tax
receipts under current law are shown to increase rather significantly to $576.8 billion in 1981 and $652.6 billion in 1982.
Representative BROWN. I want to talk about that a little bit, if I
may.
How do you anticipate that those receipts will be increasing in
1980, 1981, and 1982?
Mr. MCINTYRE. They will be increasing in several ways. Of
course, in the individual income tax area, you have people moving
to higher brackets by increases in their real personal income as
well as by inflation pushing people into higher brackets.
Representative BROWN. What is the dollar figure for the latter?
Mr. MCINTYRE. I will have to get that for you.
Representative BROWN. Would you supply that for the years you
have just given me?
What occurs to me here is that that is an actual tax increase on
individual citizens. I don't need to give any evidence of the fact
that when somebody gets a cost-of-living increase of, say, 10 percent, their tax percentage goes up unless they happen to be in the
highest brackets, so it is an increase in the income tax for those in
169
the lower income brackets. The upshot is that we get a sort of
secret, hidden tax increase and the Government gets the benefit of
it.
[The following information was subsequently supplied for the
record:]
According to estimates prepared by the Office of Tax Analysis in the Treasury,
inflation will cause individual income tax receipts to increase by $8.8 billion in
calendar year 1980 over calendar year 1979. The corresponding figures for calendar
years 1980 and 1981 are $20.6 billion and $34.0 billion.
Mr. MCINTYRE. That occurred this past year, and if you look at
the budget, there are at least six places in the budget where we
recognize this problem. We addressed the problem, and we specifically say that the administration will propose further fiscal actions
and, in particular, further tax reductions during the period 1981 to
1984.
Representative BROWN. This would indicate a sharply higher
increase.
Mr. MCINTYRE. That is because the receipts do not take into
account any changes in the tax laws, which you and I know happen
fairly regularly throughout the process.
Representative BROWN. I would like to make them much more
regular by law. I would like to see them indexed so that when the
Government is not able to control inflation, the individual citizen
does not have to pay for it through the nose, if that is the proper
part of the anatomy through which we pay.
Mr. MCINTYRE. It is a very hard thing to do. It will be difficult on
the Congress as well, because you have to make certain decisions
with respect to fiscal policy. If you limit your flexibility in how to
deal with those decisions, then it is not only going to be hard on
the budgetmakers, but it will be hard on other policymakers as
well.
We think that tax burdens should be held down by tax cuts at
the appropriate time. The appropriate time has to be determined
by looking at the factual situation we are in.
Representative BROWN. The fact of the matter is that we have
not done that historically. We have raised the burden on the
middle income individual rather precipitously over the past few
years. There was a time not too many years ago when people of
average income paid no taxes at all. That has all gotten out of
hand.
We have a tax rebellion going on now in the Congress and if the
administration does not address it, the people are very likely to
address it on their own initiative. We may find ourselves with a
constitutional amendment which is written, not in Washington, but
someplace else. Or we may find ourselves with a constitutional
convention.
Mr. MCINTYRE. Let me make this comment.
If you look at the tax system as a whole, you are correct. I could
get you the breakdowns on the percentages for the record.
Representative BROWN. I would appreciate that.
[The following information was subsequently supplied for the
record:]
The attached table shows individual income and employee social security tax
liabilities as a percentage of personal income for the period from 1960 through 1979.
170
There was no significant change in the individual income tax share of personal
income during this period; however, the employee social security share more than
doubled from 1.4 percent to 3.1 percent.
If there are no changes in tax laws, both of these shares will rise between 1979
and 1984. Without a tax cut the individual income tax share will increase to over 13
percent and the employee social security share will increase to 3.5 percent.
OF
CONTRIBUTIONS AS A PERCENT
INDIVIDUAL INCOME TAXLIABILITY AND EMPLOYEE SOCIAL SECURITY
INCOME
ofpersonal
Taxasapercent
plusemployee
income
socialsecurity
Income
taxas
a percent
of
income
personal
Calendar year:
1960 .............................
1961 .............................
1962 .....................
....................
1963 .....
1964 .........................
1965 ..........................
1966 .........................
1967 .........................
1968 ..........................
1969 .........................
1970 .........................
1971 .............
1972 .....
....................
1973 ..........................
1974 ..........................
1975 .........................
1976 ..........................
1977 ..........................
1978'.........................
1979'.........................
9.9
10.2
10.2
10.4
9.5
9.2
9.6
10.1
11.2
11.6
10.5
9.9
9.9
10.3
10.7
9.9
10.3
10.4
10.7
10.6
Employee
social
security
taxonly
1.4
1.3
1.4
1.6
1.5
1.5
2.0
2.0
2.1
2.3
2.2
2.3
2.4
2.8
2.9
2.8
2.8
2.8
2.9
3.1
Income
taxand
employee
social
security
tax
11.1
11.4
11.4
11.8
10.9
10.6
11.4
11.9
13.1
13.6
12.5
12.0
12.1
12.8
13.3
12.4
12.8
13.0
13.3
13.4
Estimated.
Includes
effects
oflegislation
proposed
in the1980budget.
Mr. MCINTYRE. The increase has been largely due to social secu-
rity and I think you are going to have to look at that issue in the
Congress. That is exactly why we have tried to look at the longrange problem and make these very minor changes in benefits in
social security that the chairman alluded to.
Representative BROWN. With all due respect, Mr. Director, a tax
is a tax is a tax. It does not make any difference to the person who
pays the tax what it is dedicated to. We pay all kinds of taxes in
Ohio. One is supposed to pay for public schools, and yet we have
public schools closing. The Federal Government is somewhat more
precise in its dedication to social security funds, although I think
the social security system has been used to cover some other things
on a bookkeeping basis in the Federal Government.
I wouldn't get into that except to say that the tax does have to
do with personal incentives, it seems to me, and that addresses the
questions the chairman was addressing to you about the issue of
productivity incentive. Productivity is related to investment, and
the ability of the individual citizen to have money for investment
171
or to feel the incentive of extra investment of his own effort relates
very much to taxes.
Mr. MCINTYRE. May I make the observation, though, that the tax
bill which the President has just approved, recommended by this
Congress, does provide some incentive for investment. We are just
now seeing the effects of that law going into effect. It will take
several months, perhaps a year, to judge the beneficial effects of
the corporate effects provided in that tax reduction package.
Representative BROWN. If you will pardon my saying so, and I
think the average citizen perceives it this way, it is not a generalized tax cut. It is a tax cut in income taxes and tax increase in
social security taxes and the net impact for most Americans is a
tax increase. And, with all due respect, I think most of them are
cynical about government anyway and with the way this has
worked out they are made even more cynical.
Mr. MCINTYRE. We think you will have to look at the benefit
structures of programs like the social security system, particularly
where the benefits duplicate other government programs. You will
have to look at those situations and tie them into future tax
reductions. That is exactly the route that this budget indicates the
administration is looking to.
Representative BROWN. Mr. Director, let me just say, as the
chairman said, we come from two different parts of the country
and in some respects two different philosophies. Perhaps that is not
a politically wise comment because, in the past, there have been
efforts to cut impact aid to schools.
I think every President since Eisenhower has suggested that. It
has never succeeded and I think its prospect of succeeding are
between slim and zero, and I am optimistic about "slim." The
President may believe it stands a chance of being accomplished in
Congress, but it is not likely to be, so I think you have overestimated your reductions. I think you have overestimated your receipts.
We have had a couple of people come before this committee and
suggest that the economic assumptions are not correct. Last week
we were told that a number of private forecasters apparently believe the assumptions are too optimistic, and real economic growth
next year may be negative. If that is the case, would you outline
for us the changes in receipts and outlays so that we have some
idea what the real budget situation will be?
You can do that for the record, if you like.
Mr. MCINTYRE. I think we have presented to you what the real
problems are. We don't have the same economic forecast as some of
the private economic forecasters.
Representative BROWN. Let's assume for the moment that you do
face that problem next year. Where will you recommend increases.
And what do you see in terms of receipts if you have half a
percentage of unemployment increase. Can you give us some figures on that?
Mr. MCINTYRE. It is very difficult at this point without knowing
the nature of the economic situation to say what we would recommend. It would depend to a large degree on the nature of the
economy at that time and why the economic situation was different.
172
Representative BROWN. Let me try one other one. You are not
really terribly responsive to my question.
Farmers are in town today asking for somewhere between 90 and
100 percent of parity. I have heard both comments from farmers in
the group. Leaving your assumptions as they are now, what would
happen now if the Congress decided to approve 100 percent parity
for farmers?
Mr. MCINTYRE. The first thing that would happen would be
increased inflation.
Representative BROWN. Why?
Mr. MCINTYRE. Higher prices.
Representative BROWN. And higher Federal expenditures, is that
correct?
Mr. MCINTYRE. I would not want to agree that all higher Federal
expenditures would have a direct impact on inflation. It depends on
the amount-Representative BROWN. Say that again. You don't think that
higher Federal expenditures would have anything to do with inflation?
Mr. McINTYRE. We are talking about a question of degree. I don't
think it would have a significant effect. It becomes a matter of
degree.
Representative BROWN. My time is up, but would you please
submit for the record the impact on the budget with no other
assumptions changed, because apparently you are unwilling to concede the possibility of changes in the economic circumstance from
that optimistic base that you have put into this budget. But would
you tell me what will happen if Congress should pass a 100-percent
parity farm legislation in terms of the expenditures of the Federal
Government?
Mr. MCINTYRE. I would be glad to submit that for the record.
[The following information was subsequently supplied for the
record:]
A year ago the Department of Agriculture analyzed the impact of the American
Agriculture Movement's proposal to set all U.S. farm product prices at 100 percent
of parity. It was assumed at the outset that this objective could be achieved by
effectively controlling the quantities of farm products reaching the market. Therefore, Federal farm program costs would fall sharply rather than increase.
This does not mean, however, that the AAM proposal would have no impact on
the budget.
Food prices would rise 20 percent leading to increased outlays in those program
areas that are indexed to rise with living costs,
Unemployment would rise by about one-half of a percentage point causing increases in unemployment benefits and welfare outlays,
GNP would grow about one-half of a percentage point less, resulting in decreased
revenues.
Mr. MCINTYRE. Let me say I am not suggesting, Congressman
Brown, that there are no ether sets of economic assumptions which
are viable. What I am saying is that we think we have a reasonable set of economic assumptions. They are the set that this budget
is based on and it would be sheer folly for me to come up here and
say we don't have any faith in those assumptions, and I am not
going to do that because we do have faith in them. The strong
showing of the economy in the fourth quarter of last year indicated
that there is strength in the economy. Therefore, fiscal policy is
designed to take account of that strength.
173
Senator BENTSEN. I promised to get you out of here by 12 noon,
so I will ask a question or two and see if Congressman Brown
would like to close.
What is your reaction to a constitutional amendment requiring a
balanced budget, or requiring a limit on Federal spending relative
to GNP?
Mr. MCINTYRE. Let me say, first, this administration has had
balancing the budget as one of its goals and objectives. This must
be accomplished over a period of years because of the high deficits
that we had when this administration took office. We think we
should try to control Federal spending and the current budget
proposals are designed to do that. However, it is our judgment that
it would be unwise to put something in the Constitution. A constitutional amendment would not give us the flexibility that is needed
in government to deal with the economic situation as we find it
each time the budget is put together.
We think that we should try to balance the budget and achieve
the reductions in Federal spending through careful and deliberate
economic planning. Ultimately there is no substitute for making
those tough economic decisions on a year-by-year basis as circumstances dictate and as we have been trying to do.
The deficit has been reduced substantially. The percentage that
the Federal Government takes from the GNP has been reduced
substantially since 1976. We think those are the best policies to use
to achieve this balance.
If we were to have such a constitutional amendment, it could not
be written flexibly enough and, therefore, it would have the effect
of tying the hands of budgetary and fiscal policy. It could cause the
Government to add to cyclical instability in the economy. It could
prevent us from responding to economic recession, thereby causing
massive unemployment and lower income for profits and investments.
Senator BENTSEN. Let me say that while you think about endorsing my proposal for ending revenue sharing to the States, remember there are about 25 such States calling for a constitutional
amendment to balance our budget. I just want to help them in that
regard and have a balanced budget as soon as we can.
Mr. MCINTYRE. They are not only receiving benefits from revenue sharing, but if you count it, there is a total of $82 billion
grants-in-aid.
Senator BENTSEN. I understand that.
When we originally came up with the real wage insurance proposal, I was quite intrigued by it and it sounded pretty good. It is
certainly a laudable objective. Then we had Chairman Schultze up
here testifying and he said the budgetary impact of real insurance
is limiting. He said, "If most workers comply with the wage standards, inflation is most likely not to exceed 7 percent." If it succeeds,
we will pay less money. Isn't it possible you would get the worst of
all worlds? You have things beyond wages, be it the cost of energy
or interest on bank loans or food prices, and then you would have a
situation that materially contributes to the deficit in the budget.
That disturbs me very much.
I have some serious second thoughts about this insurance.
47-106 0 - 79 - 12
/-
174
Mr. MCINTYRE. You are absolutely correct, Mr. Chairman. There
are things that could happen outside the area of wages that could
have an impact on inflation. I have asked Mr. Ooms to look at
some of these things and, Van, if you would, would you give the
chairman some of our thoughts on that.
Mr. OoMs. Mr. Chairman, it is undoubtedly true that one can
think of a set of circumstances such as those we faced in 1973-74,
for example, in which there would be a significant effect on the
budget. That is to say, you could have food prices rising by an
amount well out of anyone's forecast at the moment. You could
have massive shortages in-Senator BENTSEN. You have spot oil contracts at $20 now because
of the Iranian situation.
Mr. OoMs. It is also understood that the energy situation is part
of those possibilities. It is, nevertheless, the case that a higher rate
of inflation, taken alone, although adding to the budget deficit
through real wage insurance, has a larger positive effect on budget
receipts through increases in corporate and individual income
taxes.
I think the thing one has to be aware of here is if we are faced
with a set of circumstances like that, the sort of circumstances that
we faced in 1973-74 that are not only outside the range of this
administration's forecast, but outside the range of commercial forecasters, we would need to look at fiscal policy in general. We no
longer would be looking at a change of a billion dollars in receipts
in a slightly different situation, but at a totally different economic
environment than when the budget was put together.
You would have to look at the entire spending program and
fiscal situation at that time.
Senator BENTSEN. Congressman Brown.
Representative BROWN. Mr. McIntyre, I wonder if you would
provide for the record of the committee, because we have to respond to the Council of Economic Advisers' statement on the
budget for the Congress, the anticipated outlays and budget authority for off-budget Federal entities for fiscal years 1978-84.
Mr. MCINTYRE. Yes, sir.
[The following information was subsequently supplied for the
record:]
The attached table reports on the anticipated outlays and budget authority for offbudget Federal entities for fiscal years 1978-84.
I
o/
Off-Budget Federal Entities
Outlays and Budget Aulhority, Fiscal Years 1978-1984
(in millions or dollars}
1978
1979
1980
1981
1982
Actual
Est.
Est.
Est.
Est.
Outlays
Department of Agriculture:
Rural electrification and
telephone revolving fund
Rural telephone bank ....
Department of Labor:
Pension Benefit Guaranty
Corporation ............
Department of the Treasury:
Federal Financing Bank ..
Postal Service ...........
U.S. Railway Association
Total
%
1983
Est.
1984
Est.
62
113
-124
-143
-140
135
131
127
-32
-24
-31
-33
-36
-38
-40
10614
-496
66
11477
349
63
11288
529
27
11300
94
11300
-304
11300
-820
11300
-785
--
--
--
--
103-2 7
IT11990
11956
11501
11096
10574
10602
355
135
156
150
146
144
137
132
12659
15134
13869
14000
14000
14000
14000
20
27
30
26
26
26
26
T141T727IT71
14164
14159
Budget authority
Department of Agriculture:
Rural electrification and
telephone revolving fund
Rural telephone bank ....
Department of Labor:
Pension Benefit Guaranty
Corporation ............
Department of the Treasury:
Federal Financing Bank ..
Postal Service ...........
U.S. Railway Association
Total
Note:
I T6
IM17
IT404
Detail may not add to totals because of rounding.
Source:
Office of Management
and Budget January 1979.
I-.
176
Representative BROWN. May we also have a list of those things
in the budget that you consider to be uncontrollable, that is, expenditures which are included in the budget as estimates, but
which under the law have no limitation if people are entitled to
them?
I have in mind such things as USITA programs and social security benefits. If you could supply that, I would appreciate it.
Mr. MCINTYRE. Controllability of outlays is on page 560 of the
Budget of the U.S. Government, fiscal year 1980, itself. If you
would like something more detailed than this, I would be glad to
work up the additional detail.
Representative BROWN. If it can be done, I was seeking a list of
the programs themselves, such as the food stamp program-not in
great detail, but in a little more detail than what you have provided there.
Mr. MCINTYRE. We can provide that.
[The following information was subsequently supplied for the
record:]
The attached tables provide more detail of uncontrollable programs than was
previously published in the budget.
CONTROLLABILITY OFBUDGET OUTLAYS (RELATIVELY
BACKUP TABLE B.-1980 BUDGET:
UNCONTROLLABLE) PAYMENTS FORINDIVIDUALS
[In millions
of dollars]
Description
1978
actual
1979
estimate
1980
estimate
Change
Social security and railroad retirement:
81,205
Federal old-age and survivors trust fund (HEW) ..........
Federal disability insurance trust fund (HEW) ............. 12,655
Receipts from Federal old-age and survivors trust fund
-1,618
.........................
(HEW) ........
3,983
Railroad retirement account (RRB) ..............................
89,649
14,056
101,546
15,740
11,897
1,685
-1,386
4,267
-1,440
4,581
-54
314
96,225
106,585
120,427
13,842
9,171
10,281
11,435
1,154
10,908
174
156
94
52
-85
-485
6
5
12,371
228
178
113
60
-158
-324
3
8
14,035
304
198
128
71
-131
-341
2
8
1,664
76
21
15
10
26
-17
1
0
-18
-20
-20
10,806
12,459
14,253
1,794
11,169
1,165
11,000
820
13,100
950
2,100
130
Total, social security and railroad retirement ............
Federal retirement and insurance:
Military retired pay .................................
Civilian programs:
Civil service retirement and disability fund ..........
Special benefits (Department of Labor) ..............
Coast Guard retired pay .................................
Foreign service retirement and disability fund
Retirement pay and medical benefits (PHS) .......
Employees health benefits fund ...........................
Employees life insurance fund ..............................
Retired employees health benefits fund ...............
Contribution for annuity benefits ..........................
Agency payments for salaries of reemployed annuitants .................................
Total, Federal retirement and insurance,
civilian programs .................................
Unemployment assistance:
Unemployment trust fund .................................
Federal unemployment benefits and allowances ............
0
177
BACKUP TABLE B.-1980 BUDGET:
CONTROLLABILITY OFBUDGET
OUTLAYS (RELATIVELY
UNCONTROLLABLE) PAYMENTS FORINDIVIDUALS-Continued
fin millions
of dollars]
1978
actual
Description
1979
estimate
Advances to the unemployment trust fund and other
Funds .......................................................................
Repayable advances from general fund for Federal
unemployment account and for advances for extended benefits.........................................................
1,086
.................
- 1,045
Total, unemployment assistance...........................
Veterans benefits: Pensions, compensation, education, and
insurance:
Compensation and pensions......................................
Readjustment benefits.
......................................
National service life insurance fund .................. :
Other VAinsurance and education funds......................
1980
estimate
...
Change
.
.................
- 800
- 900
-100
12,376
11,020
13,150
2,130
9,573
3,362
668
- 493
10,637
2,741
740
-496
11,183
2,294
771
- 503
546
-448
31
-6
13,110
13,622
13,745
123
Medicare and medicaid:
Grants to States for medicaid......................................
Federal hospital insurance trust fund............................
Federal supplementary medical insurance trust fund
10,680
17,862
7,350
11,804
20,728
8,771
12,374
23,670
10,153
570
2,942
1,382
Total, medicare and medicaid...................................
35,891
41,303
46,197
4,894
2,920
3,588
4,404
816
691
652
720
Total, housing payments......................................
3,612
4,240
5,124
884
Public assistance and related programs:
Child nutrition programs (USDA) .................................
Foodstamp program (USDA).......................................
Special milk program (USDA)......................................
Assistance payments program (HEW)..........................
Special benefits for disabled coal miners......................
Supplemental security income program.........................
,Payment where credit exceeds liability for tax.............
Regional rail transportation protective account.............
Black lung disability trust fund (DOL).........................
Special benefits and special workers' compensation
expenses (DOL).......................................................
2,527
5,499
139
6,639
982
5,855
881
80
27
2,669
6,321
140
6,702
995
5,558
841
100
309
3,022
6,877
32
6,961
1,004
6,340
1,547
353
556
- 108
259
9
782
706
-100
146
Total, veterans benefits......................................
Housing payments:
Housing payments (HUD)............................................
Payments for operation of low-income housing projects.........................................................................
Total, public assistance and related programs.
Total-Payments for individuals..........................
23
8
68
.................
455
9
22,651
23,642
26,247
2,605
203,843
223,153
250,578
27,425
BACKUP TABLE C.-1980 BUDGET: CONTROLLABILITY OFBUDGET OUTLAYS (RELATIVELY
UNCONTROLLABLE), NETINTEREST, GENERAL REVENUE
SHARING, AND FARM PRICE
SUPPORTS
[In millions
of dollars]
Description
Net interest:
Interest on the public debt...........................................
1978
actual
49,020
1979
1980
estimate
estimate
60,129
66,034
Change
5,905
178
BACKUP TABLE C.-1980 BUDGET:
CONTROLLABILITY OFBUDGET
OUTLAYS (RELATIVELY
UNCONTROLLABLE), NETINTEREST,
GENERAL
REVENUE
SHARING, AND FARM
PRICE
SUPPORTS-Continued
[In millions
of dollano]
Description
1978
actual
1979
estimate
1980
estimate
Change
Interest (offsetting receipts)'....................
13,585
-17,137
-19,864
-2,727
Total, net interest............................
General revenue sharing: State and local government fiscal
assistance trust fond..............................
Farm price supports: Price suppurt and related programs,
reimbursement for net realized losses.................
35,435
42,992
46,170
6,823
6,852
6,863
5,509
4,986
2,785
2,201
Total......................................
47,767
54,830
55,818
987
3,178
10
Pnnpnosed
legislation
inopen-ended
pnognams
andtioed
costsincludes
$8million
in 1978
and$08million
io 1980.
BACKUP TABLE D-1980 BUDGET:
CONTROLLABILITY OFBUDGET
OUTLAYS (RELATIVELY
UNCONTROLLABLE) ANDOTHER
OPEN-ENDED PROGRAMS AND FIXED
COSTS
[in millions
ot dollars]
Description
Payment to the Postal Service.........................
Legislative and Judiciary (excluding interest payments to
miscellaneous trust funds).........................
All other relatively uncontrollable outlays:
Funds appropriated to the President:
Disaster relief............................
Advances, foreign military sales (net).........
International financial institutions.............
Agriculture: forest service permanent appropriations. ......
Commerce: Operating differential subsidies...............
HEW:
Grants to states for social services and child welfare
services...................................
Human development services (social services).......
HUD:
Federal housing administration fund ...............
New Communities fund.........................
Interior: Miscellaneous trust funds and permanent appropriations (special funds) ............................
State: Contributions to international organizations .........
Treasury:
Charges for administrative expenses of trust funds
(offsetting receipts) ........................
Claims, judgments and relief acts .................
Miscellaneous permanent appropriations (special
funds)....................................
Internal revenue collections for Puerto Rico..........
Veterans Administration: Loan quaranty revolving fund......
Other independent agencies:
FDIC
fund ...................................
FSLIC
fund...................................
Payments to air carriers (CAB) ..................
Other small accounts and offsetting receipts.............
Total all other..............................
1970
actual
1979
estimute
1980
estimate
Change
-106
1.778
1.803
1.698
1,484
1,738
1,925
188
461
-341
858
328
303
276
- 100
857
347
293
241
1,023
421
307
-34
100
165
75
14
2,809
1,517
2,965
1,499
2,586
1,680
-379
181
357
97
ill
43
257
332
229
371
276
439
46
68
-[169
198
-164
238
-173
152
9
- 86
290
210
157
86
220
30
-204
10
- 186
237
188
80
34
35
- 77
-8
-567
-404
77
118
-1,121
- 391
73
424
- 1,192
- 506
72
530
- 71
- 115
-1
106
6,736
6,607
6,201
- 406
179
BACKUP TABLE D.-1980 BUDGET:
CONTROLLABILITY OF BUDGET
OUTLAYS (RELATIVELY
OPEN-ENDED PROGRAMS AND FIXED
COSTS-Continued
UNCONTROLLABLE) AND OTHER
[in millionsof dollars]
1978
actual
Description
Total, other open-ended programs and fixed costs,
relatively uncontrollable ............................
9,998
1979
estimate
1980
estimate
Change
10,148
9,824
-324
SUMMARY-BACKUP TABLEE.-1980 BUDGET:
CONTROLLABILITY OF BUDGET
OUTLAYS (RELATIVELY
UNCONTROLLABLE) AND NATIONAL DEFENSE
OUTLAYS FROM
PRIOR-YEAR CONTRACTS
AND OBLIGATIONS
[In millionsof dollars]
1978
actual
1979
estimate
1980
estimate
Change
Defense-Military ................................
Department of Energy ................................
Other agencies.......................................................................
27,371
777
50
31,417
953
63
35,729
1,361
36
4,312
408
28
Total, national defense, outlays from prior-year contracts and obligations..........................................
28,198
32,433
37,126
4,692
BACKUP TABLE F.-1980 BUDGET:
CONTROLLABILITY OFBUDGET OUTLAYS (RELATIVELY
UNCONTROLLABLE) AND CIVILIAN PROGRAMS, OUTLAYS FROM PRIOR-YEAR CONTRACTS
AND OBLIGATIONS
[In millionsof dollars]
Agency
Funds appropriated to the President
.
.....................
Agriculture ...............
..
................
Commerce..............................................................................
Defense-Civil
.................................
Energy....................................................................................
HEW
..
...............................
HUD
..
...............................
Interior...................................................................................
Justice....................................................................................
Labor.....................................................................................
State......................................................................................
Transportation........................................................................
Treasury.................................................................................
Environmental Protection Agency
.
.......................
GSA
..
...............................
NASA
..
...............................
VA
..
...............................
Other independent agencies:
ACTION,
operating expenses
.
....................
Community Services Administration, community services program .
..........................................
................
Export-Import Bank
.
...........................
...........
Federal Emergency Management Agency .
Washington Metropolitan Area Transit Authority, Federal contribution.......................................................
National Foundation for the Arts and Humanities
.....................
National Science Foundation
.
................................
Small Business Administration .
1978
actual
2,420
1,354
654
9,553
3,364
4
7
209
3,445
190
671
746
-
1979
estimate
1980
estimate
2,506
2,750
1,594
1,461
2,845
3
,911 1,310
744
975
4,556 1,064
11,274
12,718
4,037
5,351
1,120
1,2911,6
762
720
794
,664
2,7722,
131 127
221
,779 8,826
231
190
3,410
3,918
409
381
635
1,024
867
929
Change
244
-133
-1,535
231
2,044
- 2,512
1,444
1,314
78 387
- 74
857 85
94
9,495669
-41
508
-28
389
62
56
65
58
-7
106
131
310 359
91
101
274
561
68
-85
470
-33
98
127
391
456
72
77
442
707
32
113
405
417
-40
36
-37
-290
180
OUTLAYS (RELATIVELY UNCONTROLLABLE) AND
BACKUP TABLE F.-1980 BUDGET: CONTROLLABILITY OFBUDGET
AND OBLIGATIONS-Continued
CIVILIAN PROGRAMS, OUTLAYS FROM PRIOR-YEAR CONTRACTS
ofdollars]
[In millions
1978
actual
Agency
1980
estimate
352
263
433
362
526
280
44,115
49,627
50,756
Tennessee Valley Authority fund ................................
Other................................
Total, civilian programs, outlays from prior-year
contracts and obligations ................................
1979
estimate
Change
93
-82
1,129
Representative BROWN. You seem to be very firm on what would
happen if your assumptions are wrong. Let me ask this: If you are
wrong in your predictions of the effects of those policies you are
asking Congress to implement; such as reduce social security benefits and some of the educational outlays and so forth, is the President prepared to veto bills that increase budgeted outlays beyond
those items, beyond those budget estimates for expenditures and
what you have recommended in the budget?
Mr. MCINTYRE. I do not know what the President would do under
such a general set of circumstances. As a generality, however, I can
tell you if an authorizing bill or appropriation bill has the effect of
busting the budget, I will not hesitate to recommend to the President that he disapprove that legislation.
Representative BROWN. Good.
Let me ask you now to make two other assumptions and give us
some figures. One is an assumption that sees unemployment at the
end of the year go up from 6.2, as you have predicted, to 6.7
percent, and another one that sees economic growth drop 2.25
percent, which the Council of Economic Advisers sees for real
growth for the coming year, down to A or B percent growth rate.
If you can give me some idea of what will happen to the budget
only on that basis, I would appreciate it.
Mr. MCINTYRE. Yes, sir.
[The. following information was subsequently supplied for the
record:]
The President's budget requests are based upon the economic assumptions shown
in the budget document. These economic assumptions are needed to make outlay
estimates in a large number of programs and receipts estimates for several types of
taxes. It is not possible to make these estimates with the same precision for
alternative sets of economic assumptions.
However, it is possible to employ some fairly reliable rules of thumb to estimate
the effects of alternative economic assumptions upon spending, receipts and the
deficit. If the rate of inflation beginning in the first quarter of 1979, is one percentage point higher than assumed, and other factors are unchanged, outlays, receipts
and the deficit would be changed as follows:
of dollars]
[In billions
1979
Fiscal
+0.7
Outlays.......................................................................................................
Receipts......................................................................................................
Deficit (decrease)........................................................................
(Excluding real wage insurance) .
1980
Fiscal
+3.6
+ 2.1 +4.2
-1.4
-1.4
-0.6
-5.0
181
A one percentage point reduction in the rate of growth of real output over the
same period, with other factors unchanged, would affect outlays, receipts and the
deficit approximately as follows:
[in billions
of dollars)
Fiscal
1979
Outlays.......................................................................................................
Receipts......................................................................................................
0.4
-2.1
Deficit (increase).........................................................................
2.5
Fiscal
1980
1.9
-8.3
10.2
The effects of higher unemployment rates are subsumed in the effects of lower
real growth. At present one percentage point less real growth would typically
produce about a one-third to one-half of one percentage point increase in the
unemployment rate. It is then possible to estimate the effects on the budget of
higher unemployment by extrapolating from the table above.
Representative BROWN. I would conclude by saying that two very
distinguished economists, the former Chairman of the Council of
Economic Advisers, Alan Greenspan, and Chase's economist, estimate deficits closer to $50 billion than $30 billion. So I don't think
my request is out of line because some of those assumptions go into
their figures.
Finally, the Congressional Budget Office estimates the size of the
deficit is really going to be closer to $50 billion rather than the
optimistic $30 billion which you were predicting. I would have to
say I hope your optimism is correct. Frankly, I would have preferred to see that budget deficit closer to $15 billion rather than
$30 billion. I think that is the only way we are going to get
inflation under control and if we don't get it under control, the
bottom will be dropping out of everything, which is a possibility
that has appeared increasingly ominous in the last decade or so as
a result of Congress proclivity for spending and its neglect of that
part of Keynesian economic theory that would dictate a budget
surplus any time we have any kind of recovery.
I think the President is subject to a similar inability to take the
proper action in office. I hope he is becoming a fiscal conservative,
which I think you are.
Mr. MCINTYRE. And have been for some time.
Representative BROWN. That record is perhaps as well established as the President's is, because you are replacing Mr. Lance. I
am comforted by your willingness to recommend the vetos. I just
want to see you hang in there. I have you on record on that issue.
Mr. MCINTYRE. Let me ask you one question, Congressman
Brown.
We will need some additional information to provide you the
figures you asked for under those two sets of economic changes,
one being unemployment and the other in growth. Is it permissible
for us to work with your staff and would you tell me with whom
we should work?
Representative BROWN. Get in touch with Mr. Bradford, who is
the ranking staff man on the minority side. He can provide whatever information you need on the subject.
Mr. MCINTYRE. My second point: We have recognized some of the
difficulties in characterizing fiscal policy only with a deficit figure
because of the automatic stabilizers in the budget. We recognize
182
that receipts, especially, are sensitive to the economy. Accordingly,
in my prepared statement and in my summary of that prepared
statement before the committee I tried to emphasize the expenditure side of the budget, the outlays.
If you look at outlays, they do represent a restraint in growth.
They do represent a smaller share that the Federal Government is
taking out of the gross national product. They do contribute to
further decreases in the high-employment deficit. The expenditures
that the Federal Government makes are extremely significant and
important.
We have tried to increase the awareness of the effects of expenditures, just as some people are exhibiting about the effects of the
deficits. Your point about expenditures is well taken and one which
I would urge the Congress to keep in mind under any of the
economic scenarios you have mentioned.
We have to look at the total amount the Federal Government
proposes to spend. We would urge the Congress not to exceed the
recommendations the President has made for Federal spending.
Representative BROWN. I join you in that and let me say for your
benefit, and for that of the Chairman, that I don't consider myself
an identifiable economist. By that, I mean that I do not identify
myself as either a "fiscalist" or a "monetarist." I think there is a
lot of psychology in economics. I think different things affect different people at different times in different ways.
I think we need to control expenditures and deficits, and we
would be served well by a tax cut which would restore some incentives to our society. Those three things have to be achieved with
some degree of balance, of course. So, I am more interested in your
assumptions at the moment than I am with embarrassing you with
any thought of what happens in the event of a half percent increase in unemployment.
I want to know what you think is going to happen in the event
something totally separate from your Federal budget affects the
growth rate. Perhaps inflation in general is the result of energy
policy, which is totally out of your control at the moment, or at
least significantly so.
Senator BENTSEN. Let me say I strongly commend the President
for breaking that line in budget deficits and bringing out what I
think is a lean budget, and I will be very supportive of keeping it
that way.
We are very pleased that you could come to testify this morning.
The committee is recessed.
[Whereupon, at 12:10 p.m., the committee recessed, to reconvene
at 10 a.m., Tuesday, February 6, 1979.]
THE 1979 ECONOMIC REPORT OF THE
PRESIDENT
TUESDAY, FEBRUARY 6, 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. William Proxmire (member
of the committee) presiding.
Present: Senator Proxmire and Representative Rousselot.
Also present: Louis C. Krauthoff II, assistant director-director,
SSEC; Richard F. Kaufman, assistant director-general counsel;
John M. Albertine, L. Douglas Lee, and Thomas F. Dernburg,
professional staff members; Mark Borchelt, administrative assistant; Katie MacArthur, press assistant; and Stephen J. Entin and
Robert H. Aten, minority professional staff members.
OPENING STATEMENT OF SENATOR PROXMIRE, PRESIDING
Senator PROXMIRE. This morning I am pleased to welcome a
distinguished panel of experts to discuss current fiscal and monetary policies. Our witnesses are Alan Greenspan, former Chairman
of the Council of Economic Advisers; Nancy S. Barrett, director,
Program of Research on Women and Family Policy, the Urban
Institute, and formerly with the Congressional Budget Office; Carl
Christ, professor of economics at the Johns Hopkins University;
and Ray C. Fair, professor of economics at Yale University.
Your assistance to the committee at this time could not be more
timely. If we knew only that unemployment averaged 6 percent in
1978 and is expected to go higher this year, we would be calling for
expansionary policies.
On the other hand, if we knew only that consumer prices accelerated throughout 1978 and that the CPI would be 9 percent higher
in December than it was 1 year ago, we would be stepping on the
monetary-fiscal brakes.
That is our quandary. How can we stop the inflation without
stopping the economy?
A second issue that we are very much concerned about is the
mix of monetary and fiscal policy. Some time ago, Professor Franco
Modigliani told our Subcommittee on International Economics that
one of our problems is that we have attempted to slow inflation by
means of tight money.
The result, frequently, has been recession and we have responded
to that by tax cuts and other forms of fiscal stimulus. Repetition of
that sequence has produced a consumption oriented policy mix that
(183)
184
causes high interest rates and massive budget deficits. It also
places a drag on capital spending and home construction and thus,
perhaps, accounts for our recent poor productivity and unit labor
cost performance.
Welcome to this hearing. I hope you will address yourselves to
the issues I have raised in my opening statement.
We are very delighted to have this distinguished panel before us.
Mr. Greenspan, go right ahead.
STATEMENT OF ALAN GREENSPAN, PRESIDENT, TOWNSENDGREENSPAN & CO., INC., NEW YORK, N.Y., AND FORMER
CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS
Mr. GREENSPAN. Thank you, Senator.
While I intend to address all of the issues which you raised in
your opening remarks some time this morning, I would like to
concentrate on just a few of them in my opening statement.
There can be little doubt that in recent months the President has
endeavored to some degree to restrain Federal spending and is
sincere in his desire to sharply reduce and, ultimately, balance the
budget.
In the context of the current services budget, there is some
element of restraint implicit in the document the President presented to the Congress in January. I regret only that this administration did not sense the dangers of inflationary fiscal policy when
it first came into office. Had it done so, I believe we would be much
farther along the road to restoring a noninflationary economic
environment than we are today.
Let us not forget that the then outgoing President Ford proposed
outlays for fiscal 1981 of $527 billion, $51 billion less then President Carter is currently proposing for that year. Only a small part
of the difference reflects cutbacks advocated by President Ford
which President Carter has not chosen to follow.
Certainly, little of the gap can be attributed to a change in
economic forecasts. The current projections for 1980 and 1981 are
not substantially different from those of the outgoing Ford administration. The difference lies largely in new programs advocated by
President Carter and/or passed by the Congress.
From the context of someone who has been intimately involved
in attempting to curtail a budget with vast political constituencies
supporting it, I admire much of what the President and his budget
people have endeavored to do in the last several months. Nonetheless, I do not believe they have gone far enough in curtailing the
growth in outlays. It is becoming increasingly evident that we must
create a far more effective mechanism to restrain outlay expansion.
The basic problem, as we have all observed, is that, while re-
straint in total outlays is supported by virtually everybody, when it
comes to a specific expenditure proposal, the short-term benefits to
a specific constituency tend to override the long-term costs to the
Nation as a whole.
The current services budget estimates for future years invariably
indicate that expenditure growth will slow rather markedly. But
this is partly illusory, since there is an implicit assumption that
185
the Congress will be on vacation 52 weeks a year and will add no
new spending to the budget.
We often forget that there is a special type of uncontrollable
spending which is built into our political system. It derives from
the fact that the Congress meets for extended periods each year
and that most bills on which committees hold hearings have a
significant price tag on them. It is rare that a congressional committee will meet in extended session on an inconsequential budgetary matter, unless it has wide political or media interest. One
cannot tell in advance which particular bills will pass or which
particular expenditures will be authorized.
However, we would not be terribly far off if we specified a
certain aggregate level of newly authorized outlays per day of
congressional session. This, in a certain sense, is as much an uncontrollable add-on as previously mandated outlays.
It appears, therefore, that the only way in which we can curb a
rate of growth in Federal outlays which outruns the revenue raising capacity of the economy is to impose some form of constitutional restraint on outlays.
I say this with great reluctance. Constitutional amendments
should not have to deal with technical problems such as those
which now confront us on the budget.
However, given our institutional structure, I see little hope of
achieving the type of restraint that our economy requires other
than through the Constitution.
Now, it may be that rather than focus on a particular level of
outlay growth, real or relative to GNP, which would be difficult to
monitor, we can probably resolve the outlay growth problem by
requiring that all budget authority, appropriation, and expenditure
bills be passed by two-thirds, rather than a simple majority of both
houses and signed by the President.
A Presidential veto, in that case, would merely require that the
two-thirds vote be reaffirmed. Such a procedure would avoid many
of the problems associated with defining an appropriate constitutional amendment. It would not, however, resolve the problem of
defining what in fact constitutes expenditures.
I have no doubt that if we restrain what is covered under the
current definition of outlay or expenditure by some legal prohibition, the Congress, in its wisdom, will find alternate means to
accomplish what it ordinarily would do on the expenditure side.
However, I nonetheless believe that such means are limited and
that, while we can never expect any particular constitutional
amendment, either one requiring a two-thirds vote on money bills
or one restricting the level of outlays generally, to be fully effective, it clearly will have a major impact on restraining the growth
of the Federal sector.
Restraining budget outlays, however, will not be enough in itself.
We must focus not only on on-budget outlays and financial requirements, but on all of the direct and indirect preemptions of private
savings embodied in Federal policy as well. The inflationary impact
of the Federal Government is only partly related to the on-budget
deficit financing requirements and I believe we take far to simplistic a view by employing the deficit as our sole measure of fiscal
policy.
186
Off-budget borrowing has risen sharply in recent years. So have
mandated capital investment by business-pollution, safety equipment, et cetera-which must be financed; and matching grants,
which have induced increased spending and borrowing by State
and local governments. These demands have added heavily to capital market pressures, but in total, have been small compared with
the extraordinary expansion in mortgage credit.
Prior to the 1970's, an increase in mortgage credit on one- to
four-family homes rarely exceeded $15 billion per year. During the
past year, the increase has approached $100 billion. Changes in
institutional structures and subsidy programs sponsored by the
Federal Government, from mortgage-backed bonds to the newest 6month certificates tied to the Treasury bill rate, have been responsible for this explosion in mortgage credit.
As a result, we have arrived at a point where we no longer have
the luxury of employing sophisticated mixes of fiscal and monetary
policy. Monetary policy has become increasingly hostage to fiscal
policy in recent years. Until we reduce the aggregate drains on the
credit markets created by Federal policy, direct and indirect, the
Federal Reserve will have little leeway to pursue a discretionary
monetary policy.
We have largely run out of options which enable us to calibrate
various degrees of monetary restraint and budgetary stimulus.
Unless we apply strong restraining policies, both on the fiscal and
the monetary side, we risk being unable to subdue, and ultimately
defuse, the inflationary pressures which undercut the productiveness of the American economy.
There is no question that policies of restraint risk the inadvertent triggering of a recession. But we have procrastinated so long
in suppressing inflationary pressures, that we have run out of lowrisk policies.
I can readily envisage an easier monetary policy carrying economic growth and employment through the end of this year and
into 1980. But that could be done only through increasingly more
stimulative monetary and fiscal policies. This would accelerate inflation at a prodigious cost to the economy and the Nation in 1980
and beyond. We cannot eliminate a confrontation with the inflationary forces which now grip the economy. We can, perhaps, postpone the inevitable date, but at increasingly negative tradeoffs
between inflation and recession.
We no longer have a broad set of options available to us. Policy,
in my judgment, must focus on reducing the credit pressures engendered by the Federal Government, thereby enabling the Federal
Reserve to reduce the rate of growth of the monetary aggregates
without driving interest rates sharply higher. The Federal Reserve's ability to lower interest rates in the context of heavy credit
demands from the Treasury and other Federal preemptors of credit
is currently extremely limited.
Senator PROXMIRE. Thank you very much, Mr. Greenspan.
Mr. Fair, please proceed.
187
STATEMENT OF RAY C. FAIR, PROFESSOR OF ECONOMICS,
YALE UNIVERSITY
Mr. FAIR. I have been asked to comment on the appropriateness
of the monetary policy-fiscal policy mix for fiscal year 1980 in
light of the administration's budget. I have also been asked to
comment on Prof. Franco Modigliani's complaint at the recent set
of hearings of the Subcommittee on International Economics that
the current mix is too heavily weighted toward a tight monetary
policy.
The question of whether the mix is appropriate or not is difficult
to answer because much more is known about future fiscal policy
than about future monetary policy. For the first three quarters of
1979, we know roughly what fiscal policy will be from the fiscal
year 1979 budget, and for fiscal year 1980, we have the administration's budget to help us predict what fiscal policy will be. For
monetary policy, on the other hand, one has little to go on except
to extrapolate past behavior of the Federal Reserve. My answer to
the question about the appropriateness of the mix is thus that it
depends on what future monetary policy will be, about which we
know very little. Since this answer is not very satisfying, I will try
to be more specific.
If the Federal Reserve allows short-term rates to fall by 1 or 2
percentage points during the next year and a half, then the administration's budget seems about right to me. I should add that I am
only talking about the macroeconomic implications of the budget.
Obviously, similar macroeconomic goals can be achieved with, for
example, quite different allocations of expenditures among categories. The President's budget is, by his own admission, lean and
austere, and in view of this, it seems to me that a somewhat easier
monetary policy is needed to avoid such things as a significant rise
in the unemployment rate.
Note that if monetary policy does ease relative to fiscal policy,
this will help meet Professor Modigliani's complaint. I agree that
monetary policy has been too tight relative to fiscal policy in the
past year, and I hope the Federal Reserve will ease its policy in
light of the proposed budget.
I might add in support of Professor Modigliani's complaint that
my econometric work indicates that a tight monetary policy is,
other things being equal, inflationary. A rise in interest rates
increases costs, and my work indicates that at least some of these
higher costs are passed along in the form of higher prices. This
increase in prices is in addition to the obvious increase in the
consumer price index that results from a rise in the interest rates
that are a part of the index itself. So as not to give a misleading
impression about the effects of monetary policy on inflation, it
should be noted that a tight monetary policy also cuts aggregate
demand, which is, other things being equal, deflationary. The net
effect of a tight monetary policy on inflation is thus ambiguous.
The important point here, however, is not whether the net effect is
inflationary or deflationary-my work indicates that it is deflationary-but that a mix of tight money and an easy fiscal policy is
likely to be more inflationary or less deflationary than is a mix of
easy money and a tight fiscal policy. This is particularly true if the
188
tight fiscal policy is a result of expenditure cuts rather than tax
increases.
Coming back now to the assumption about the behavior of the
Federal Reserve. If the Federal Reserve is not going to ease its
policy in the next year and a half, then I think the administration's budget is too restrictive. In this case, I would argue for more
expenditures or lower tax rates.
In the time left, I would like to make two further points about
the present situation that I think it is important to keep in mind
as the economic events for the year develop. The first concerns the
impact of a tight monetary policy on housing investment and plant
and equipment investment. With the recent reforms that have
taken place in the financial sector, there is now less credit rationing in the mortgage market than there used to be during periods of
tight money. This means, among other things, that the same
degree of monetary tightness now corresponds to higher interest
rates than before since interest rates are now allowed to play more
of a role in clearing markets. It also means that plant and equipment investment is now hurt more relative to housing investment
during periods of tight money. This is not to say that I feel that the
removing of restrictions in the financial markets is a bad thing,
but only that one should be aware that a tight monetary policy is
now likely to hurt plant and equipment investment more and
housing investment less than it did in the past. This is, of course, a
further argument for an easier monetary policy for those who feel
that more stimulus for plant and equipment investment is needed.
My second point concerns the emphasis of the administration on
the size of the budget deficit in its fight to control inflation. This
emphasis is, in my view, misguided. In examining the likely effects
of fiscal policy on inflation, one should consider how the policy will
affect aggregate demand and supply, rather than what budget deficit will result from the policy. To give an example, say that the
administration's forecast of the economy for fiscal year 1980 is too
optimistic, in particular that it has overestimated real growth. In
this case, tax revenues are likely to be less than anticipated, and so
the budget deficit is likely to be greater than anticipated. It would
surely not be reasonable, however, to argue that because of the
larger deficit, there will be more inflation in this case than in the
more expansionary case.
I would finally like to conclude with an argument by way of
analogy. If the administration and Congress disagree with the Federal Reserve about the goals for the economy, my argument is that,
on average, the Federal Reserve will win out. This seems to me to
be undesirable in our democratic society, and so I believe that
Congress and the administration should have more power in determining such things as the future monetary policy-fiscal policy
mix.
The analogy is as follows: Consider a reservoir with two pipes
running into it, one large and one small. Each pipe has a valve
that controls whether water flows into or out of the reservoir and
at what speed. The valve for the large pipe is controlled by Congress and the administration. The valve for the small pipe is controlled by the Federal Reserve. The valves can be changed monthly, but Congress and the administration must decide a year in
189
advance what each of the 12 monthly settings will be. The Federal
Reserve, on the other hand, can decide its setting each month. The
Federal Reserve knows the 12 settings of Congress and the administration at the time they are announced. Now, if the two groups
differ as to what the height of the reservoir should be, who do you
think will, on average, come closer to achieving its goal? Unless the
small pipe is quite small relative to the large pipe, which my work,
among others, indicates is not the case, then it is obvious that the
Federal Reserve will on average come closer to its target. Note that
this is true even though Congress and the administration may
control a larger pipe.
I forgot to say, however, that Congress can also throw softballs at
the Chairman of the Federal Reserve. These sometimes hurt, especially when thrown by Senator Proxmire-I should add, Senator,
that I wrote this before I realized you were going to chair this
session. I hope you left your arsenal at home-but generally they
do not hurt enough to make the Federal Reserve change its preferred height very much. An important question is whether the
present institutional structure should be changed to allow Congress
and the administration more say in how the small pipe's valve is
set. My view is that this should be done. Softballs are not enough.
Senator PROXMIRE. Thank you, Mr. Fair. We used to call pitchers
like you "junk pitchers." Eddie Lopat was a pitcher of junk balls
and he was very effective.
Mr. Christ, please proceed.
STATEMENT OF CARL F. CHRIST, ABRAM G. HUTZLER PROFESSOR OF ECONOMICS, THE JOHNS HOPKINS UNIVERSITY, BALTIMORE, MD.
Mr. CHRIST. Thank you, Senator Proxmire.
It is a pleasure to be here to discuss the best mix of monetary
and budget policy. These remarks will be a shorter version of the
prepared statement that has been distributed. I will refer to one
additional sheet, containing two tables.
The program I advocate can be summarized in four main recommendations.
Let me first list the results that can realistically be expected to
occur under this program, after a suitable transition period. They
are: (a) Zero inflation, permanently maintained. (b) Permanently
low interest rates. (c) Absence, or at least extreme rarity, of major
depressions. (d) Routine occurrence of mild recessions. (e) An overall unemployment rate averaging about 6 percent, varying between
perhaps 5 percent in prosperity and 7 or 8 percent in recessions.
The four main policy recommendations are as follows. The third
one is listed first.
Three: Manage stabilization policy with due regard for the analogy between its effects on the economy and the effects of amphetamines on the human body.
One: After a transition period starting immediately, keep the
rate of growth of the M2 money stock: (a) Low on the average,
about 3 percent a year, and; (b) Fairly steady, usually between 2
and 4 percent, and always between 1 and 5 percent.
These numbers may need to be revised very slightly, every 5
years or so.
47-106 0 - 79 - 13
190
Two: Provide countercyclical variation in the Federal deficit,
from about zero in prosperity to perhaps 2 percent of GNP in the
normal mild recession, and averaging about 1 percent of GNP.
Four: Use labor-market and human-resources policies to reduce
unemployment and/or to assist those who suffer from it.
Part I of my prepared statement deals with long-run effects of
inflation and money.
In every country and every era of which I have knowledge, the
rate of inflation is inseparably connected with the rate of growth of
the stock of money. The United States is no exception.
Table 1, attached to my oral statement, compares the low-inflation period 1948-61 with the high-inflation period 1970-78. Notice
how the growth rates of the monetary base and the M2 money
stock accelerated.
Theory and experience make it clear that inflation cannot be
stopped until monetary growth rates are reduced to near zero and
kept there, whereas inflation will be stopped if that is done.
The Federal Reserve System is the agency that controls these
growth rates, but as Mr. Greenspan indicated earlier, the Fed
needs some budgetary discipline from the Congress if monetary
growth rates are to be brought down and kept down, as we will see
in a moment.
The inflation rate depends heavily on the growth of the money
stock, but also on the growth of real output and on changes in the
velocity of money. For 20 years the velocity of M2 has been almost
constant, fluctuating between 2.2 and 2.4.
Suppose it stays constant in the future. Real output will probably
grow about 3 percent a year., Ten, if M2 grows at 3 percent a year
to match real output, the price of output will stay constantinflation will be zero.
This is the basis of my recommendation 1(a), that the average
growth rate of the M2 money stock should be about 3 percent a
year. The reduction should be made gradually, over a period of
years, for the reasons to be discussed later.
I will venture the prediction that over the next 5 years, 1979-83,
the average annual inflation rate, based on the GNP deflator, will
be 1 to 5 percentage points below the average annual growth rate
experienced during the 5 years 1978-82 by M2 , provided that the
past relationship is not disturbed by major changes in technology
or government regulation, such as price controls, or interest rate
regulation.
Interest rates have risen to historic highs since the early 1960's.
This is chiefly because of inflation. Market interest rates include a
premium to allow for expected future inflation.
The only way to obtain and maintain low interest rates for the
future is to stop inflation. Then interest rates will come down, as
borrowers and lenders come to realize that the inflation is done
with.
In a hearing before a House subcommittee a year ago, I said:
If monetary policy maintains the growth rate of the monetary base at 8 or 9
percent a year in the future, interest rates will rise somewhat more, and will settle
somewhat above 8 or 9 percent, in or near the 10 to 14 percent range.
This prediction has come true.
I See the "Economic Report of the President," January 1979, p. 74.
191
A persistent large budget deficit requires the Treasury to issue
new securities continuously to finance it. If the Fed did not buy
any of them, they would have to be sold to private lenders.
That would push interest rates up, without inflation, and crowd
out some of the private investment we need for growth. Hence the
Fed is pressed to buy a good share of them. But that means a large
increase in the monetary base. And that means more inflation.
The conclusion is that persistent large deficits are bad, because
their financing will either cause inflation, or risk crowding out
private investment.
If the deficit were to amount to 1 percent of GNP on the average,
this would permit about a 3 percent annual average rate of increase in the monetary base and in the privately held Federal debt,
since annual GNP, now $2,100 billion, is equal to about three times
the sum of the monetary base, $140 billion, plus private holdings of
Federal debt-$509 billion.
This is the basis of the part of my recommendation 2 that says
the deficit should be small, about 1 percent of GNP on the average.
President Carter's fiscal 1980 budget provides for a deficit of $29
billion, which is 1.2 percent of predicted GNP. This is a welcome
improvement over the large deficits of 1975-77. It is just about
right. Bear in mind, however, that if 1979 and 1980 bring the
recession that some people expect, then the deficit will go up and
GNP will fall short, so the deficit will exceed 1.2 percent of GNP.
In the 30 years from 1900 through 1929, the average overall
unemployment rate for the United States was 4.6 percent. For the
31 years, 1948-78, it was 5.1 percent. For 1970-78, it was 6.2 percent.
With present labor-market policies, it appears unlikely that the
average unemployment rate over the next several business cycles
will be as low as 6 percent. More about this later.
Part II of my prepared statement deals with short-run effects.
The first concerns monetary growth.
The experience of many countries shows that, if the rate of
growth of the money stock is increased, the first effect is a temporary improvement in output and employment. This wears off after
3 or 4 years, even if the growth rate of the money stock is kept
high.
The second effect, if monetary growth is kept high, is a corresponding increase in the inflation rate.
In the last half century we have had only three episodes in
which the annual unemployment rate was below 4 percent for 2
consecutive years or more. They were all wartime episodes in
which the growth rate of the money stock was increased, followed
first by temporary low unemployment for 3 to 6 years, and then
followed by the return of unemployment to normal levels, together
with increases in the rate of inflation.
The three episodes were in 1943-48, 1951-53, and 1966-69. After
the first two, the growth rate of the money stock was decreased
and the inflation subsided. After the third, the growth rate of the
money stock was increased further, and the inflation accelerated,
but the improvement in unemployment was still temporary.
192
Decreases in the growth rate of the money stock appear to have
similar effects, in reverse. First a temporary decline in output and
then a reduction in inflation.
The moral is that substantial abrupt variations in the rate of
growth of the money stock are bad policy. This is the basis of my
recommendation 1(b) calling for a fairly steady growth rate of the
money stock. And it explains why my proposed reduction in monetary growth rates should be gradual, not sudden.
The effect of amphetamines on the human body is analogous to
the effect of changes in monetary growth rates on the economy. An
injection of amphetamines produces a short-lived high.
Some people develop a tolerance to the high. They escalate the
size of the injection in order to repeat or continue the high. This
results in undesirable side effects, loss of appetite and weight,
paranoia, and sometimes violent aggression. In some cases there
are withdrawal symptoms.
It is better not to embark on such highs in the first place.
Similarly, it is better not to use increases in monetary growth rates
to achieve highs in output and employment, because the inflationary side effects become intolerable, and then one must endure the
withdrawal symptoms in order to get rid of the inflation.
This is the meaning of my recommendation 3.
Monetary growth rates were kept high, on the average, insuring
continued high inflation, for the 8 years from late 1970 to October
1978. Since October, monetary growth rates have decreased considerably, as shown on table 2, attached to my oral statement. The
growth rate of the monetary base has declined 2 percentage points.
Ml has not only stopped growing, it has actually declined. But M,
is no longer a reliable policy indicator, because depositors are now
switching from demand deposits to time deposits to take advantage
of the new automatic transfer service that became permissible on
November 1. There is an estimate of the amount of this which is in
the economic report on page 50.
The growth of M2 has slowed greatly, but the growth of large
CD's, which are not in M2 , has accelerated. M4 , which is M2 plus
large CD's, has grown more in line with the monetary base.
The gradual reduction in the growth rate of the monetary base
that the Fed has brought about since October is just about right, in
my view, provided that it is continued gradually and steadily for
the next several years until about a 3-percent rate, consistent with
zero inflation, is attained.
The best speed of reduction is probably somewhere about onehalf percent to 1 percent a year. This is a guess on my part. We
really don't know too much about that but I think that would be
slow enough to involve little risk of creating or exacerbating any
recession or depression.
This will take 5 to 10 years. The reduction process should be
carried to completion even if we get into a recession. Otherwise,
inflation cannot be stopped.
President Carter's wage and price standards can be helpful if
they are accompanied by steady reductions in monetary growth. If
not, the standards will serve only to erode further the credibility of
Government officials who claim to oppose inflation.
193
The budget deficit automatically rises in recession, and falls in
prosperity. This exerts an automatic stabilizing effect. Additional
budget stimulus, if it is begun quickly in recession and phased out
in recovery, can be helpful.
Changes in Federal spending, unlike changes in the growth rate
of the money stock, do not appear to have important delayed
effects on employment or prices. Hence they are relatively well
suited to countercyclical variations in the deficit.
I might add one reason I believe this is because of some work
that Professors Modigliani and Ando did with their econometric
model which comes to this conclusion. That is why I differ slightly
with the policy recommendation they made in December.
But variations in the deficit must be financed by variations in
the Treasury's debt sales to the private sector, not to the Fed, if the
growth rate of the monetary base is to be kept steady.
In brief, my recommendation 4 would include the following
measures: Abolish the minimum wage law, or at least exempt
teenagers. Maintain the unemployment compensation program,
and lengthen the period of eligibility to 1 year, but let it begin only
after 30 days of unemployment. Continue job training programs for
the disadvantaged. Replace the welfare program with a negative
income tax. And for the long run, improve elementary and high
school education so that every child learns to read and write. A tall
order, I know.
In summary, my program is this:
One: Keep the growth rate of the money stock slow and fairly
steady.
Two: Keep the budget deficit small on the average, but let it vary
countercyclically. Finance its variations by varying Treasury debt
sales to private lenders.
Three: Don't use monetary policy for temporary highs of employment, lest you get long-lasting inflationary after-effects.
Four: Work on unemployment with labor-market and humanresources policies.
This program will not abolish all recessions. It will not keep the
overall unemployment rate from going above 7 percent sometimes,
in recessions. I know of no program that will.
But after an adjustment period of 5 to 10 years, this program
will permanently eliminate inflation, permanently lower interest
rates, prevent major depressions or at least make them very rare,
and bring a modest improvement in unemployment.
Further, it will provide assistance for those afflicted by the consequences of recessions.
Thank you.
[Tables 1 and 2 referred to in Mr. Christ's oral statement, together with his prepared statement, follow:]
TABLE 1.-INFLATION AND THEGROWTH OFMONEY STOCKS
growth
rates(percent)
annual
Average
toDecember)
(December
Period
1948 to 1961 ............................
1970 to 1978 ............................
(CPI)
Inflation
1.7
6.9
Monetary
base
1.6
8.4
M2
3.4
9.4
194
TABLE 2.-MONETARY GROWTH RATES BEFORE AND AFTER OCT. 18, 1978
Annual
growth
rates
(percent)
stock
Type
ofmoney
Monetary base ........................................
ml............................................................................... I..............................
M2.........................................................,.........,..................,......,...............
.............................
M
2 plus large CD's ...........
4 equals M
First10months
of 1978
10
sinceOct.18,1978
8
8
-. 2...
9
1
6
10
PREPARED STATEMENT OF CARL F. CHRIST
I am glad to be here this morning to discuss the best mix of monetary and budget
policy.
The program I advocate can be summarized in four main recommendations. Let
me first list the results that can realistically be expected to occur under this
program, after a suitable transition period. They are:
(a) Zero inflation, permanently maintained.
(b) Permanently low interest rates.
(c) Absence, or at least extreme rarity, of major depressions.
(d) Routine occurrence of mild recessions.
(e) An overall unemployment rate averaging about 6 percent, varying between
perhaps 5 percent in prosperity and 7 or 8 percent in recessions.
The four main policy recommendations are as follows. The third one is listed first.
3. Manage stabilization policy with due regard for the analogy between its effects
on the economy and the effects of amphetamines on the human body.
1. After a transition period starting immediately, keep the rate of growth of
growth of the Mz money stock:
(a) low on the average, about 3 percent a year, and
(b) fairly steady, usually between 2 and 4 percent, and always between 1 and 5
percent.
(These numbers may need to be revised very slightly, every 5 years or so.)
2. Provide countercyclical variation in the Federal deficit, from about zero in
prosperity to perhaps 2 percent of GNP in the normal mild recession, and averaging
about 1 percent of GNP.
4. Use labor-market and human-resources policies to reduce unemployment and/
or to assist those who suffer from it.
1. LONG-RUN EFFECIS
A. Inflation
The average inflation rate in 1948-1961, as measured by the consumer price
index, was 1.7 percent a year. In 1966-1978 it had risen to 6.2 percent a year. And
in 1978 it was 9.0 percent, December to December.
In every country and every era of which I have knowledge, the rate of inflation is
inseparably connected with the rate of growth of the stock of money. The U.S. is no
exception. When inflation was 1.7 percent a year, in 1948-1961, the average annual
monetary growth rates were small: 1.6 percent for the monetary base, 2.2 percent
for Ml, and 3.4 percent for M2. When inflation had grown to 6.2 percent a year, in
1966-1978, the monetary growth rates were correspondingly higher: 7.4 percent for
the monetary base, 6.2 percent for Ml, and 8.8 percent for M2.
Theory and experience make it clear that inflation cannot be stopped until these
growth rates are reduced to near zero and kept there, whereas inflation will be
stopped if that is done. The Federal Reserve System is the agency that controls
these growth rates. But the Fed needs some budgetary discipline from the Congress
if monetary growth rates are to be brought down and kept down, as we will see in a
moment.
B. The money stock
The inflation rate is mathematically equal to the growth rate of the money stock,
plus the growth rate of the velocity of circulation of that same money stock, minus
the growth rate of real output. Now real output can be expected to grow about 3
percent a year on the average (see last month's ERP, Economic Report of the
President, p. 74). The velocity of circulation of M2 has stayed virtually constant
since 1959, ranging between 2.23 and 2.42. If M2 were made to grow at 3 percent a
year in the future, and if its velocity of circulation were to stay constant, and if real
195
output were to grow at 3 percent a year, then the inflation rate would be zero. This
is the basis of my Recommendation 1(a), that the average growth rate of the M2
money stock should be about 3 percent a year. The reduction should be made
gradually, over a period of years, for reasons to be discussed later.
Of course you will have noticed that the different concepts of the money stock do
not all behave in the same way. For example, M, has grown more slowly than M2
since World War II, and its velocity has increased gradually. This is because time
deposits (which are in M2 but not in M.) have become steadily more attractive as
compared with demand deposits and currency (which together make up M,), in two
respects. First, interest rates paid on time deposits have increased steadily, while
demand deposits and currency yield no interest. Second, the transfer of funds
between time and demand deposits has been made progressively easier. The latest
development of this kind occurred last November 1, when automatic transfer of
funds from time to demand deposits became permissible. Under this arrangement,
you keep a zero balance in a checking account, and an interest-earning balance in a
time deposit at the same bank. Whenever a check you've written is presented to the
bank for payment, the bank automatically transfers the amount of the check from
your time deposit to your checking account and then immediately pays the check.
Thus you earn interest on all your funds all the time. This innovation induced
depositors to shift about $1.6 billion of balances from demand deposits to time
deposits during November and December (ERP, p. 50). The shift will probably
continue. Thus the velocity of M. will probably continue to increase. Therefore the
growth rate of M2 will continue to be a more reliable predictor of inflation than that
of Ml.
I will venture the prediction that over the next 5 years, 1979 through 1983, the
average annual inflation rate (based on the GNP deflator) will be below, by 1 to 5
percentage points, the average annual growth rate experienced during the 5 years
1978-1982 by M2, provided that the past relationship is not disturbed by major
changes in technology or government regulation (such as price controls, or interestrate regulation). If such changes do occur, it should be possible to assess the
direction and magnitude of their effect, and adjust the prediction accordingly.
C. Interest rates
Since World War II we have seen not only a rise in the inflation rate, but also a
rise in interest rates. These two phenomena are closely related. Interest rates set by
bids and asks in the market are the sum of two components: the expected rate of
inflation over the course of the loan, plus the real rate of return that the parties
expect will be paid and received after allowance is made for the decline in the
purchasing power of money during the life of the loan. The real rate of return has
not changed much. To illustrate, in the 1950's when inflation was at about 2 percent
a year, mortgage rates were about 41/2 percent, for a real rate of return of about 21/2
percent. Recently, inflation has been running between 7 and 9 percent, while
mortgage rates have climbed to above 10 percent, again for a real rate of return in
the neighborhood of 2 /2 percent.
The only way to obtain and maintain low interest rates for the future is to stop
inflation. Then interest rates will come down, as borrowers and lenders come to
realize that the inflation is done with.
In a hearing before the Domestic Monetary Policy Subcommittee of the House
Banking Committee on January 30, 1978, I said, "If monetary policy maintains the
growth rate of the monetary base at 8 or 9 percent a year in the future, interest
rates will rise somewhat more, and will settle somewhat above 8 or 9 percent, in or
near the 10- to 14-percent range." In fact the monetary base was made to grow 9
percent in the last 12 months, and in fact mortgage rates and the prime rate are
now in the 10- to 14-percent range.
D. The budget
Why did the Federal Reserve cause, or permit, the stocks of money to grow so
fast, beginning gradually in 1961, accelerating in 1967, and accelerating again in
1970 and 1971? In 1961 it may have been associated with the attempt of the new
Kennedy administration to stimulate the economy in order to reduce unemployment
below the 5.5 percent rate which had prevailed in the recovery of 1959-1960. In 1967
it was presumably associated with the deficits incurred by increased Viet Nam war
expenditures without a general tax increase. In 1970-71 it may have been associated
with the Nixon administration's abandonment of the 1969-1970 policy of monetary
and fiscal restriction, in favor of price controls to suppress inflation, and stimulative
monetary and fiscal policy to increase employment and output. The budget has been
in deficit every year from 1970 onwards. The deficits were unusually large in the
calendar years 1975, 1976, and 1977 by post-World War II standards. Expressed as
196
percentages of GNP they were respectively 4.6, 3.2, and 2.5 percent, on the national
accounts basis.
A persistent budget deficit has to be financed by Treasury borrowing, either from
the Federal Reserve, which increases the monetary base (in effect printing money),
or from private lenders (including foreigners), or some mixture of the two. We have
seen that to avoid inflation, the growth rate of the monetary base must be kept
small. Hence if we have persistent large deficits they must not be financed by large
increases in the monetary base . . . then they must be financed by borrowing from
private lenders. But if persistent large deficits are financed by large sales of Treasury bonds on the private market, this will drive up interest rates (even without
inflation), and may crowd out the private capital formation that we need for future
growth. That is why large deficits create pressure on the Federal Reserve to raise
the monetary base. The conclusion is that persistent large deficits are bad, because
their financing will either cause inflation, or risk crowding out private investment.
If the deficit were to amount to 1 percent of GNP on the average, this would
permit about a 3 percent annual average rate of increase in the monetary base and
in the privately held Federal debt, since annual GNP (now $2100 billion) is equal to
about 3 times the sum of the monetary base ($140 billion) plus private holdings of
Federal debt ($509 billion). This is the basis of the part of my Recommendation 2
that says the deficit should be small, about 1 percent of GNP on the average.
President Carter's fiscal 1980 budget provides for a deficit of $29 billion, at an
estimated GNP of $2510 billion, which is 1.2 percent of GNP. This is a welcome
improvement over the large deficits of 1975-1977. It is just about right. Bear in
mind, however, that if 1979 and 1980 bring the recession that some people expect,
then the deficit will exceed $29 billion and GNP will fall short of President Carter's
estimate, so that the actual deficit will exceed 1.2 percent of GNP.
E. Unemployment
In the years from 1900 through 1929, the average overall unemployment rate for
the U.S. was 4.6 percent. For 1948-78 it was 5.1 percent. For 1970-1978 it was 6.2
percent. The annual figure has not been below 4.9 percent in 1970-1978, and has not
been below 6.0 percent in 1975-1978. With present labor-market policies, it appears
unlikely that the average unemployment rate over the next several business cycles
will be as low as 6.0 percent. I will make a few suggestions about this later.
II. SHORT-RUN EFFECTS
A. Monetary growth
The experience of many countries since World War II indicates that, following a
period during which the expected rate of inflation matched the actual, if the rate of
growth of the money stock is increased, the first effect is a temporary improvement
in output and employment. This wears off after perhaps 3 to 4 years, even if the
growth rate of the money stock is maintained at its new higher level. The second
effect, if the growth rate of the monetary stock is kept high, is a corresponding
increase in the inflation rate.
In the last half-century in the U.S. (i.e., since we have had good unemployment
statistics) there have been only 3 episodes in which the annual unemployment rate
was below 4 percent for two consecutive years or more. They were all wartime
episodes in which the growth rate of the money stock was increased, followed first
by temporary low unemployment for 3 to 6 years, and then followed by the return
of unemployment to normal levels, together with increases in the rate of inflation.
The 3 episodes were in 1943-48, 1951-53, and 1966-69. After the first two episodes
the growth rate of the money stock was decreased and the inflation subsided. After
the third episode the growth rate of the money stock was increased further, and the
inflation accelerated, but the improvement in unemployment was still temporary.
Decreases in the growth rate of the money stock appear to have similar effects, in
reverse: first a temporary decline in output and employment, and then (if the lower
monetary growth rate is maintained) a reduction in the inflation rate.
Recent research has produced theoretical economic models of this process, incorporating the effects of changes in the public's expectations about inflation. These
models are consistent with the experience of the U.S. and some dozen other countries.
The moral is that substantial rapid variations in the rate of growth of the money
stock are bad policy. Increases in monetary growth bring good effects on employment and output, but only temporarily, followed later by long-lasting bad effects in
the form of faster inflation. In order to get rid of the faster inflation, it is necessary
to reduce the monetary growth rate, which brings temporary bad effects on employment and output, and then eventually the long-lasting good effect of reducing the
197
inflation rate. This is the basis of my Recommendation 1(b) calling for a fairly
steady growth rate of the money stock.
It also explains why a transition period would be prudent for reducing monetary
growth from the high rates of the last dozen years to the low rates that are
imperative for stable prices.
B. The amphetamines analogy
The effect of the amphetamines on the human body is analogous to the effect of
changes in monetary growth rates on the economy. An injection of amphetamines
produces a short-lived "high." Some people develop a tolerance to the high: They
escalate the size of the injection in order to repeat or continue the high. This results
in undesirable side-effects: loss of appetite and weight, paranoia, and sometimes
violent aggression. In some cases there are withdrawal symptoms. It is better not to
embark on such highs in the first place. Similarly, it is better not to use increases in
monetary growth rates to achieve highs in output and employment, because the
inflationary side-effects become intolerable, and then one must endure the withdrawal symptoms in order to get rid of the inflation. This is the meaning of my
Recommendation 3.
C Current monetary policy
Monetary growth rates were kept high, and fairly steady, insuring continued high
inflation, for the twelve years from 1967 to October, 1978. Since October, monetary
growth rates have decreased considerably. As compared with the first 10 months of
1978, annual growth rates since October 18 have declined as follows:
Percent
1978
(Ist 10mos.)
The monetary base .10
ml8.............................................................................................................8
M2.............................................................................................................9
M4(M2 plus large CD's) .10
Since
Oct.18,1978
8
- 2
1
6
The actual decline in the level of M, (corresponding to its negative growth rate)
arose because of shifts out of demand deposits and into time deposits, in response to
the automatic transfer service that became available on November 1. This was
noted earlier.
The sharp decline in the growth rate of M2 is associated with a relative shift of
time deposits into large CD's (certificates of deposit, which are not included in M2)
and out of other kinds which are included in M2 . M4 , which is the sum of M2 plus
large CD's, is unaffected by this shift. Its growth-rate decline has been more moderate, from a 10 percent rate to a 6 percent rate, and has approximately matched the
decline in the growth rate of the monetary base.
The gradual reduction in the growth rate of the monetary base that has been
brought about by the Federal Reserve since October is just about right, in my view,
provided that it is continued gradually and steadily for the next several years until
about a 3 percent rate, consistent with zero inflation, is attained. The best speed of
reduction is probably somewhere around 1/2 percent to 1 percent a year, slow
enough to involve little risk of creating or exacerbating any recession. This will take
5 to 10 years. The reduction process should be carried to completion even if we get
into a recession. Otherwise inflation cannot be stopped.
D. The wage and price standards
President Carter's wage and price standards are meant to encourage people to
reduce the rates of increase of wage and prices in 1979. Such standards are of course
unnecessary once monetary growth rates have been brought down to noninflationary rates and kept there. Standards can be helpful at a time like the present,
however, if they are accompanied by steady reductions in monetary growth. If not,
the standards will serve to erode further the credibility of government officials who
claim to oppose inflation.
B. The budget
Even if the Congress were in a permanent recess, a business cycle would influence
the Federal budget. On the revenue side, tax revenues rise and fall with incomes
and output. On the expenditure side, many Federal programs automatically in-
198
crease expenditure when inlcome and output fall. Thus, with no change in the law at
all, deficits will increase in recession, and in prosperity they will decline, possibly
even changing to surplus (though this has happened only once since 1960). Such
automatic variation in the deficit is a good thing in at least two respects. First, the
additional expenditures in recession cushion people against the ill effects of unemployment and reduced incomes. Second, the increased deficit reduces the depth of
the recession and hastens recovery. Similarly, the decreased deficit in prosperity
moderates the recovery and eases the jolt that can occur when the economy comes
up too fast against the ceiling imposed by its productive capacity.
In a recession, the Congress usually enacts additional spending programs to
combat the recession. There is some debate about what kinds of programs can be
turned on and off quickly enough to be worth while. Those that get started quickly,
and are phased out when recovery occurs, are probably helpful. Changes in Federal
spending, unlike changes in the growth rate of the money stock, do not appear to
have important delayed effects on employment or prices. Hence they are relatively
well suited to countercyclical policy. This is the basis for the part of my Recommendation 2 that advocates countercyclical variations in the deficit.
If the growth rate of the monetary base is to be kept steady, as I have argued it
should be, then the countercyclical variations in the deficit should be financed by
variations in the amount of Federal debt sold to private lenders. This will help to
smooth out the cycle in interest rates, for the largest Federal borrowing will occur
during recessions when private borrowers are lying low and interest rates typically
fall.
Ill. UNEMPLOYMENT
Suppose we decide to keep the money stock growing slowly and steadily, that is,
we do not use monetary policy to try to control unemployment. Suppose further
that countercyclical deficits do not bring unemployment as low as we would like it.
Are any other alternative policies available to deal with it? Yes, there are. They are
not the main subject of this hearing, but I want to mention them since I have ruled
out monetary policy for this purpose.
The overall unemployment rate appears to be about two percentage points higher
nowadays than it was in the 1950's. About half of one percentage point is due to
changes in the composition of the labor force (ERP, p. 119). Apart from that,
different groups in the labor force have had very different increases in unemployment. Consider these comparisons between 1956 and 1978, both prosperous years.
The overall rate rose 2 percentage points. Adult males, both black and white, had
small increases: about 1 percentage point. So did adult white females. Adult black
females had an increase of 3 points. White teen-agers had increases of 3 points for
males and 5 points for females. Black teenagers had by far the largest increases, 19
points for males and 16 for females. Black teen-age unemployment actually rose
during the recovery from the recession of 1954, while the overall unemployment
rate was declining. Black teen-age unemployment for 1978 was 34 percent for males
and 38 percent for females.
Surely the decline in the quality of the high school diploma has been partly
responsible. Recently the Baltimore school system announced that henceforth students will not be graduated from high school unless they can pass a so-called
survival reading skills test, which requires them to understand a job application
form, the instructions on a packaged food product, and the like. This strongly
suggests that some students have been graduated in the past without even such
rudimentary competence.
The minimum wage, now at $2.90 an hour or $5,800 for a year of 50 40-hour
weeks, is partly responsible. It is a type of price control. Like all price controls, it
has the effect that some of those it is ostensibly designed to protect are excluded
from the marketplace altogether.
The strengthening of unemployment compensation is also partly responsible. But
is it not a good program anyway?
In brief, my Recommendation 4 would include the following measures: Abolish
the minimum wage law, or at least exempt teen-agers. Maintain the unemployment
compensation program, at a level significantly below the income lost through unemployment, and lengthen the period of eligibility to one year, but let eligibility begin
only after 30 days of unemployment. Continue job training programs for the disadvantaged. Replace the welfare program with a negative income tax. And for the
long run, improve elementary and high school education so that every child learns
to read and write. A tall order, I know.
199
IV. CONCLUSION
In summary, my program is simple. (1) Keep the growth rate of the money stock
slow and fairly steady. (2) Keep the budget deficit small on the average, but let it
vary countercyclically. Finance its variations by varying Treasury debt sales to
private borrowers. (3) Don't use monetary policy for temporary highs of employment, lest you get long-lasting inflationary after-effects. (4) Work on unemployment
with labor-market and human-resources policies.
This program will not abolish all recessions. It will not keep the overall unemployment rate from going above 7 percent sometimes, in recessions. I know of no
program that will.
But after an adjustment period of 5 to 10 years this program will permanently
eliminate inflation, permanently lower interest rates, prevent major depressions or
at least make them very rare, and bring a modest improvement in unemployment.
Further, it will provide assistance for those afflicted by the consequences of recessions.
Thank you very much.
200
MONEY MARKET RATES
W.tIL,
1973
1974
of
AVILAINS
1975
01ILY FICERES
1977
1976
1978
LATESTDATAPLOTTEO.OGE.SEU
R3USSSSIN OF5St.LIS
PANPXED BYFEDEtRAL
LONG-TERM
RCENT
INTEREST
oF GAIY
W.TThTLAVEEAC*ES
RATES
FERCEIN
FPAES
a
T
6
5
1973
1974
1975
1976
1977
Is9r
TASIEDLIES 1II1CITEDATANAT A'AI.ALE.
IEIFR*O-TLABtBTTC*NEN.
TM.ITLY AEIECS OF et'IIAYVIItES.
... EhO'
" I'S .s5
...
1t DU RCi^L
J^V"Esl or "L"lo og coro
nOmE.
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INE OS tI
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OTIETR-NOTtNEV
PLOrED. FHA-WTA,
LATENTDATA
II
BANEVSoNE.L*
O- FEOEI.L ENSEWAE
PSEPARED
201
a'
GROSS NATIONAL PRODUCT
RATIO SCALE
RATIO SCALE
OUARTERLYTOTALS AT ANNUAL RATES
TRILLIONS OF DOLLARS
SEASONALLY AOJUSTED
TRILLIONS OF DOLLARS
2 2
_
_2_2
2.1~~~~~~~~~~~~~~~~~~216
2. 0
I.8
2 C
DOLLARS
-CURRENT
/1.8
1.7
.I.
1.6
I1.6
1.5
1
_
I 2
I. 5
*I.
7
1.6
0.9
0.
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s0 28
k
~4Z
0.8~~~~~~~~~~~~~~~~~~~.
+6.
_ 9 _
I1 3
1.2
__
1. I
I.O
0
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-0
197T2DOLLARS.
_
1970
_
_.
j
.9
0.8
__
__
t
1971
1972
_
1973
1.0
k, _t
-
t
1974
0.9
1975
t
1976
SCURCEEU.S.
PERCENTAGESARE ANNUALRATES OF CHANCEFRR PERIODS INDICATED.
_
1977
40.8
1978
DEPARTMENTRF COMMERCE
LATEST SATAPLOTTEO: 3RD OUARTER
PREPARES BY FEDERALRESERVEBANK OF ST. LOUIS
202
9
INDEX X
PRICE
GENERAL
RATIO SCALE
AT110 SCALE
191-100
160
=
-
155
=
=
=
_
l
_.jarv
__
-.6
1970-100
160
150
J.
ISO.',~~~~~~~~~~~~~~~~~~~~~~14
45
135
130
I.,
30
I20
=
115
°s5
-
100
-
=
=
=
-
-
Z
=
=
=
r-i
_
=
=
0 0
-
.....
=100
~~~~~~9s
So~~~~~~~~~~~~~~~9
I
0
0
.....
19 7 3
197 4
6~~~~~~~~~e
0
6~~~~~~~~D
6
0 00
2_
-
+
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11 10
10s°
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t
Io
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-
..6 _,!,911
5
IST
19 7......
.1.
_T . .. _
,
"I
L
-r...
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t
,._
-
-rs.s
GOVERNMENT DEBT
OWNERSHIP OF FEDERAL
OF END-OF-MONTHFIGURES
OUARTERLY AVERAGES
SEASONALLYADJUSTED
60010 SCALE
o0 D0LLSt
BILLI"OS
7500
Too___
1
c0 71 601.0
l l
11
650
600
550
_
_
=tro
.'.....62_
-0II
I
I±-----4-I
500
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I7
150
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-
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.1 961 1962 19631 964 1965 I6
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9
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19s958 1959 16
203
MONETARY BASE
AND ADJUSTED FEDERAL RESERVE CREDIT
RAT IO SCALE
MUONTHLY
AVERAGES OF DAILY FIGURES
RAT IO SCAL
BILLIONS OF DOLLARS
SEASONiLLY ADJUSTED
BILLIONS OF DOLLAF
I'
140
1.35
130
125
120
1 15
UONEARYBAS E U-
/
I;
I:
1 10
5
8. 4Z37
/
105
100
95
90
.r
0.7.'A
ZVOr'"I.flO
85
-f9.Wf
t 122.
80
75
70
\
A6-5
V.
1973
1974
1975
1976
1977
1978
[LOSES OF THE MONETARY BASE ARE MEMBER BANK RESERVES AND CURRENCY HELD BY THE
PUBLIC AND NONMEMBER BANKS. ADJUSTMESNTS ARE MADE FOR RESERVE REQUIREMENT
CHANGES AND SHIFTS IN DEPOSITS AMONG CLASSES OF BANKS. DATA ARE COMPUTED BY
THIS BANK.
IZFEDERAL RESERVE CREDIT CONSISTS OF FEDERAL RESERVE HOLDINGS OF SECURITIES,
LOANS
FLOAT AND OTHER ASSETS. ADJUSTED FEDERAL RESERVE CREDIT IS COMPUTED
BY SU6TRACTING TREASURY DEPOSITS AT FEDERAL RESERVE BANKS FROM THIS SERIES.
AND ADJUSTING THE SERIES FOR RESERVE REOUIREMENT RATIO CHANGES AND SHIFTS
IN THE SAME TYPE OF DEPOSITS BETWEEN BANKS WHERE DIFFERENT RESERVE REQUIREMENT RATIOS APPLY. DATA ARE COMPUTED BY THIS BANK.
PERCENTAGES ARE ANNUAL RATES OF CHANGE FOR PERIODS INDICATED.
LATEST DATA FLOTTEDs NOVEMBER
PREPARED BY FEDERAL REISEIVE BANK OF ST.LOUIS
I.
204
MONEY STOCK
W
RATIO SCALE
FURS
,.
AssMIIEorO
SUIAALL $0CBTTSE
DOLLARS
BILLIONS OF
(Mi)
BILLIONS
IRATIO SCALE
OF DOLLARS
G7
370
_
360
350
350
2 40
J
340
330
330
320
320
.s~s.
3 10
r
300
_
f
-
280
,$.,ry
300
290
_
-J.
go
290
280
_
t
270
,
///
270
310
7
260
260
250
250
it
1S11
_____
1240
1977
1976
1975
1974
1973
1978
FORPEtIODS I.DICATED.
RATESOFCRABSE
ARE RIMSAL
ERCENTAGCES
LATESTOT PLOTTED. RWAEMBEr
TESErTEPARKOF ST.LOTiS
PrEFASEo ST rEDERAL
(M2 )-
MONEY STOCK PLUS NET TIME DEPOSITS
RATIO SCALE
BILLIONS OF DOLLARS
_To.:
880
rR
RATIO SCALE
FGLGPI
a FrAIL,
DLTRRASRTR BILLIOhS OF DOLLARS
880
R'2
860
840
820
800
'860
840
820
5Sf
780
760
7401J
800
780
760
,
Il740
880
61
660
640
6
Ad
51
820
81
600
580
5I
A
5605
5405
52 0S~fO
500
dl
I
1973
-
-SlA'4f
1974
1975
ISl
1976
_
1977
vl
-
fl
5
5
1978
WET
TIES ATTBRRR
TI,!BEFOSITS
AEPOSITS.
IRTITOS
TRSARTAzrOSITS.
LLTURBRRCT.
BATIB
TL Cr C.-AGEFOr FUISDS IROAIUTEZ.
AGETE A
PERC.ATS
LATST OITAFLITEIC. RR1MABR
r
to, EDErAhXELj
..
,.E^^l
oF ST.tc"I
205
Senator PROXMIRE. Thank you very much, Mr. Christ.
Ms. Barrett, please proceed.
STATEMENT OF NANCY S. BARRETT,' DRECTOR, PROGRAM OF
RESEARCH ON WOMEN AND FAMILY POLICY, THE URBAN INSTITUTE, WASHINGTON, D.C., AND FORMER DEPUTY ASSISTANT DIRECTOR, FISCAL ANALYSIS DIVISION, CONGRESSIONAL BUDGET OFFICE
Ms. BARRETT. I would like to turn to the question of the Presi-
dent's recent budget proposals and trends in monetary policy.
As you know, President Carter has proposed a fiscal policy for
1980 that reflects a conscious effort to convince the American
people that the administration views inflation as the Nation's No. 1
economic problem and that it is serious about bringing inflation
under control.
The President's Economic Report stresses the switch in emphasis
away from a budget designed to strengthen growth in real economic activity toward one designed to restrain inflation. The budget
proposes spending cuts relative to current policy that would produce a decline of about $15 billion in the high employment deficit
relative to fiscal year 1979.
Interest rates have been rising at an alarming pace since mid1978. However, until November, it was not clear whether rising
interest rates were due to unusually rapid growth in the demand
for money, with the Fed attempting to accommodate credit demands at higher interest rates, or to a conscious effort on the part
of the Fed to restrain credit.
In November, a major shift in monetary policy was announced
that committed the Fed to maintaining high interest rates for
purposes of supporting the international value of the dollar.
Since then there has been a substantial slowdown in the growth
rate of the monetary aggregates, although there is evidence that
this slowdown is partly due to institutional factors and is not
directly tied to the defense of the dollar.
My testimony today will address the following questions:
Will the fiscal year 1980 budget proposed by the President and
restrictive policies of the Fed have an adverse macroeconomic
effect on the economy?
Will these actions help to bring down inflation?
What is the significance of the monetary/fiscal policy mix?
In view of these considerations, what is the appropriate congressional response?
Most forecasters are predicting a mild recession in the second
half of 1979. In my view, fiscal policy is not flexible enough to
offset the downturn entirely. Substantially lower interest rates, on
the other hand, would reduce the likelihood of a recession, since
the downturn is predicted on the probable adverse effects of tight
credit conditions on housing and consumer demand.
However, it is not altogether clear whether the Fed could, in
fact, take actions that would bring down the interest rate significantly by midyear unless inflation expectations are quickly brought
under control.
The views expressed in this statement are those of the author and not of any organization
with which she is or has been affiliated.
47-106 0 - 79 - 14
206
Turning first to the adequacy of the fiscal policy contained in the
President's budget, the main question is whether there is enough
underlying strength in the economy to keep the recession of short
duration as the President's spending cuts are put into place. The
answer to that question requires a look at longer term trends in
real growth in the economy.
We know that despite robust growth in employment since the
1974-75 recession, the recovery has been problematic. The principal
sources of strength have been in housing and spending on consumer durables, both fueled by an inflationary psychology, and until
recently, fairly accommodative monetary policy.
Consumer indebtedness has continued to outpace growth in disposable income, and the demand for housing has remained high in
the face of rapidly rising interest rates. Most analysts are expecting the household saving rate to rise as consumers are forced to
reduce spending to pay off their indebtedness and as a decline in
consumer confidence breaks the buy-in-advance psychology.
At the same time, continued high interest rates are likely to
have an adverse effect on the housing market. The recovery has
been characterized by sluggish business investment, due in part to
the severity of the recession that left considerable excess capacity,
coupled with a low-pressure economic policy stance.
Low levels of capacity utilization remain even after 3½/2 years of
continual growth. Uncertainties posed by the Government regulatory environment, the future course of energy and raw materials
prices, and the possible reemergence of double-digit inflation have
also been factors in the general climate of pessimism that has
restrained business investment.
Unemployment, too, remains high relative to historical peaks,
and slack labor-market conditions together with relatively low
levels of capacity utilization have produced a recession mentality
that has contributed both to sluggish investment and to poor productivity performance.
In addition, the recession mentality has given impetus to compensatory pricing on the part of firms and to catchup wage demands by workers who have experienced little real gain in purchasing power since the recession.
These practices have contributed to inflation. Rising unit labor
costs in recent years have been more the result of this recession
mentality than of tight labor markets.
The international economic situation has also thrown a monkey
wrench into the recovery. Restrictive macroeconomic policies pursued by our major trading partners have restrained the growth of
our exports.
Together with the balance-of-payments problems associated with
oil imports, these policies have not only contributed to slow economic growth in the United States, but have placed the dollar
under considerable pressure. As mentioned earlier, pressure on the
dollar was the primary impetus for the Fed's shift to a more
restrictive monetary policy last November.
Of course, lurking behind all these factors is the persistent high
rate of inflation which has gained momentum over the past year.
Not only does the political reaction to inflation force the Government into a restrictive policy stance, but it also has direct adverse
207
effects on consumer and business confidence that can slow the rate
of macroeconomic activity.
What these observations add up to is a situation of considerable
downside risk in the macroeconomic forecast-a downside risk that
will be enhanced by the adoption of the President's budget.
If the higher interest rates cause a downslide in housing and
consumer spending, and there is already some evidence that this is
occurring, the outlook surely will not be good for business investment.
Exports and spending by State and local governments may provide a slight cushion to the downturn, although the latter will
certainly be restrained by the momentum of proposition 13-type
initiatives.
The main issue is whether monetary policy will ease sufficiently
to soften the downturn in housing and spending on consumer durables. There is very little upside risk in the administration's forecast
of real growth.
This means that a more stimulative fiscal policy than that proposed in the President's budget would not be likely to generate
excessive pressure on aggregate demand, should the Congress
prefer to challenge the President's decision to shift toward restraint.
The second issue in assessing the impact of fiscal policy concerns
the possibilities for the proposed budget to bring down the rate of
inflation. The inflationary momentum that has developed in the
economy is not primarily the result of excess pressure on capacity
or of tight labor markets.
Undoubtedly, there are isolated bottlenecks and some skills in
short supply. But given the proposed mix of spending cuts-reductions in social programs coupled with a real increase in defense
spending-there is no indication that the changes in spending
being proposed will be a moderating effect on prices and wages.
If bottlenecks and skill shortages occur, they are more likely to
be in defense-related sectors than in the labor markets most affected by social programs. Consequently, the only weapon that the
President's budget offers in the fight against inflation is psychological, that is, its impact on expectations. And there is no way to
predict how effective such a weapon will be.
Although most budget watchers have focused on the spending
side of the ledger this year, I would like to call the committee's
attention to the problem of fiscal drag that is increasing marginal
tax rates at the same time the President is calling for wage restraint.
Not only is inflation pushing people into higher brackets, but
payroll taxes are also increasing. These tax increases cannot help
but have an adverse effect on the credibility of government to
maintain real purchasing power in its wage-price program.
I think we can all agree that the effectiveness of monetary and
fiscal management is severely damaged by the persistence of inflation. As a consequence, every avenue should be sought to get
inflation under control through policies other than the painful and
costly recourse to monetary and fiscal restraint:
Monetary policy, in the past months, has taken a far more restrictive turn than the fiscal policy proposed in the President's
208
fiscal year 1980 budget. Whether the recent slowdown in the
growth of the monetary aggregates is a technical adjustment to
various changes in financial practices, or whether it portends a
longer term trend is debatable at the moment.
Year-over-year monetary growth has not been unduly restrictive.
There is not yet a liquidity shortage as occurred during the disastrous credit crunch of 1974. But if trends of the past few months
continue, a serious credit shortage and much deeper recession than
is now being predicted would undoubtedly occur, due to the severe
impacts on housing and consumer durables.
While there is uncertainty over the intent of the Fed regarding
the growth of the monetary aggregates, the November actions that
sharply raised interest rates to bolster the dollar were a clear
statement of the Fed's restrictive policy stance.
The Federal funds rate reached 10 percent in December and the
discount rate at 9.5 percent is at an alltime high. However, interest
rates began their sharp, upward climb well before the Fed's November actions, suggesting that increasing demand for money,
fueled by inflationary expectations, was at least partly responsible.
There is no question the monetary climate today is different
from the liquidity shortage of 1974-75 that produced such a deep
recession. There is no liquidity crisis now as there was in 1974.
Consumer indebtedness continues to rise and housing has not yet
been seriously impacted by double-digit interest rates. The buy-now
mentality of consumers combined with a demand for housing as a
hedge against inflation has increased the demand for money, even
at high interest rates.
Unlike the 1974 experience, high interest rates have not occasioned a massive outflow of funds from savings and loan institutions to the more lucrative Treasury bill market, because of the
new money market savings certificates introduced in spring, 1978.
However, and here I disagree with my colleague, Mr. Fair, even
in the absence of a liquidity shortage in savings and loans, if the
current high rates of interest persist, housing, and the demand for
consumer durables and some types of business investment, particularly new construction, will be adversely impacted. Moreover, a
liquidity crunch-that is, unavailability of funds even at high interest rates, would spell disaster.
A decline in interest rates is absolutely essential for the return
to normal, prosperous economic conditions. What remains to be
seen, however, is whether or not high interest rates are symptomatic of the inflationary momentum referred to earlier or whether
they can be reckoned with independently of policies to control
inflation.
Because the economic downturn is predicted to occur before the
President's fiscal year 1980 budget is actually in place, the ability
or willingness of the Fed to reduce interest rates and to head off a
liquidity shortage is in the short run far more crucial than Mr.
Carter's proposed spending limitations.
Although the ability of the Fed to accomplish a turnaround in
monetary policy depends in part on the success of the President's
anti-inflation program, the Fed should not be permitted to hide
behind the cloak of exchange rate considerations to justify a delib-
209
erate tightening of credit. It must be kept in mind that a stable
exchange rate is not in and of itself a goal of economic policy.
Finally, you asked me to comment on the general issue of the
monetary/fiscal mix, particularly with respect to Professor Modigliani's suggestion that there has been a policy bias toward slowing
inflation by monetary restraint and then dealing with subsequent
recessions by resorting to tax cuts and other stimulative fiscal
measures.
Although I have not read Professor Modigliani's testimony, you
alluded in your letter to the possible adverse effects of monetary
restraint on capital spending and the productivity lag of the last
few years.
First, I would like to emphasize that the key issue in macroeconomic policy today is not the monetary/fiscal mix, but how to
achieve a full-employment and full-capacity level of economic activity in an inflationary climate.
Economic stagnation, not tight money, is depressing. business
investment and retarding productivity growth.
This is not to say, however, that the monetary/fiscal mix will not
affect the sectoral composition of economic activity. But its effect
may be different from what the conventional wisdom would have
us believe.
The more heavily monetary relative to fiscal stimulus is relied
on, the greater impetus is given to the interest-sensitive sectors of
the economy to lead the growth'in real output; conversely, monetary restraint will have an adverse impact on the interest-sensitive
sectors of the economy.
But the fact is that business investment is not the most interestsensitive component of aggregate demand. In today's economy,
housing and spending on consumer durables will be the most heavily impacted by high interest. Not only are these components of
spending more interest-sensitive than most aspects of business investment, but households have replaced business enterprises as the
principal borrowers in credit markets.
I have provided a table at the end of my testimony which shows
this shift in the composition of private borrowing since 1970, away
from a situation in which businesses were borrowing twice as much
as households-and' I am talking here about nonfinancial businesses-to a situation in which households were borrowing about
50 percent more than businesses.
In 1970, the total funds raised in credit markets by business was
around $47 billion, nearly double the amount raised by households.
In 1977, households far surpassed the business sector in their
borrowing activity, raising $139.6 billion, compared with $91.3 billion in nonfinancial, nonfarm borrowing. Of this household borrowing, $96.4 billion was in home mortgages, and $35 billion was in
installment credit.
Business investment has been sluggish throughout the recovery,
largely because there has been a prolonged period of widespread
excess capacity. Government policies are likely to continue to produce a low-pressure demand environment.
Uncertainties regarding government regulations and the possible
resurgence of double-digit inflation have also contributed to the
reluctance of business firms to undertake new investments.
210
It is clear if you are uncertain about the demand environment, if
you are uncertain about the regulatory environment, if you don't
know what is going to happen to inflation, it is far less risky to
expand your output by increasing the number of workers and the
labor-capital ratio than by locking yourself into expensive new
plant and equipment.
Clearly, a decline in spending on consumer durables and in housing starts would precipitate a decline in business sales, compounding the disincentives for business investment. Moreover, some components of business investment, such as structures; are interest
sensitive, so that a more expansionary monetary policy could improve the investment climate, both directly and indirectly.
At the same time, however, the business community is uneasy
about what it views as excessive monetary growth. Tax relief in the
form of accelerated depreciation or increased investment tax credits has the potential for offsetting the adverse consequences for
investment of a tight money policy if an expansion of business
investment is desired.
As for the productivity slowdown, it is not clear that the monetary/fiscal mix per se has been nearly as important as the adverse
consequences of the prolonged period of economic slack and the
recession mentality it has produced. Again, imaginative tax policies
could offset some of the disincentives to investment that have crept
into the system in recent years.
A final note concerns the timing of shifts in the monetary/fiscal
mix, an issue raised by Professor Modigliani. It seems to me appropriate that fiscal stimulus is used to bring the economy out of
recession.
Accommodative monetary policy is, of course, desirable, but it is
a weak instrument taken alone without a direct impetus to real
spending. On the other hand, if monetary targets are set to accommodate a desired level of real income growth, an inflationary upsurge will result in a rise in interest rates.
In such a policy environment, the typical recovery would be led
by public-sector demand and would be choked off by a downturn in
housing and spending on consumer durables. The potential effects
of such cyclical behavior on business investment and long-run productivity growth are probably not nearly as significant as whether
the overall level of macroeconomic activity, on the average, has
been close or far from potential.
Thank you.
[The table attached to Ms. Barrett's statement follows:]
TABLE 1.-FUNDS RAISED INCREDIT
MARKETS
BY HOUSEHOLDS AND NONFINANCIAL, NONFARM
BUSINESS, 1970-78
[In billions
of dollars]
Household
borrowing
Business
borrowing
1970 .24.9
47.5
71 .45.2
1972 .64.3
1973 .80.9
1974 .49.2
1975 .48.6
56.1
72.4
85.5
89.2
39.0
211
TABLE 1.-FUNDS RAISED
IN CREDIT MARKETS BY HOUSEHOLDS AND NONFINANCIAL, NONFARM
BUSINESS, 1970-78-Continued
[In billionsof dollars]
Household
borrowing
1976 ...........
1977 .139.6
1978(3)X ................
.......................................................
.
899
.......................
...........
.
1 1
142.1
Business
borrowing
63.44...........
91.3
9..
96.2
6................
1978(3)refersto the3d quarterof 1978at a seasonally
adjusted
annualrate.
SourceEconomic
Report
of the President,
1979,tableB-62.
Senator PROXMIRE. Thank you.
I want to thank you all for excellent statements and very interesting conclusions and recommendations.
Mr. Greenspan, you were the first witness to testify. You blamed
much of our increase in spending on Congress. You indicate that
Presidents have been reasonably responsible in recent years but
that Congress has gone over the edge. The last study I saw indicated that of the last 25 years, in 24 Congress cut the President's
budget and in only 1 year, and I think that was when you were
Chairman of the Council, in 1974 or 1975, only 1 year did Congress
exceed the President's request; so that in every Ford budget except
one, all the Nixon budgets, all the Kennedy-Johnson budgets and
Carter budgets, the Congress has cut, reduced below the President's
recommendation. That was true in the Eisenhower years, too.
I recall last year the President recommended a budget of $12.5
billion above what we finally enacted. So, why do you conclude that
the main problem is lassoing and hogtying Congress, recognizing
that it is both the Executive and Congress sinning here?
Mr. GREENSPAN. Mr. Chairman, I am not certain that is my
position. I think I have argued it is the political process in general,.
and I don't recall stipulating that the Congress has been solely to
blame. And I don't recall making a specific statement that Presidents have in general been responsible and the Congress has not. If
I did, it is certainly an inadvertence and surely false.
Senator PROXMIRE. One of the reasons I raise that is because,
yesterday, I introduced in the Senate-and I had a substantial
number of cosponsors equally divided among Republicans and
Democrats-a bill, not a constitutional amendment, but a bill that
would require that the President submit a budget that would be in
balance if the real growth of the economy was 3 percent or better.
It seems to me that that would have a degree of economic reality
which a mandated constitutional amendment would not have. It
would mean that in the last 17 years, instead of having 16 deficits
and one small surplus, we would have had 12 surpluses and 5
deficits. It would mean whenever the real growth of the economy
exceeds the average over the last 200 years, which has been about
3 percent, you would have a balance and surplus. Whenever it is
below that, we would have some stimulus. We would have a straining of effect in exuberant periods. The budget would have a stimulating effect on the economy in a stagnating or recession period.
212
What would you think of that kind of proposal? It may be we ought
to modify it in general ways. But, generally, the principles?
Mr. GREENSPAN. If it could be implemented, it would be a major
fiscal improvement in the fiscal policies of the country. My main
concern, Senator, is the difficulty in trying to synchronize the
policies. To be sure we know what real growth has been in the
most recent period with some degree of accuracy, and we do know
basically what our budgetary processes are.
Unfortunately, the leadtimes of initiating significant changes in
the budget may make it difficult to synchronize the policies in the
direction which you would like to see them go.
Senator PROXMIRE. I understand that. But, you see, the benefit
here would be if, for example, in the coming year, instead of the
sluggish growth that many anticipate-and these forecasts, as we
all know, are subject to error-say, instead of 2 percent growth,
instead a deficit, we had 4 percent growth, if it worked out to a
surplus without changing the budget, you get that because of
course with the 4-percent growth your revenues increase, some of
your expenditures in aggregate decline slightly and, therefore, you
would have an automatic stabilizing effect.
Mr. GREENSPAN. I am sorry. I think I misunderstood what you
were stating.
Are you saying, Senator Proxmire, that you would focus the
structure of the budget so that it would automatically balance at 3
percent?
Senator PROXMIRE. Yes; as closely as you could.
Mr. GREENSPAN. I think there is no question that that type of
direction for fiscal policy would significantly improve how we run
our policy mix and, if it could be implemented, and I suspect there
are a number of technical problems, as there are in any proposal, it
would work in a very important direction to diffuse the major
inflationary imbalances in our system.
Senator PROXMIRE. Mr. Fair.
Mr. FAIR. I see some problems with it, although I have not
studied it in detail. You do cut down your flexibility when you put
a law like that on the books. You lock yourself into certain spending and tax patterns.
Senator PROXMIRE. It does not do anything to me, and it can be
criticized on this basis. If you want to increase spending, you have
to do it, but you have to increase taxes at the same time, so the
effect on the price level should be more limited and should be more
moderate.
Mr. FAIR. I understand, but say that the administration and most
of Congress expect, for some reason when they look ahead a year,
that there is going to be a serious recession.
Senator PROXMIRE. Of course, they could all be wrong or right.
Mr. FAIR. True, but let's say that in this case they are right. If
you have this law on the books, you will not be able to run as
expansionary a fiscal policy as you might like, given your future
expectations.
Senator PROXMIRE. That is exactly right, and that is exactly why
I think it would have benefit. You would not come out of 1974-75
recession like gangbusters, and the resultant 9 percent inflation we
had last year.
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Mr. FAIR. I understand your argument. All I am saying is you do
have less flexibility if this bill is passed.
Senator PROXMIRE. Say we have a military emergency, obviously
in a major military demand, you might very well have growth and
have to have a deficit. You have had it in the past, and you would
have it again, so I would permit a two-thirds vote of both Houses of
Congress to set aside this requirement. Of course, the Fed would
have flexibility.
Mr. FAIR. You would be giving the Fed more power than it now
has to achieve its targets. Say the Fed disagreed with you on what
the economy should do. If you lock yourself in, not just a year in
advance, but into a set of policies that pretty much go on indefinitely, then the Fed clearly knows what the fiscal policymakers
will do and it can work even more through monetary policy to
achieve its aims.
Senator PROXMIRE. It is my fault as much as anybody's in the
Congress because I am chairman of the Senate Banking Committee, which has oversight over the Fed, and Henry Reuss in the
House. If that happens, I think the Congress can, under those
circumstances, and might very well take action.
Mr. CHRIST. I would like to comment on this proposal.
I think if it is worded in such a way that it is clear what we are
talking about is a 3-percent longrun pattern of growth, then, yes, I
would be all for it. But think a moment about what happens if the
economy goes through a business cycle. There will be two places in
the cycle where the growth rate for a short time will be 3 percent.
One will be at the top and one at the bottom, and you don't want
the same budgetary stance for both.
Senator PROXMIRE. You would have a surplus in a period of
expansion.
Mr. CHRIST. If it is stated in such a way that we look at kind of
an average path around which the economy oscillates as it goes
through minor recession, and that is a 3-percent growth path, and
below that we should have a deficit, and above that we ought to
have a surplus, I think that would be reasonable.
Ms. BARRETT. I think it would depend on what you would want
your budget to do. There is no reason to think a budget that would
be balanced at 3 percent real growth would actually produce 3
percent real growth. That depends on what is happening in the
other sectors of the economy, what the trade balance is, how much
pessimism or optimism there is in the business community; so, if
you want to use your budget as an instrument of fiscal policy, then
the balancing rule that would balance the budget at a specified
growth rate does not make very niuch sense.
As Mr. Fair said, you would be putting a lot more pressure on
the Fed to conduct macroeconomic policy.
I also think that making rules-Senator PROXMIRE. At this point, let me just ask: What is the
alternative? Is the alternative what we have been doing, for the
Congress and President, to be sensitive or perhaps too sensitive to
the situation that may be temporary of high unemployment and
coming on with a problem that is too stimulative or a restrictive
policy that under other circumstances would be too restrictive?
Wouldn't it be better to have a policy that we could comment on?
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Secretary Blumenthal said the other day to make a long-term
commitment. How do you make such a long-term commitment?
One way is to have this kind of law, drafted into law, so the
President would abide by it, Congress would have to play by the
rules of the games, and it is a long-term commitment in that sense.
Anything else is rhetoric. Even if we are sincere about it, we are
here for relatively a short period of time, especially in the executive branch. If you are going to have a stable, long-term commitment, it seems to me you have to have a law, maybe a constitutional amendment, but a law I would think at the very least.
Ms. BARRETT. One, the Congress has put into place a budget
process which has focused on the deficit, which has tried to give
Congress a little bit better handle on controlling the deficit, and
that seems to be working well-Senator PROXMIRE. Not working so well from the standpoint of
inflation. We have had the worst inflation that we have ever had
in peacetime except the energy inflation we had in 1974-75.
Ms. BARRETT. It seems to me, given the automatic stabilizers that
are built into the budget, what will happen as a result of passing
any of these balancing the budget or spending cut amendments or
laws would be an attempt to redefine budget concepts so as to find
a way to keep us in compliance with the amendment or the law, at
the same time being able to use budget policy as an instrument to
stimulate or restrain the economy.
So I wonder whether or not some of this is not an exercise in
futility unless we are really prepared to commit ourselves to a
budget concept that is realistic.
Senator PROXMIRE. I would agree we have to have an agreement
on definition. You could undoubtedly hook it up so your budget
would be a capital budget. That would be one approach.
Let me ask on another issue.
Mr. Fair, you say that tight money policy is ambiguous now on
the basis of our experience. Certainly the overwhelming majority of
your colleagues in the economic profession would agree. On the
other hand, there have been some recent distinguished challenges
to that. I would like to ask you about that at the present time.
I am not sure tight money is as restrictive. No. 1, housing is
involved, with the 6-month certificates and others. Inflation is
widely anticipated and, therefore, the Chairman of the Federal
Reserve Board keeps telling us the nominal rate of interest is not
very high, and there is something to that, and the experience of
the last several months indicates that even a monetary policy that
results in very high interest rates does not have much bite.
So, if it does not have much bite and is not restraining demand,
what we know it is doing is increasing costs-the costs to the
homebuyer, the costs to the business that has to borrow, costs that
are passed on to the consumer in higher prices. So, isn't it possible
under present circumstances, rather than having a deflationary
effect, tight money at least at the present time is having an inflationary effect?
Mr. FAIR. I would not necessarily disagree with that. When I said
that my work indicated the net effect is deflationary, this is not
always the case in my econometric model. There are times when I
run an experiment with the model in which monetary policy is
215
tightened that the net effect for the first few quarters after the
change is inflationary.
Senator PROXMIRE. If you continue to have a continuing inflationary psychology, isn't that likely to persist for some time?
Mr. FAIR. That is quite possible. It is difficult to measure empirically people's view of the future, and although some of this is
captured in the work, perhaps not enough. As I said in my testimony, however, this is not the important point with respect to the
mix questions. Even if I take your case and you take mine, we
would both still argue, it seems to me, for a mix of looser monetary
policy and tighter fiscal policy. Even if you feel the inflationary
effect is larger than I feel it is, we would still come to the same
conclusion about the mix.
Senator PROXMIRE. Let me ask Mr. Greenspan; you heard Mr.
Fair's reservoir analogy. I don't know whether it is right or whether it is a pipe dream.
According to you, monetary policy has become kind of a hostage,
I guess is how you put it, of fiscal policy. Fiscal policy has been just
so dominant that it required a certain kind of monetary policy.
According to Mr. Fair, the fiscal policy has to be determined in
advance, considerably in advance, and relatively fixed during that
period. Monetary policy can change every month, and even though
the pipe going into the reservoir is a smaller monetary policy, it
has the advantage of being able to have control because it operates
on a much shorter time basis. What is your response to that?
Mr. GREENSPAN. If you are asking about the strictly mechanical
characteristics of monetary policy, obviously that is true. The time
period can change in seconds. You can transmit to the New York
money market desk a major shift in monetary policy in a matter of
minutes. I think, however, that we overestimate the effect of monetary policy's ability to significantly alter the real aggregates.
The Fed acts on the margin of the overall money market. I think
that Professor Christ explained one form of the process in which, if
you have an excessive expansion of aggregate credit in the capital
markets, that is in excess of the ongoing savings of the private
sector, you have a spillover into the commercial banking system or
into financial intermediaries generally, in a manner which creates
demand for reserve balances by the commercial banks, and drives
up the Federal funds rate as a consequence. That process is always
confronted by the Federal Reserve by pressing down on the rate of
rise in Federal funds, which means they supply reserve funds to
the system, expand the monetary base, and thereby ultimately
expand the money supply or bank credit, creating at a later date,
in my view, an excessive inflationary bias to the system.
On the other hand, if there is an excess of savings, and interest
rates are falling, the Federal Reserve endeavors to absorb some of
the money market's excess liquidity. The Fed tends to work on the
margin of the markets, which is another way of saying that the
Federal Reserve really is functioning as a creature of the money
market, and it merely reacts to the aggregate amount of credit
supplied in the system.
One element of that credit is the Treasury's direct financing
requirements. But if we now look at the aggregate direct and
indirect credit effects which is what fiscal policy should be defined
216
as, it is clear that you cannot accurately project in advance the
degree fiscal policy pressure if you include in it the actions of
Fannie Mae, the Federal Home Loan Bank, Ginnie Mae, that is all
the credit transactions. I don't think it is that easy to forecast what
the fiscal policy will be.
But further, the presumed tradeoffs between monetary and fiscal
policy is more an illusion than a reality. As a consequence the
situation is far more complex, both in timing and in interrelationships, than are theories of fiscal and monetary mix questions postulated, say, 5 or 10 years ago.
Senator PROXMIRE. You would conclude that fiscal policy does
dominate the monetary policy overwhelmingly pretty much?
Mr. GREENSPAN. Yes.
Senator PROXMIRE. What is your answer to that, Mr. Fair?
Mr. FAIR. I think Mr. Greenspan's argument is-if you consider
the water to be real economic activity-that the small pipe is very
small and there is not much the Fed can do. As I said in my
testimony, my work and that of others indicate that this is not the
case, that interest rates have an effect on real decisions in the
economy. This is true with respect to such things as consumer
durable purchases, as well as housing investment and plant and
equipment investment.
Senator PROXMIRE. Mr. Greenspan is indicating the level of interest rates is very largely a function of fiscal policy or all of the
activities of the Federal Government, not only the budget but also
these other off-budget activities, too.
Mr. FAIR. I will let him speak to that. My view is that the Fed
can control interest rates, and that interest rates have an effect on
private real decisions.
Senator PROXMIRE. The only thing he said is that the Fed controls the interest rates.
Mr. GREENSPAN. I think the Senator stated it correctly. In the
longer run, interest rates, so far as governmental policies are concerned, are largely affected by fiscal policy and that the effects of
monetary policy are either to sanction or endeavor to fend off
small marginal changes that are created by fiscal policy.
In other words, I think that monetary policy's ability to significantly alter the pattern of interest rates or monetary aggregates is
limited, and that the major thrust of governmental policies is more
fiscal in the aggregate sense.
Mr. FAIR. I would argue the monetary policy is much more
powerful than that, that the Fed can in fact alter long-term interest rates as well as short term interest rates and their real decisions.
I think we disagree,-with respect to the pipe analogy-about
the size of the pipe.
Mr. GREENSPAN. We are disagreeing on data interpretation. His
econometric model differs from mine and the question gets down to
which structure more appropriately captures the nature of the
economic environment in which we are working and, where there
are no data which neither one of us can adduce to prove our case,
what would we expect the data to show if we had it.
217
Senator PROXMIRE. Mr. Christ, you talked about M2 expansion in
the last 5 to 7 years. Isn't much of this the result of change in what
M2 really constitutes? Haven't there been changes in Ml and M2 ?
Mr. CHRIST. There have been very great changes in allocation
between M, and M2. This has been going on for 25 years.
Senator PROXMIRE. Especially with the transfer accounts.
Mr. CHRIST. The automatic transfer has been the latest in the
series, but there has been an easing of the barriers to transferring
between time deposits and demand deposits and people have been
taking advantage of this.
Senator PROXMIRE. How about the 4-, 6-, and 8-year certificates?
Mr. CHRIST. They have not changed that much relative to the
rest of M2. M2 has always paid interest and Ml, since 1933, has not.
The interest gap has widened and that is why M2 has grown over
Ml over the years.
Senator PROXMIRE. I notice fortunately the Federal Reserve
Board, as you know, is about to give us a new aggregate. It will be
years before we can get a pattern that will enable us to follow
what is going on down there, but, unfortunately, I think we have to
do that.
You will agree that Ml has been changing and we don't know if
what is happening to Ml is a genuine restraint or a change in the
content of MK.
Mr. CHRIST. Declining Ml does not indicate to me there is any
restraint. The fact that the growth rate of the base has declined
about 2 percent from about 10 percent to about 8 percent, that
sounds to me like a real decline.
It is very hard to have that, without it amounting to-Senator PROXMIRE. Then there is the perfectly understandable
change Mr. Burns used to point to. Whenever interest rates get
high, you have a predictable increase in velocity because people use
their money more importantly.
They can sock it away for 10 percent and they will do it. They
will not let it sit in a checking account.
Mr. CHRIST. That is certainly true of currency and Ml but it has
not made much difference between M2 and Ml because M2 's velocity stayed between 2.2 and 2.4.
Senator PROXMIRE. You said a $29 billion deficit in 1980 is about
right-$29 billion in an austere budget with an inflation of 9
percent is about right.
Why should it not be closer to a balance under these circumstances?
Mr. CHRIST. The way I arrived at it is this: We need a gradual
increase in the quantity of money in the country if we are not
going to have prices going down.
There is no reason for prices to go down. It is hard enough to
stabilize prices. Let's settle for stable prices.
If we have stable prices, we need. the money stock to grow
roughly in accordance with the growth of the country. Where will
that come from?
First, it can come from a small deficit on the average over a 10or 20-year period.
If the deficit is about 1 percent of GNP on the average, then that
would add about enough to the money stock to make it grow about
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3 percent a year, which is about what we need, and it would also
allow the Federal debt-Senator PROXMIRE. Now you are really getting far out. You are
advocating a permanent policy of $30 billion a year on average?
Mr. CHRIST. On average, yes. If you wanted it balanced, I think it
would be practically as good because it would not do great harm to
increase the money stock by reducing the national debt a little bit.
But once the national debt is all gone, we could not do it any more.
Senator PROXMIRE. You are really relaxed. You must have given
us more than an amphetamine analysis. We are really getting to
be monetary junkies.
Usually economists get very passionate about these things-a $29
million deficit, balanced budget, so what.
Mr. CHRIST. The rate of inflation we have had in the past is
much more critically related to growth of the money stock than to
the deficit.
I went back and looked at individual years. We have had substantial periods of large deficit without much inflation in our history, and we have had substantial periods of surplus without deflation in our history. The budget deficit is not directly connected to
inflation.
It impacts on inflation because whenever there is a big deficit
there is lots of Federal borrowing and that tends to push up interest rates which causes people to say to the Fed that interest rates
need to be eased up; they are eased up, and that creates more
inflation.
If the Fed would sit tight and not create more money when the
deficit rises, then it would not be necessary to have inflation.
Senator PROXMIRE. You are relaxed on fiscal policy but you are
definitely clear but not necessarily dogmatic on monetary policy.
Would you say it would depend on how long or how deep the
recession is?
Mr. CHRIST. The rate of growth of the stock of money should be
reduced gradually even if we get into a depression. If we get into a
depression, interest rates will go down-they always do, somewhat.
Some people will say that is easy money. It seems to me the
better definition of easy money is not in terms of what is happening to market interest rates but what is happening to the growth
rate of the stock of money.
Senator PROXMIRE. YOU want it as a growth rate of stock money
to continue to slow down even if we get into a recession?
Mr. CHRIST. Yes.
Senator PROXMIRE. Do you do that with 10 or 15 percent unemployed regardless, or is it your argument that it would not go that
high?
Mr. CHRIST. That is my argument. But I will stick my neck out
and say yes, even if we had 10 or 15 percent unemployment I
would like to see monetary growth decline. And I would not object
to large deficits brought about by some combination of tax cuts and
spending to try to alleviate the unemployment.
I think it would work.
Senator PROXMIRE. You say M2 normally grows at about the
normal rate of GNP?
Mr. CHRIST. It has over the years.
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Senator PROXMIRE. What makes you confident that it will slow
inflation rather than real growth?
Mr. CHRIST. I think it will slow real growth at first.
Senator PROXMIRE. Why wouldn't it slow it in the long run?
Mr. CHRIST. Because I think growth in the long run is independent of the steady rate of inflation that you have. We have had
roughly 3 to 4 percent growth in the United States for, as you said,
200 years, and we had a period from the Civil War to 1880 when
the money stock was not growing fast and prices were falling.
We had the same growth rates in stable prices, and again, roughly the same growth rates since we began to embark on this inflationary policy in the 1960's.
It is quite clear to me from looking at all of the countries of the
world that there really is a tight connection between the monetary
growth rates and inflation.
If we don't some time stop creating money at these high rates,
we will not at any time start to conquer the inflation.
Senator PROXMIRE. I agree with that. I am just wondering about
the side effects.
Mr. CHRIST. There are side effects, but I am pretty confident they
are temporary.
That is why I think the drug analogy is apt. I consulted a
pharmacology professor at Johns Hopkins on this and he referred
me to a Consumer's Union book entitled "Licit and Illicit Drugs,"
especially the chapter on amphetamines.
Senator PROXMIRE. That is a time when I wish Senator Humphrey was still with us. He was a pharmacist and he would have
enjoyed your analogy.
Ms. Barrett, you say consumer confidence has been undermined
by inflation but statistics show continued consumer strength not
only in housing and automobiles but also a drop in the percentage
saved, close to an alltime high in consumer credit as a percentage
of income, and it looks like inflation is stimulating not retarding.
There was a time in the last big inflation, 1973, 1974, and 1975,
that it seemed to retard consumer spending. Now it does not seem
to be doing that.
Do you see a change in behavior?
Ms. BARRETT. There seems to be evidence that things in the
consumer sector will change somewhat, in terms of the psychology
that is going on, the buy-in-advance psychology. The consumer
expenditure projection surveys now are showing consumer confidence has dropped somewhat. Also because the need to repay installment indebtedness and mortgage repayments will undoubtedly
have to drive the savings rate back up. Consumers have gotten
locked into higher mortgage payments, higher payments for automobiles and they will have to start repaying those and that shows
up as higher savings.
Senator PROXMIRE. Ms. Barrett, you worked in the Congressional
Budget Office; is that right?
Ms. BARRETT. Yes, sir.
Senator PROXMIRE. They claim now a current level of service
would require outlays of $551 billion, $19 billion above the President.
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Even with these high outlays, unemployment is expected to be
well above the President's level. The deficit is almost $50 billion.
Are you in accord with CBO's projections or do you regard the
President's projections as more realistic?
Ms. BARRETT. The differences have to do with the economic assumptions. They are not talking about differences in programmatic-Senator PROXMIRE. I realize that, but whom do you think is
right?
I realize there is a difference here.
Is it Charlie Schultze or Alice Rivlin?
Ms. BARRETT. I think I would lean more toward CBO's projection
of the economy, but I am not sure I could say who is right in terms
of projected outlays.
Both CBO and the President in the past have been far off the
mark in terms of the spending projections, both because there has
been an unanticipated shortfall in spending and because it is very
difficult to estimate outlays from the various eligibility programs.
This gets back to the whole question of enacting legislation to
balance the budget. Some of these budget numbers are very iffy.
The President's projections, for example, of interest payments in
the 1980 budget, are predicated on an interest rate which is substantially lower than the one the Treasury is now paying.
Just a rise of 2 percentage points in the interest rate could add
another $10 billion to the deficit. So, there are a tremendous
number of uncertainties about what outlays are going to be even if
we knew for certain what the real economic growth would be.
Senator PROXMIRE. I realize there are real uncertainties.
Ms. BARRETT. I think the President is overly optimistic in terms
of real growth and in terms of the inflation projection.
Senator PROXMIRE. Do you see any harm in setting outlays
almost $20 billion below the present service level?
Ms. BARRETT. I think that the risks in real economic growth, not
in inflation but in real economic growth, are on the down side,
depending on very much what happens to monetary policy.
I don't think that the President's budget, if enacted, in terms of
the cuts in spending, would precipitate a major recession, but I
think that it will weaken the economy relative to the current
services level of spending.
Senator PROXMIRE. Are there any areas of services that you
think are being seriously neglected?
Ms. BARRETT. Do you mean in terms of the individual components of the cuts?
Senator PROXMIRE. Yes.
Ms. BARRETT. Certainly, some of the employment programs that
are being cut back would have an adverse effect on the target
populations.
Senator PROXMIRE. Of all the programs, isn't it more logical to
cut them back in view of the colossal increase in employment?
Ms. BARRETT. The unemployment rate really has not been going
down. We have high unemployment among blacks, for example.
Senator PROXMIRE. The President has tried to target the employment program so that it does provide employment for the blacks
221
and teenagers and away from this general notion of, for instance,
letting municipalities use it to pad their payrolls.
Ms. BARRETT. That is right. The problem is that the cutbacks are
being proposed in the CETA program, as I understand them. There
is no guarantee at all that the State and local governments will
now use the remaining job openings that they have to employ
disadvantaged people.
As you know, in CETA, by far the majority of the participants
are adult white males with 12 or more years of school. Given the
fact that the CETA guidelines are not only vague but have such a
multiplicity of target groups, it essentially gives State and local
governments the right to hire whomever they want. The ones that
are going to lose the most heavily are going to be the blacks and, to
some extent, women.
Senator PROXMIRE. Professor Fair, let me come back to a dilemma cited in the opening statement-that is, monetary fiscal policies
designed to raise employment and growth will worsen inflation
whereas policies to slow inflation will slow growth and increase
unemployment.
What should be done about this stagflation dilemma?
Mr. FAIR. I do not believe, and I think Ms. Barrett would probably agree, that aggregate demand policies in the current situation
have very much of an effect on the rate of inflation. You don't get
very much of a drop in inflation by bringing the economy into a
recession. I think this seems to be pretty well accepted.
If this is true, then there isn't very much with respect to fiscal
policy that you can do. You can change the mix, as I indicated.
Perhaps an easier monetary policy relative to fiscal policy might
be-Senator PROXMIRE. What about what Mr. Christ is proposing, not
deliberately pushing us into a recession-nobody advocates thatbut a measured, gradual, persistent reduction in the rate of
growth.
Mr. FAIR. That is a tight monetary policy. I think Mr. Christ and
I differ by miles in our underlying models and in our view of how
the economic system works.
Senator PROXMIRE. I think we might argue the recession won't
give you ease in inflation for months. It may be 1 year or 2, but if
you persist in it year after year, it will.
Mr. FAIR. That is a very high cost if it is in fact the case. I would
argue that a much better way-Senator PROXMIRE. Let me just interrupt to say it is high cost
when, for instance, in West Germany they followed a more restrictive policy than ours and they have low levels of unemployment
and lower levels of inflation than us in both cases. Mr. FAIR. But not with the cost I think we would suffer if we
tried to do the same thing. Our situation is not exactly analogous
to the German situation. If we tried to do that, given the present
conditions in the United States, I think the cost in terms of lost
output and jobs would be very large over the next decade or so.
This seems, from my point of view at least; to be a bad thing. I
would argue, as I said, for an easier monetary policy-Senator PROXMIRE. Why would the costs be large in view of the
contention that seems to have some merit that inflation itself is an
47-106 0 - 79 - 15
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element that prevents employment and expansion in growth, if
people can be assured of relatively stable prices, that the economy
will function better, there will be more jobs, and in the long run
greater growth.
Mr. FAIR. There is no question that inflation is bad, but the issue
here is if we pursued a restrictive monetary and fiscal policy, if we
brought the economy into a recession and held it there for a long
time, how would this affect inflation. My reading of the econometric results is that you would have to do this for a long time to
bring the inflation rate down very much.
Senator PROXMIRE. In the last 25 years we have had 25 recessions. Each period has been on the average of 9 months, some
more, some less, but none of them have been very long.
During much of that period we have certainly had more restrictive monetary policies.
Historically, it would seem that the case is not very strong that
we are going to stay in a perpetual recession if we follow moderating monetary policies.
Mr. FAIR. I am not sure I followed that completely. Would you go
over that again?
Senator PROXMIRE. I am saying that historically we have had
recessions.
I think everybody recognizes that when you have a free system
you have recessions, but that is one of the prices you pay for a free
economic system.
There have been periods when we have had restrained monetary
policy and during those periods there has been no analysis I have
ever seen that would indicate the recessions have been longer.
Mr. FAIR. The recessions have not had that much effect on the
rate of inflation. Take the 1974 recession. This very serious recession had a small negative effect on inflation, but not all that much,
and we are still suffering from-Senator PROXMIRE. Again, I am not saying that we should get
into a recession, but we will get into it regardless of the policy we
follow.
There is no way to avoid recession without socializing our economy and making it an economy that does not provide for the general and major economic policies.
We will have periods of recessions and inflation, or don't you
think we can avoid inflation.
Mr. FAIR. I don't think we can avoid them. We can mitigate
them. I think the recession we may have, say 6, 9, 12 months
hence, could be mitigated substantially by an easier monetary
policy than probably will be followed.
Senator PROXMIRE. The price you pay for that is less restraint on
inflation.
Mr. FAIR. But not much. That is the point. There is not much
effect on inflation from these aggregate demand policies one way or
the other.
Senator PROXMIRE. Mr. Greenspan.
Mr. GREENSPAN. I want to strenuously argue the opposite case.
We have heard considerable discussion about the short term
impacts of anti-inflationary policies on price. Most of this analysis
derives from simulations from our macroeconomic models.
223
By the way we fit those data, we pick up only what we would
usually call short term impact multipliers:
We have little ability to capture the type of phenomenon that
Professor Christ has raised. It is certainly true that shortrun impacts, ultimately become long term impacts.
It is a very difficult to show significant price effect from antiinflationary policies, but if there weren't any, you could not explain history.
The post-Civil War period that Professor Christ refers to when
prices were falling and real growth was relatively good would not
be explainable in terms of our current models.
There is an anti-inflationary policy effect on growth to be sure.
The short term impact is a decrease in real economic growth or
recession. But at a constant rate of anti-inflation pressure that
gradually reverses, and you eventually get fully effective impacts
on price with no long term effect on real growth.
I think the evidence on that is rather conclusive.
Senator PROXMIRE. You have been very, very helpful.
In the past 6 months, there has been a deceleration compared to
the Fed's target growth for M1 and M2 and it is below the lower
level of the range and the range is very broad, as you know.
How long should the Fed allow this slow growth to persist?
Mr. CHRIST. In the present circumstance, I think Ml should be
ignored. As we have noted, there now is this arrangement whereby
you can keep a zero balance in your checking account and all your
money in your savings account, and the bank will pay your checks.
Senator PROXMIRE. M2 also has decelerated.
Mr. CHRIST. It has decelerated but not as much. M2 , I think, is a
little more meaningful.
When I was looking at the data for this hearing today, I was
somewhat surprised at the large decline in the growth rate of M2.
It grew at a 9-percent rate in the first 10 months of 1978 and it has
been growing at an annual rate of 1 percent from October 18 to the
last data I had, which was about 10 days ago.
Then I looked at the rate of growth of large certificates of deposit
which has increased very markedly during this same period so that
the growth of M2 plus the large CD's has declined from a 10percent to a 6-percent annual rate.
I think partly what is happening there is that because the interest rates are completely uncontrolled on the larger certificates of
deposit of $100,000 or more, more funds are going into those.
There are, as you know, the money market funds which specialize in taking money from small investors and packaging it in
$100,000 lots and buying these CD's.
A large majority of the bank accounts covered in M2 have interest rate ceilings, even the 4- and 6-month ceilings, which are far
below the going market rate.
Not many people have $10,000 which they can use to buy money
market certificates which became legal in July. We are still discriminating heavily against the small buyers.
Senator PROXMIRE. We have a bill in to reduce that to $1,000.
Mr. CHRIST. Very good. Why don't you reduce it to zero?
The interest rate ceilings are muddying the water. If you look at
the monetary base, which supports all of these financial aggre-
224
gates, the growth rate of the base is lowered only slightly, so it
seems to me the Fed is doing very well in the last 2 months. I say
keep it up.
Senator PROXMIRE. I mentioned the view of Professor Modigliani
in my opening statement, which is that capital spending has been
impeded by a tight money-easy fiscal mix of policy.
Do you agree with Professor Modigliani that this is a serious
problem for the economy?
Would you be willing to accept the President's rather tight
budget if this were combined with substantial monetary easing?
An alternative view of the capital spending issue is that capital
spending has been impeded, not by tight money, but rather by a
number of disincentives arising from our tax system.
For example, high marginal rates of income taxation are alleged
to have impaired the incentive to save and invest.
Similarly, it is claimed that the insistence that capital assets be
depreciated on an original cost basis for tax purposes lowers the
real after-tax rate of return when the inflation rate increases and
that this reduces capital spending.
I would like the panel to address itself to these questions.
What, in addition to changes in the monetary fiscal mix, should
we do to raise investment's share of the GNP?
Ms. BARRETT. As I said before, I think that the main problem is
that we still are operating so far from potential, but given that
original statement, let me say I think we certainly could use tax
policies to offset the potential disincentives of high interest rates.
For instance, better depreciation rules, an increase in the investment tax credit are examples of tax incentives to investment. I
don't think we have begun to explore the possibilities for such tax
policies. I think I lean more in that direction.
Senator PROXMIRE. I wonder about that. I read an article not
long ago which indicated that the Fed is losing control of monetary
policy partly because housing has been insulated and housing was
a big element in retarding growth.
If you follow what you suggest, you are just saying that you are
going to provide tax measures to offset monetary policy and discouragement of high interest rates. The result will be that interest
rates will have to go higher and higher before they have a bite that
achieves their objectives?
Ms. BARRETT. I am not sure I see that, how that will happen.
Basically, what you are talking about is reducing corporate taxes
so that more investment would be financed internally rather than
externally. This would put less pressure on external credit markets-Senator PROXMIRE. That is exactly correct. You want to restrain
the overall economy. I realize I am on both sides of this, but I
wanted to get your reaction because we are not restraining housing
at a 10-percent interest rate; 15 years ago, housing would have
gone right through the floor. We would have had a dropoff of 1
million housing starts. But now, it has had little effect. Maybe as
high rates go on, we might anticipate a 20-percent drop in housing,
but nothing like it used to be.
If we move over to the corporate sector, then more and more you
have higher and higher interest rates which translates to higher
225
cost and an increase in the cost of living and an increase in
inflation without having the effect of regarding effective demand.
Ms. BARRErr. It seems to me the people advocating monetary
restraint are doing it because they want inflation to come down
rather than because they want to see interest rates go up and real
spending down. I think that that is the position.
So, what we are talking about is a new kind of policy change
which is basically a fiscal stimulus to investment. You reduce
taxes, but you do it in such a way as to provide a disinflationary
impetus rather than an inflationary impetus. So you are shifting
away from monetary stimulus to fiscal stimulus.
But it is a fiscal stimulus that is going to favor the investment
area.
If you then want- to moderate the level or rate of economic
growth, you may want to offset that fiscal stimulus by some other
measure, such as reducing government spending.
But I am just talking now about a situation where you have a
given amount of fiscal stimulus and you want to reorganize the
package through tax incentives to business investment and perhaps
higher taxes levied elsewhere or lower levels of government spending.
Senator PROXMIRE. Mr. Greenspan, according to the CEA estimates, the decline of the dollar adds about 1 percent to our inflation in 1978. That is a huge impact that then supports the notion
we ought to try to achieve a more stable value of the dollar in all
currency markets.
My question is this: Was the decline of the dollar in 1978 an
independent source of inflationary pressure or was it the means by
which U.S. inflationary measures remained bottled up at home?
In other words, if we tried to maintain a fixed rate of exchange,
would not some of our internally generated pressures be foisted on
the rest of the world and what does this indicate to support the
dollar?
Mr. GREENSPAN. There is no way in which we could have unilaterally supported the dollar. By implication, that would have required either, for example, the Deutsche Bundesbank loaning us
marks to support the dollar or they themselves creating the marks
to absorb dollars in the world market.
In either case, it would expand their monetary base which, of
course, would have engendered inflationary forces. To the extent
there was support and support was rather substantial, such effects
did occur. The expansion in money supply in Germany was far in
excess of what they would have preferred.
Certainly in Switzerland, where the money supply went up a
remarkable 17 percent when they were trying to hold it to a small
increase, indicates that the intervention process does ultimately
create monetary expansion in the intervening countries. And
while, for the. moment, we have not had international inflation
transmission, I think that the authorities in Germany, Switzerland,
Japan, and the like, are getting extremely concerned about the
potential of their own monetary base creating inflation in those
countries. In effect, I think we are in the process of transmitting
our inflationary forces abroad. And I don't know of any way in
which we could have avoided that except by zero intervention, in
226
which case it is quite probable that the dollar would have fallen
still more.
Senator PROXMIRE. Isn't the whole concept unsound, that as the
dollar falls, we export more and import less and if there is any
elasticity of demand that should fall and that should be somewhat
self-correcting as our balance improves?
Doesn't it frustrate that objective to support the dollar, increase
the value of the dollar over these occurrences and, therefore, decrease our ability to traffic in imports?
Mr. GREENSPAN. Yes; I think it does.
What we are finding is that international financial stability is
largely a function of the range of differences in domestic economic
policies and that there is no quick and simple international monetary system which will resolve differences of basic economic policy.
Senator PROXMIRE. The fundamental problem is inflation here at
home.
Mr. GREENSPAN. That is true. And until we reduce inflation
substantially, and more importantly, communicate that fact to
people who hold dollar balances abroad, we are going to have a
continuing problem in the international financial system.
Senator PROXMIRE. Mr. Fair, you argued for a larger role for the
Congress and the administration in determining monetary policy,
especially if we are to do more than throw softballs at the Fed.
I think under Humphrey-Hawkins it will help. The Fed has to
have different rates because they must relate the targets to shortterm goals suggested by the President. This involves housing.
First, Mr. Fair, would you go further than that and, if so, what
would you do?
Mr. FAIR. I think that is clearly a step in the right direction. I
think I would go further. I don't have a bill or a proposal to make
about what the best way to do that would be. There are many
options that one can consider, but I would be reluctant to try to
push one particular option. I think, however, that the Congress and
the administration should have some mechanism to control the
policy of the Fed more than is now done, than merely requiring the
Fed to submit what it is planning to do with respect to Ml growth
and the like.
Senator PROXMIRE. Ms. Barrett, do you have any views on that?
Ms. BARRETT. I essentially agree with Mr. Fair.
Senator PROXMIRE. You don't have any specific recommendations
to what we can do to achieve that?
Ms. BARRETT. That is right.
Senator PROXMIRE. I think you are all aware of the independence
we have had, and we can always amend the Constitution, but we
have been served fairly well.
But there is the argument to the extent they become more
politically dominated, their policies will be more volatile or inflationary, less stable.
What would you think of that Mr. Christ?
Mr. CHRIST. I think, in retrospect, the Federal Reserve's actions
from about 1948 to about 1960 were probably better than they were
before, or than they have been since, until very recently.
227
There were some anticyclical changes that were made by the Fed
during that period of the 1950's, but in terms of the long run, the
growth rate was kept fairly constant.
The way in which the monetary policy is organized, as I read the
Constitution, is this. The Congress shall have the power to coin
money and regulate the value thereof. I take-it that that is the job
that has been delegated to the Fed.
As you say, it can be taken back from the Fed at any time. I
think the Fed is extremely conscious of that.
A Fed staff member once told me, "We are so busy guarding our
independence, we try hard to find out what Congress wants to do,
and we do that in order that they don't take away our independence."
Senator PROXMIRE. Do you see a difference between Mr. Miller
and Mr. Burns in degree of independence, particularly in the executive branch?
Mr. CHRIST. I don't really know the answer to that. It seems to
me in the last 3 months, since October, there has been a substantial improvement in Federal Reserve policy.
Senator PROXMIRE. Do you see any contradiction in the Secretary
of the Treasury announcing the increase in the discount rate, the
biggest increase we ever had? That occurred about November 1.
Secretary Blumenthal said increase it at 1 percent. It was not done
by the Fed. It was done by Blumenthal.
Mr. CHRIST. No; I did not notice that. That is very interesting.
Senator PROXMIRE. To correct M, for the transaction accounts, I
understand the suggestion is you add 3 percent to the observed
growth rate. That is the estimate of Mark Willis, President of the
Fed of Minneapolis.
Would you think that may be about right?
Mr. CHRIST. That is the first time I have heard this so I have to
do some fast arithmetic. If you look at the minus 2 percent growth
rate of M, since November and add 3 percent you get 2 percent.
That is the growth rate of M2 .
I don't know if that is the way he got the figure or not, but that
is my first reaction.
Senator PROXMIRE. Mr. Fair, you have argued tighter monetary
policy is inflationary. I have one more question and I will yield to
Congressman Rousselot.
Mr. Fair, you said the administration's budget is about right
provided the Federal Government allows short-term rates to fall by
1 or 2 percentage points in the next year and a half.
The Fed provides policy aims and objectives to the Congress in
terms of growth rates and in terms of monetary aggregates.
What is your prescription for growth rates translated into M, or
M2.
Mr. FAIR. It is highly interpretive in part because of the recent
financial reforms and changes that have been made, so I am not
sure what that would translate into.
To get back to your last question, to require the Fed to give you
its interest rate target would be helpful. For those of us who
believe interest rates have a real effect on decisions, interest-rate
targets would be much more helpful in deciding--
228
Senator PROXMIRE. I guess we are in real limbo as far as monetary aggregates. We know that we are going to come up with new
aggregates.
Mr. FAIR. They keep changing.
Senator PROXMIRE. Most are mystified. Everybody knows, not
only Members of Congress, but the general public is well aware of
what interest rates mean. I think if we discuss it in those terms we
will get a lot more concern and probably more intelligent discussion.
Mr. FAIR. As a first step, I would clearly advocate trying to get
more control over the Fed.
Mr. CHRIST. Could I comment on that very briefly?
Senator PROXMIRE. Yes, sir.
Mr. CHRIST. It is true what has been said, yet there is no reason
why interest rates should be kept stable but there is good reason
why monetary growth rates should, so there is no reason to put the
emphasis on the interest rates.
Senator PROXMIRE. I think that is true, but nevertheless you
ought to be prepared to discuss and understand and have justified
what their target interest rates are and why.
We would have a greater understanding than we have now.
Under most circumstances, you don't get a turnout of members
of the committee because they should just figure they don't know
what is going on.
We are lucky to get three people here, even when the Chairman
of the Federal Reserve comes up. Mr. Burns is a great attraction
and so is Mr. Miller. They are fine, articulate, intelligent people,
but monetary policy is pretty recondite.
It is something that seems to require 3 or 4 years of graduate
work and nobody wants to talk about it and then, after 3 or 4 years
of graduate work, nobody really wants to talk about it.
Congressman Rousselot.
Representative RoUSSELOT. Thank you, Senator Proxmire.
First, I am fascinated with your laundry list of suggestions for
curing inflation and other monetary problems. I especially like
managed stabilization policy and what you regard as its effect on
the economy. And then, after a transition period, just starting
immediately to keep the rate of growth of the M2 money stock (a)
low on average about 3 percent a year, and (b) fairly steadyusually between 2 and 4 percent, and always between 1 and 5
percent.
You put heavier attention and focus, obviously, on the growth of
money stock in contrast to all the attention that is usually given to
interest rates.
Mr. CHRIST. That is right.
Representative ROUSSELOT. In the Ways and Means Committee
we have had two economists who have said that even though the
growth of money stock is a central issue in inflation, we don't
really pay attention to it.
Describe again-I know you did for the committee-how you
would go about tightening the money supply so as to reduce inflation if you were the Chairman of the Federal Reserve Board.
229
Mr. CHRIST. I would probably be fired if I were the Chairman of
the Federal Reserve Board, but I would be glad to tell you what I
would do.
I think that you have stated correctly that the growth rate-Senator PROXMIRE. Let me interrupt to say that once you become
Chairman of the Federal Reserve Board, you can't be fired.
Representative ROUSSELOT. Maybe we will put him up as a candidate.
Senator PROXMIRE. His position is more secure because he is
appointed for 14 years. Mr. Burns was persuaded to step down but
he could have said no.
Mr. CHRIST. I am aware of the 14-year term but the Congress has
great powers to alter these matters.
The history of every country that I have looked at-and I would
really be glad if there were an exception, if somebody would tell
me about it-makes it very clear that the rate of growth of the
money stock over any substantial period of time is very closely
related to the inflation rate averaged over that substantial period
of time.
There is a good monetary theory that we learn in undergraduate
school and in 4 years of graduate work that is consistent with that.
I think if we are going to stop the inflation, we really have to get
to a place where monetary magnitudes are not growing so fast.
There are two ways to do it: One is to try to do it all of a sudden
and one is to try to go from where we are now to that position
gradually.
There are many economists who claim that changes in the rate
of growth of the money stock-Representative ROUSSELOT. Last year, as I recall, it was somewhere around 8 or 9 percent.
Mr. CHRIST. There is a little table on this-I don't know if you
have a copy of it in front of you-Representative ROUSSELOT. Yes.
Mr. CHRIST. It shows-Representative ROUSSELOT. Did you make this part of the record?
Mr. CHRIST. I would like to.
Senator PROXMIRE. Yes, it is already a part of/the record.
Representative ROUSSELOT. We are referring to tables 1 and 2.
Mr. CHRIST. In the second table we see what the growth rates
were in the first 10 months of 1978.
As you say, they were high.
Representative RoUSSELOT. M2 was 9 percent and Ml was 10
percent, right?
Mr. CHRIST. Yes.
There is a minority of the economics profession which says if you
change the rate of growth of the money stock suddenly, you will
have a recession-Representative
RoUSSELOT.
Or a wrench effect.
Mr. CHRIST. I think there is some evidence that that is correct.
That was the source of the amphetamine analysis I put forth. So, I
would like to see the rate reduced gradually.
Representative RoUSSELOT. Over what period of time?
Mr. CHRIST. Ten years.
230
Representative ROUSSELOT. How long would the downturn last if
you did that, and if it was known by the general money market,
that it would be done over a period of time?
Mr. CHRIST. If everybody believed it would be done over a period
of time, which everybody does not believe, then it would be no
longer than any normal recession.
If it is really stuck to, then in a year people will begin to believe
that it is being stuck to, and then I think after that it might not be
much longer than the normal recession, so I would look for a
rather short period of restriction of real output if this policy were
followed.
Representative ROUSSELOT. What would be the long-term effect of
doing that, in your judgment?
Mr. CHRIST. I think one long-term effect would be that after we
finish the process 5 or 10 years from now we would have the
inflation down to zero.
The other long-term effect would be that we would be in the
position of having normal cycles again and we could use fiscal
policy to moderate them. I don't think they would be any bigger
than they were from 1948 to the present, and maybe a little smaller.
Representative ROUSSELOT. You mention you are in the minority
among economists on this thesis.
How many other economists of noteworthy reputation agree with
you on this, would you say?
Mr. CHRIST. You might ask the people at the table here and see if
you get an answer.
Mr. FAIR. No.
Representative ROUSSELOT. Just a flat no?
Mr. FAIR. No. I don't agree.
Representative RoUSSELOT. Do you want to keep the money stock
large?
Do you believe that increasing the money stock helps decrease
inflation?
Mr. FAIR. At times that is true, if it lowers interest rates. We
discussed, before you came in, that a tight monetary policy, according to my work, raises interest rates, which is a cost. And some of
this cost is passed on in higher prices. Therefore, there are times in
which a tight monetary policy-high interest rates, low growth of
Ml-leads to inflation. I would not subscribe to a simple relationship between inflation and Ml growth.
Representative ROUSSELOT. I think your statement was basically
about M2 .
Mr. FAIR. Or M2 , too.
Representative ROUSSELOT. Would you try to keep money supply
constant, or would you be primarily concerned about interest
rates?
Mr. FAIR. I would be primarily concerned about interest rates.
Representative RouSSELOT. Do you want the Government to
manage interest rates?
Mr. FAIR. It does now through the Federal Reserve.
Representative ROUSSELOT. You want controls on money interest?
Would that stop inflation?
Mr. FAIR. It has some effect on inflation, but not that much.
231
Representative ROUSSELOT. What has?
Mr. FAIR. The issue is whether you have a tight money
policy-Representative RoUSSELOT. Money stock?
Mr. FAIR. Let me reverse the situation. In the next year, I would
like to see a somewhat easier monetary policy, if the budget, as
submitted by the President, is enacted.
Representative ROUSSELOT. Easier money stock?
Mr. FAIR. Right.
Representative RoUSSELOT. So, instead of an increase of 8 or 9
percent, you would rather see an 11 percent increase?
Mr. FAIR. I would concentrate on what monetary growth would
need to be in order to get interest rates down.
Representative RoUSSELOT. Isn't the interest rate just the price of
money?
Mr. FAIR. Yes.
Representative ROUSSELOT. Doesn't the marketplace determine
that somewhat?
Mr. FAIR. Somewhat, but the Fed has a lot of control. Open
market operations, as we know from many past episodes, can have
an important effect on interest rates, particularly short-term interest rates.
Representative RouSSELOT. Obviously there is a difference in the
understanding of the marketplace.
Mr. Greenspan, do you want to comment on the recommended
formula of a phasedown?
Mr. GREENSPAN. I agree with his formula, but I think his phasing
is far more than necessary. But I don't feel we should dramatically
wrench the markets.
Representative ROUSSELOT. He is a moderate.
Mr. GREENSPAN. I am a radical in that respect.
Representative ROUSSELOT. What would you say, 3 years?
Mr. GREENSPAN. It depends not so much on monetary policy per
se as whether the aggregate of credit preemption by the Federal
Government is sufficiently reduced to allow the Federal Reserve to
sharply lower the rate of monetary growth without driving interest
rates higher. I think that is really a timing question. It is not a
monetary question, but a fiscal policy question.
Representative RoUSSELOT. If you were the Fed Chairman, would
you do it in a 3-year period?
Mr. GREENSPAN. First, I would harangue the administration,
which Federal Reserve Chairmen have been known to do. The
reason for that is that it is only if the Treasury and the Federal
Government, leaving aside the Board of Governors, create an atmosphere which enables monetary growth to be reduced, that you
can .accomplish it. I don't think it is strictly an issue of Federal
Reserve.
Representative RoUSSELOT. In other words, they need the cooperation of the rest of the Federal Government in not increasing the
borrowing requirements in the marketplace?
Mr. GREENSPAN. That is a necessary condition to bring interest
rates down. I don't feel that by expanding monetary guidelines, you
can bring the interest rates down. If that were the case, one would
say a 10-percent growth rate was consistent with 7-percent interest
232
rates, a 20-percent growth rate in M2 would be consistent with a
lower level of interest rates. I would suspect the evidence is exactly
to the contrary.
Representative ROUSSELOT. You have made a good point, and I
am sure Mr. Fair will discuss it with you after this hearing is over.
The reason an increase in the money stock helps bring down
interest rates is a fascinating theory, and I have never seen it in
history-Senator PROXMIRE. Would the gentleman yield on that point for
a moment?
Representative ROUSSELOT. Certainly.
Senator PROXMIRE. I am inclined to agree with the position Mr.
Greenspan and Mr. Christ talk about, but I think in all fairness, if
you increase the supply of money, you increase the supply of
money. It is a matter of demand of my money and your money. If
the supply is more available, if the marketplace works, the price
tends to fall certainly in the short run.
The difficulty, as I understand it, is that, as you increase the
supply, there is an anticipation that this is going to be an inflation,
and the attitudes, because of inflation, become translated into
higher interest rates. But I think there is a perfectly logical, understandable reason why people say an easy money policy-Representative RoUSSELOT. Increasing the money supply-Senator PROXMIRE [continuing]. Tends to reduce the price of
money.
Representative ROUSSELOT. Unless there are fewer goods and
services being produced, as Bill Simon tried to point out in his
book. That is an interesting chapter.
Senator PROXMIRE. It is perfectly logical, if you increase the
supply-Representative RoUSSELOT. Ms. Barrett, did you want to get into
this discussion?
Ms. BARRETT. I think everyone will agree there is a relationship.
I think what we disagree about is what is driving what.
It seems to me in the period 1974 to 1978, for the most part, the
monetary base was driven by the inflation rate, and not the other
way around. For example, if you look at what went on in 1974,
there was a big upsurge in the inflation rate as a result of a lot of
external things that went on.
Representative RouSSELOT. It was not all external. We don't want
to blame it all on oil. They did not have the inflation rate in West
Germany or Switzerland where they were depending on foreign oil,
too. So we cannot blame it all on the increase in the price of
foreign oil.
Ms. BARRETT. That is right, but some countries experienced a
larger than normal increase in inflation rate and to a large degree
the rate was the result of external factors. It was the result of the
pressure on the monetary authorities to accommodate increases in
inflation that originated externally.
Representative ROUSSELOT. And an increase in the Federal debt.
Ms. BARRETT. That may have been caused by the automatic
stabilizers going into effect.
233
Going back to Professor Christ's point, in order for his policy to
work, we would need also to find ways to get the inflation rate
down, to get the inflation, driven by other things, down.
Representative RoUSSELoT. What would you name as the other
important items?
Ms. BARRETT. If the President is successful in his program to try
to break the inflationary link between wages and prices, Professor
Christ's proposal would be far more desirable than where we have
the escalating process occurring largely independently of monetary
growth and where, at the same time, the monetary authorities are
being pressured to accommodate these other inflationary factors
through increasing the monetary base. So it seems to me this kind
of policy has to go hand-in-hand with other kinds of-Representative RoUSSELoT. Lower expectations.
Ms. BARRETT [continuing]. Anti-inflation policy. If you don't do
that, it seems to me you are going to repeat the situation in which
a monetary crunch has more effect in the short run on real growth
than on inflation and politically-Representative ROUSSELOT. Do increased taxes play a role?
Ms. BARRETT; I think so. I think that payroll tax increases
coming at a time when you are trying to convince people their real
wages will not be eroded by inflation does not make much sense.
It is not a very credible policy.
Representative ROUSSELOT. You would put relief on taxation like
we did with proposition 13?
Ms. BARRETT. Definitely, but I would not tie the tax cuts to the
spending cuts. It would depend on the outlook for real growth.
There is no reason, why a tax program should not be part of an
anti-inflation program.
Representative RoUSSELOT. I am glad you partially endorse such
a policy. I appreciate your comments.
Mr. Greenspan, I have been interested in the "Special Analysis
of the Budget of the U.S. Government, Fiscal Year 1980," by the
Office of Management and Budget. They have a fascinating chart
on page 131, which I think you have commented on before, which
relates-Senator Proxmire, if it is possible, I would like to have the
chart as part of the record at this point, so it is clear what we are
discussing.
Senator PROXMIRE. Without objection.
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234
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Ediate
Representative RoUSSELOT. This chart shows Federal borrowing
by the Treasury and also federally assisted borrowing, which I
guess is mostly off-budget borrowing, which the Office of Management and Budget projects $80 billion for 1980. We only hear about
the on-budget borrowing that would be required. Would you like to
comment on that chart on page 131 and also on the general topic of
crowding out in the marketplace as a result of this tremendous
amount of borrowing by the Federal Government?
Mr. GREENSPAN. Congressman Rousselot, this type of analysis,
which has been around for a number of years, probably should be
in the official budget, as distinct from the special analysis, because
in many respects it does represent the measure of the impact of
Federal Government activities on the private sector. There is no
logical reason to merely segregate the so-called on-budget procedures of the Federal budget from what it does indirectly or, by
definition, off-budget.
Representative RoUSaELOT. So you think we should include both
categories in the total?
Mr. GREENSPAN. Yes, in fact there has been a great deal of
discussion on the accuracy of the $29 billion budget deficit.
But that is not a budget which is obviously out of line or rigged
in any way which one could immediately perceive.
On the other hand, when you look at some of the federally
assisted borrowing estimates which are quite important in the total
economic system, it strikes me that we are considerably underesti-
235
mating the total fiscal 1980 numbers. I would suspect that, whereas
that chart shows a number slightly over $80 billion for 1980, the
more realistic number is probably a good deal closer to $100 billion,
which would put-Representative ROUSSELOT. $100 billion instead of $80 billion?
Mr. GREENSPAN. Closer to it. It is probably in the 1990's. That
would put 1980 borrowing and federally assisted borrowing close to
its alltime peak of fiscal 1976 and hugely in excess of anything we
have historically seen even as recently as the 1960's.
So, if we are looking at the aggregate impact of fiscal policy on
the credit markets and, therefore, indirectly on the money supply,
there is nothing I envisage in this particular budget document that
gives me great hope that we are about to enter a period of sharply
reduced fiscal stimulus.
Representative RoUSSELOT. When the Federal Government has to
borrow, whether it is called on budget or off budget, then this
tremendous amount that you say-around $90 billion is your estimate-does it in effect tend to compete in the marketplace more
aggressively than the private market can absorb?
Mr. GREENSPAN. It depends to a substantial extent what the
ongoing flow of savings are. I don't think it is appropriate to add
merely different types of Federal borrowing and assistance dollar
for dollar.
Technically, the impact differs depending on the degree of socalled inelasticity of demand for funds. In fact, on-budget and legal
off-budget borrowing probably has almost nothing to do with the
interest rate; that is, the Treasury will borrow what it requires to
finance its deficit independent of what the rate of interest is.
I would suspect, however, that at extremely high interest rates
some of the federally assisted borrowing which is largely borrowing
by the Federal Home Loan Bank Board, and Fannie Mae, would
probably be partly curtailed. But there is no question that the
aggregate itself is terribly important. In today's environment, with
aggregative private credit demands being quite strong, we are
seeing, as a consequence of these very large numbers, tremendous
stringency in the short-term money markets. The loan deposit ratio
for the commercial banking system has now pierced the 1974 peak.
So we see extreme difficulty on the part of the financial intermediaries, particularly the commercial banking system in trying to
balance the supply and the demand for funds, largely as a consequence of the very large borrowing requirements, directly and
indirectly, of the Treasury.
Representative RoUSSELOT. That does not help capital formation.
Mr. GREENSPAN. No, clearly, it is detrimental to it.
Representative RoUSSELOT. I think we have heard that state-
ment. Thank you for your point.
Do any of you want to coniment on that?
Mr. FAIR. I would concentrate as I indicated in my testimony, not
on the deficit, but instead on the effects of the expenditure and tax
proposals on aggregate supply and demand. I consider the deficit to
be a residual, the result of the various expenditures and tax decisions. I gave an example where, if the administration forecast is
too optimistic for fiscal 1980, then the budget deficit will be larger
than the administration expects.
236
Representative ROUSSELOT. Congressman Giaimo, our Budget
Committee chairman in the House, said it would probably be as
high as $30 billion or $40 billion.
Mr. FAIR. It would seem to me that this is not terribly interesting in itself. You would not say-Representative RoUSSELOT. Why is it not interesting?
Mr. FAIR. Consider the case in which the administration turns
out to be wrong, where there is less expansion, and a larger deficit
than expected. I think most people would argue that there would
be less inflation in the less expansionary case even though the
budget deficit is higher.
Representative RoUSSELOT. Mr. Christ, do you want to comment?
Mr. CHRIST. Just to comment on the effect of growth of the
money stock on interest rates: If we increase the money stock
faster than we have been doing it before, the short-run effect will
lower interest rates. But soon after that-after the inflation rate
rises as a consequence-we get higher interest rates.
So, the way to lower interest rates in the long run is to slow
down the growth of the money stock. Get rid of the inflation and
rates will come down.
Mortgage rates are now 2l/2 percent above the inflation rate.
That is about the same spread as in 1950.
Ms. BARRETT. I think one thing that Mr. Greenspan has pointed
out is that the short-run effects on the deficit of fiscal policy
changes that we might adopt from year to year are probably far
less significant in terms of their impact on credit markets than
other things the Government does.
We have been focusing a lot on the crowding out of effects of the
deficit. We need to know a lot more than we do, and Congress
needs to have more information from economists about what the
credit market activities of the Government are, and this should be
part of the whole budget process.
And I think the idea of trying to get a handle on what you call
the credit budget or the operations of Government in credit markets is an important next step in this whole question of the evolution of the budget process.
Representative ROUSSELOT. The total activity, which point I think
we made very well.
Ms. BARRETT. Yes.
Representative RoUSSELOT. Thank you. Senator Proxmire.
Senator PROXMIRE. That pertains to a very interesting little note
I saw in the Washington column of the Wall Street Journal. It
reads this way: "Smaller pay hikes loom in some firms as guidelines begin to bite."
That sounds like very good news. As one pointed out, one of the
problems with inflation is that high wages, particularly with productivity, lead to high prices. There is no question about it. It is
inevitable.
I realize this income policy depends very heavily on effective
fiscal and monetary policy.
Mr. Greenspan, would you say this would indicate the President
may be on the right course with the guideline program he has or
would you say it is too early to tell?
237
Mr. GREENSPAN. As a member of a couple of companies' compensation committees, I can tell you those are cuts in salaries of highsalaried employees.
Senator PROXMIRE. It sounds like it is not only effective but just.
Mr. GREENSPAN. I was about to indicate that, like the expenditure limits in the Federal budget, there are many ways you go
around those things. As a consequence, I am inclined to see it as
representing a very small number of people.
Senator PROXMIRE. That looks like a very big sample, 624 companies. When Gallup makes a poll of 624 people, they claim the error
is about 3 percent.
Mr. GREENSPAN. I think the company number is right, but I
think they are only covering the executive group which is a very
small number of people in each company.
Senator PROXMIRE. It says management employees will be most
affected by the employees and only 26 said management employees
would be hardest hit.
That suggests they would not be as drastically hit. The biggest
cuts would be at the top.
Mr. GREENSPAN. I have very little experience with this. But I
would say companies are behaving as though these controls are
mandatory, and the individual corporations have been, as best I
can judge, behaving, expecially with respect to management salaries, as if they are dealing with a mandatory system. So the results
do not surprise me.
Senator PROXMIRE. If there were a reduction, it would be very
good news, would it not, from an inflation standpoint?
Mr. GREENSPAN. I would say if it is spread throughout the total
economy, it would be. But this is a very small number and I would
hesitate to generalize from this particular study.
Senator PROXMIRE. Would you all agree that this can only work
in an atmosphere of reasonably restrained monetary and fiscal
policy, that if you don't restrain your fiscal and monetary policy, it
would not work, but it may be a useful part of any anti-inflation
policy, providing you concentrated on monetary and fiscal policy.
Would you agree with that, Mr. Fair?
Mr. FAIR. Yes, I would.
Senator PROXMIRE. Mr. Christ?
Mr. CHRIST. Yes.
Senator PROXMIRE. Ms. Barrett?
Ms. BARRETT. I don't know what you mean by restraint, but
disastrously restrictive monetary-Senator PROXMIRE. I don't think it is restrained enough, but
more than the restraint practiced now by the administration?
Ms. BARRETT. Probably.
Senator PROXMIRE. Thank you very much. You have been an
excellent panel and you have done a fine job. We are very greatful
to you.
I will be happy to call your observations to other members of the
committee.
The committee will stand in recess until tomorrow when we have
a panel consisting of Herbert Stein, on the economic scene.
[Whereupon, at 12:15 p.m., the committee recessed, to reconvene
at 10 a.m., Wednesday, February 7, 1979.]
47-106 0 - 79 - 16
THE 1979 ECONOMIC REPORT OF THE
PRESIDENT
WEDNESDAY,
FEBRUARY 7, 1979
CONGRESS OF THE UNITED STATES,
JOINT ECONOMIC COMMITTEE,
Washington, D.C.
The committee met, pursuant to recess, at 10:15 a.m., in room
6226, Dirksen Senate Office Building, Hon. Lloyd Bentsen (chairman of the committee) presiding.
Present: Senator Bentsen; and Representatives Brown and Wylie.
Also present: Louis C. Krauthoff II, assistant director-director,
SSEC; Richard F. Kaufman, assistant director-general counsel;
John M. Albertine, L. Douglas Lee, Thomas F. Dernburg, Kent H.
Hughes, and William R. Buechner, professional staff members;
Charles H. Bradford, minority counsel; and Robert H. Aten and
Stephen J. Entin, minority professional staff members.
OPENING STATEMENT OF SENATOR BENTSEN, CHAIRMAN
Senator BENTSEN. Gentlemen, as soon as you are ready, we will
get started. I understand that Mr. Eckstein's plane has been diverted to Dulles, and he should be landing about now. He obviously
will be late.
Mr. Stein was not scheduled until 11 o'clock.
This morning we are continuing our review of the economic
outlook for the remainder of 1979 and for 1980. Over the past few
weeks we have heard from administration witnesses like Charles
Schultze, Jim McIntyre, Secretary Blumenthal, all of them talented economic analysts, men of impeccable repute, who hold positions
of power and influence in the Carter administration.
Today, just in case anyone might disagree with the administration's economic outlook, we are presenting an impressive array of
hard-boiled, highly skilled private economic analysts, who will look
behind that veil, behind the official mask, and give us an unbiased
professional view of where the economy is going-at least that is
what it says here.
Actually, as I noted last Friday, our economists keep predicting a
recession, but they keep postponing it until such time as they have
data'to support their prediction.
The Joint Economic Committee is privileged to welcome this
morning Mr. Edward Bernstein, the president of E.M.B., Ltd., who
will focus on the international situation and its impact on our
domestic economy.
He will be followed by Mr. George Perry of the Brookings Institution, who will discuss the economic outlook in general.
(239)
240
We will have Mr. Eckstein, if he can get in from Dulles, and
Professor Stein, former Chairman of the Council of Economic Advisers, who will join us at 11 o'clock.
Gentlemen, we hear estimates of the budget deficit ranging all
the way from the President's low of $29 billion to various figures as
high as $55 billion. President Carter suggests a growth rate of 3.3
this year and no recession. At least one forecaster says it will be
closer to 1.5 percent, and a whole host of private forecasters are
predicting a recession. We really need some enlightenment this
morning, gentlemen. I would ask you to proceed, Mr. Bernstein.
STATEMENT OF EDWARD M. BERNSTEIN, PRESIDENT, E.M.B.,
LTD., RESEARCH ECONOMISTS
Mr. BERNSTEIN. Mr. Chairman, in my opinion, the critical element in the achievement of the forecasts of the Council of Economic Advisers may be the behavior of the foreign sector, that is to say,
our balance of payments.
Senator BENTSEN. Mr. Bernstein, I really want to hear what you
have to say. If you will, pull that mike closer.
Mr. BERNSTEIN. The critical factor in the achievement of the
forecasts of the Council of Economic Advisers may be the behavior
of the balance of payments of the United States. Whether the
United States can achieve an increase in output and maintain the
level of employment that is forecast depends upon what happens to
our exports and our imports. Whether the administration approaches the target for slowing the inflation will depend to a
considerable extent on the behavior of the exchange rate. It is not
generally recognized that a contributing factor in the large budget
deficit of recent years has been the deterioration in our trade
balance.
It is more than a coincidence that in 1977, when President
Carter came into office and sent his first message on the budget, he
proposed a stimulus program of $16 billion. It was almost exactly
equal to the deterioration in our trade balance between 1975 and
1976, which was $18 billion.
In his original budget message for 1978, the President called for
tax reductions of about $24 billion, and, as I said, it is more than a
coincidence that that was about equal to the deterioration in our
trade balance-that is, the increase in the trade deficit from $9
billion to $31 billion.
The depreciation of the dollar from the end of September 1977 to
the end of October 1978 averaged about 20 percent relative to the
currencies of the large industrial countries. It was an important
factor in the acceleration of the inflation. It was a reason given by
the oil-exporting countries for the increase in the price of oil.
I think we have to understand that the problem of the U.S. trade
balance is much more than a simple question of relative prices or
differential rates of expansion. The increase in the imports of the
United States from 1975 to 1978, excluding imports of oil, were
about 21/2 times as large as the increase in the goods output of the
United States. This means that a very large part of the growth of
domestic demand during this period was diverted to creating
output and employment in other countries. It was also, of course,
the principal reason for the depreciation of the dollar.
241
Since the administration began its new program on November 1,
the dollar has recovered. Until February 2, it had risen about 8
percent on the average against the currencies of the Group of Ten
and Switzerland-the 10 largest industrial countries.
In the last 2 days the dollar has weakened, and it was weaker
again this morning. In fact, the price of gold touched $250 an ounce
in London.
The main reason for the depreciation of the dollar and the deterioration of the trade balance is of a structural character. We
already had the first inklings of this in the period from 1957 to
about 1971.
What happened was that in Europe and Japan. the growth of
output was on a great scale, much of it in the industries in which
we had been specializing for many years, and this manifested itself
in a recurrent payments problem for the United States.
Ordinarily, when a country or a group of countries like Europe
and Japan grow rapidly, it ought to be good for our balance of
payments, that is to say, their demand for imports would increase
more than ours. We would be among the suppliers of these imports,
and we would expect our trade balance to improve. What happened
in Europe and Japan, though, is that the increase in the consumption of their own output, plus the domestic investment in their own
output rose very much less than the increase in their production.
In short, exports became far more important as a contributor to
the level of production and employment in these large industrial
countries.
It is astonishing that this should happen. From an economist's
point of view, there is only one explanation of how you can have
such an enormous increase in output and income and such a limited increase in domestic consumption and investment, that is to
say, relative to the increase of output and income: It is because real
wages are too low in Japan and in some European countries for
their productivity and their real interest rates are too high for
their savings.
The two devaluations of the dollar in 1971 and 1973 and the
depreciation of the dollar de facto in the exchange market since
then have not given us a strong payments position. It is because
the structural factors have been against us.
The main contributors to the recent structural changes are the
rise in the price of oil and the worldwide inflation. Let me explain
how these two factors work back on our trade difficulties.
First, a good many countries-in fact, all countries that import
oil-found that their balance of payments suddenly had become
distorted by the need to make large payments for this oil. For
many of these countries the easiest way to solve this payments
problem was by exporting more to the United States. In 1974,
around January, I wrote a paper in which I pointed out that there
was a great danger that with the passive attitude of the United
States toward its balance of payments and the exchange market,
we would become the residual absorbers of the deficit with the oil
countries that other countries were unwilling or unable to accept.
Incidentally, this paper was published in a Senate report. I must
say that the reality has been much worse than the expectations I
had in 1974.
242
The second reason is the inflation. I don't for a moment want to
condone our relative indifference to the inflation problem. We certainly haven't done as well on inflation as Germany or Switzerland
or even Japan where the traditional rise in the consumer price
index has always been greater than ours.
Our own inflation is not really the reason for our deterioration
in the trade position, because the depreciation of the dollar should
have offset the greater inflation of the United States and maintained the price competitiveness of our exporters in world markets
and our domestic producers in our own market.
What happened is this: In Europe and in Japan the determination to hold the inflation to a minimum resulted in a further
deficiency of domestic demand. Their producers confronted with
large excess capacity and in some cases with high overhead costs,
for example, for maintaining employment, preferred to cut their
profit margins sharply in order to maintain the level of output by
exporting to the United States. After all, we are an enormously
attractive market for any other country that has trouble in maintaining output.
We buy 15 million automobiles and trucks a year. Any country
that is having trouble maintaining sales in its domestic market can
easily offset that if it can capture another 1 or 2 percent of our
market. And this, in my opinion, is one of our basic problems, that
the rest of the world finds that the United States is the one great
market in which they can sell their output when domestic demand
is weak or when demand in other areas falls. I might add, incidentally, that one of the reasons Japan pushes so hard to export to the
United States is that it is very sharply discriminated against in its
exports to Europe.
Now I am deeply disappointed that we have had no improvement
in our trade balance despite the enormous depreciation of the
dollar. I don't regard what has happened this year as any indication of an improvement in our trade balance. After all, our trade
deficit ran something like this:
It jumped from $3.6 billion in the fourth quarter of 1976 to an
average of nearly $7 billion in the first three quarters of 1977. It
then made a quantum leap to a deficit of over $10 billion in the
fourth quarter and another leap to $11 billion in the first quarter
of 1978.
This sudden jump in the trade deficit at a time when the dollar
was depreciating was due to anticipation of depreciation of the
dollar. The Europeans and the Japanese wanted to get their exports through our customs before the dollar depreciated much
more. In Germany, for example, in the last months of 1977 exports
to the United States rose by 40 percent, measured in deutsche
mark, compared to the previous year. This was just to build up
inventories of goods sold by Germany in this country before the
dollar depreciated more.
After the dollar began to become a little more stable, our imports
dropped and in the second quarter of 1978 our trade deficit fell to
$7.7 billion and in the third quarter it rose a little to $8 billion. In
the fourth quarter it dropped to around $7.4 billion. These are
quarterly trade deficits on a balance-of-payments basis.
243
Now, the $7.4 billion trade deficit is really no sign of improvement. For one thing it includes $300 million of receipts from the
sale of gold in December and smaller quantities in October and
November. Besides, the $7.4 billion trade deficit in the fourth quarter is larger than the $7.3 billion trade deficit in the third quarter
of 1977 that precipitated the flight from the dollar.
I think the dollar has recovered primarily because there is a
feeling in the exchange markets that the Treasury and the Federal
Reserve won't let it depreciate much more. If the Treasury and the
Federal Reserve won't allow the dollar to depreciate much more
and interest rates in the United States are raised, why there is a
big inducement for those that have been maintaining a short position in dollars to cover their positions, that is to say, not to expose
themselves to a risk of recovery in the dollar. There isn't much
they can gain in the near future from a further depreciation of the
dollar.
I welcome this policy. I think it has been successful so far, but I
think we must bear in mind that it is not a policy that can be
successful in the longer run, and I am thinking only in terms of
1979, unless the exchange market sees a significant reduction in
our trade deficit.
I don't want to sound too pessimistic. The Council of Economic
Advisers makes the point that the improvement in our current
account from the fourth quarter of 1977 to the fourth quarter of
1978 was a great contributor to the maintenance of output and
employment in the course of 1978. I think we ought to bear in
mind that this is from the biggest current account deficit that we
have ever had, and that if we had measured, say, from the third
quarter instead of the fourth quarter of 1977, there would have
been no improvement whatever.
It may be that the depreciation of the dollar that has already
occurred, the slowing of the growth of output in the United States,
perhaps the acceleration of the growth of output in Europe and
Japan will bring an improvement in our trade balance; but I think
that if it doesn't in the next few months, and that is all really the
market is prepared to wait for, then I think it will be necessary for
us to take stronger measures to restrict the inflow of finished
manufactured goods from the large surplus countries.
Senator BENTSEN. That is quite a closing, Mr. Bernstein.
I think we will go ahead and hear Mr. Perry and then proceed
with questions of you gentlemen.
[The prepared statement of Mr. Bernstein follows:]
PREPARED STATEMENT OF EDWARD M. BERNSTEIN
The past few years have been a period of great monetary instability. In the
United States, the inflation of prices and costs accelerated. In the foreign exchange
markets, the dollar depreciated considerably relative to the currencies of almost all
of the large industrial countries. Until the United States succeeds in slowing and
halting the inflation, the dollar will be under pressure in the exchange market. And
as long as the dollar depreciates, there cannot be an orderly or stable international
monetary system.
The greater inflation in the United States than in some other countries, such as
Germany, Japan, and Switzerland, would of itself necessitate a depreciation of the
dollar relative to the Deutsche Mark, the yen, and the Swiss franc. Unless the
dollar depreciated to that extent, the United States would be unable to maintain the
price competitive position of U.S. exports in world markets and of domestic products
244
in the U.S. market. In fact, the dollar depreciated far more than that, particularly
from the end of September 1977 to the end of October 1978. Over these 13 months,
the dollar fell by 24.2 percent relative to the D-mark, by 32.6 percent relative to the
yen, and by 36.0 percent relative to the Swiss franc. Against all of the currencies in
the Group of Ten and Switzerland, weighted by their total exports in 1977, the
dollar fell by an average of 19.7 percent (Table 1).
The dollar fell sharply in this period because the exchange market lost confidence
in the dollar as a result of the deterioration in the U.S. payments position. In order
for the dollar to be reasonably strong in the exchange market-that is, to depreciate
no more than the relative rate of inflation-there must be an inflow of foreign
funds equal to the U.S. deficit on current account plus the loans and investments of
the U.S. Government, banks, and business. When the deficit on current account
becomes too large, it is difficult to attract an adequate inflow of foreign funds at
prevailing exchange rates. As a consequence, the dollar depreciates until either it
has fallen so much that the risk of loss to private investors in acquiring and holding
dollar assets is more than offset by the prospect of gain, or the monetary authorities
intervene to halt the depreciation because it has become excessive and disruptive.
This is what happened in the past three years. In 1975, the United States had a
current account surplus of $18.4 billion, including reinvested earnings of U.S. and
foreign direct investment enterprises. By 1978, this had shifted to a current account
deficit of about $16.3 billion. As other current receipts increased much more than
current payments, the change was entirely due to the fall in the trade balance from
a surplus of $9.0 billion in 1975 to a deficit of $34.2 billion in 1978. Not surprisingly,
the exchange market regarded such an increase in the trade deficit as evidence of
great weakness in the U.S. payments position. Under the circumstances, foreigners
did not find investment in U.S. assets attractive and the dollar depreciated far more
than could be justified by differences in the rate of inflation. The depreciation was
halted only when the Treasury and the Federal Reserve took measures to support
and strengthen the dollar.
What is most astonishing is that the large depreciation of the dollar had no effect,
at least so far, in reducing the trade deficit. On a quarterly basis, the trade deficit
rose from $3.6 billion in the fourth quarter of 1976 to $7.0 billion in the first quarter
of 1977. The trade deficit fell and rose moderately in the next two quarters but then
leaped to $10.2 billion in the fourth quarter of 1977 and $11.1 billion in the first
quarter of 1978. The trade deficit fell to $7.7 billion in the second quarter, rose
moderately in the third quarter, and fell moderately to $7.5 billion in the fourth
quarter of 1978 [Table 2).
The shift of the trade balance from a moderate surplus in mid-1975 to a moderate
deficit in late 1976 could be regarded as a typical response to the more rapid
recovery in the United States than in the other large industrial countries. The neardoubling of the deficit to a quarterly average of $7.0 billion in the first three
quarters of 1977 cannot be regarded as cyclical in character, unless one interprets
the very large increase of U.S. imports of finished manufactured goods as resulting
from the low level of domestic demand in other countries. The leap in the quarterly
trade deficit to the $10-11 billion range in the fourth quarter of 1977 and the first
quarter of 1978 was due to the flood of imports form Europe and Japan and the fall
of U.S. exports in anticipation of the depreciation of the dollar. The reduction of the
trade deficit since then is not an improvement in the U.S. trade position, but a
reversal of the previous leads and lags. The fact is that the trade deficit in the
fourth quarter of 1978 was larger than it had been in the third quarter of 1977
which precipitated the flight from the dollar.
The persistence of the enormous trade deficit is the result of basic changes that
have been going on in the structure of the world economy. The remarkable increase
in output and productivity in Europe and Japan until 1975 would ordinarily be
expected to have a favorable effect on the U.S. payments position. So it would if
consumption and investment in these countries had increased about in proportion to
the increase in their output. Instead, the growth of output and employment in these
countries has depended on a very large surplus on current account. The development of their economies on the basis of an excessive export surplus shows that their
real wages have been too low for their productivity and their real interest rates
have been too high for their savings.
This basic cause of imbalance in international payments was intensified by new
factors that emerged in the past few years. The sharp increase in the price of oil in
1973-74 placed great strain on the balance of payments of the oil-importing countries. For many of these countries, and they include some large industrial countries,
the most convenient way of meeting the much higher cost of oil imports was to
245
increase their exports to the United States. This danger was foreseen in 1974; the
reality has been much worse than expected.
The other factor that. has contributed to the intensification of the imbalance in
international payments is the emergence of inflationary pressures throughout the
world. Some European countries and Japan have succeeded in dampening the
inflationary pressures by holding down domestic demand. In order to maintain
output, however, their producers have placed even greater emphasis on increasing
exports. The United States, with its enormous market for goods of all kinds, is an
inviting target for the exporters of other countries. If the domestic market for
automobiles, for example, is weak, foreign producers can easily offset it by increasing their share of the U.S. market by an extra 2 or 3 percent. To some extent, they
have been helped by the policies of their Governments. In any case, they have not
hesitated to cut profit margins to a minimum in order to capture a larger share of
the U.S. market.
It should not be overlooked that the enormous trade deficit of the United States is
in large part the consequence of the policies of other countries that have resulted in
their having an enormous trade surplus. To put it bluntly, the United States would
not have a trade deficit of over $34 billion in 1978 if, say, Germany did not have a
trade surplus of about $22 billion and Japan a trade surplus of about $25 billion last
year. The reason such an imbalance in the pattern of world trade could develop is
that the United States takes a passive attitude toward its balance of payments. In
fact, other countries believe that the United States should be the residual absorber
of whatever balance of payments they regard as appropriate for them. They recognize that the depreciation of the dollar places great pressure on the profit margins
of their exporters, but they are reluctant to recognize that this is due to their
determination to maintain an excessive level of exports.
All sorts of arguments have been presented to rationalize this unprecedented
imbalance in the pattern of trade as somehow necessary and even desirable. The
former Minister for External Economic Affairs of Japan (the post has since been
abolished) said a few months ago that its bilateral trade with the United States will
have to remain indefinitely in surplus because it needs such a surplus in order to
help the developing countries. The right way for Japan to help the developing
countries is by having a surplus with them which is financed by aid from Japan. A
few months ago, a director of the Bundesbank said that the German surplus on
current account would be a serious problem only if other countries were to have
foreign exchange difficulties because of it. This was not to be expected, he said, as
the Federal Republic was a large exporter of long-term capital. Unfortunately, the
United States cannot have an acceptable balance of payments, one which is compatible with a reasonably stable dollar, if other large industrial countries have an
excessive current account surplus, even if they invest the proceeds abroad.
Arguments have been presented in the United States that the trade deficit is
caused by the high level of domestic demand, that the increased imports serve to
moderate inflationary pressures, and that our trade balance is a reflection of comparative costs. In fact, the trade deficit is far greater than could have been caused
by the cyclical recovery of domestic demand. Since 1975, U.S. imports, excluding oil,
have increased about two-and-a-half times as much proportionately as the goods
output of the United States. This had a restraining effect on output and employment which the Administration tried to offset by a fiscal stimulus. It is fair to say
that the increase in the trade deficit was a contributing factor in the budget deficit.
As for its contribution to the slowing of inflation by increasing the supply of import
goods, that could be little more than marginal. On the contrary, the depreciation of
the dollar as a result of the trade deficit had the effect of raising the prices of all
basic commodities and even domestic goods not competing with imports.
What troubles me most is the assumption that the enormous trade deficit is a
reflection of comparative advantage and that it must therefore be beneficial to the
United States and its trading partners. When trade is based on comparative advantage, we export the goods in which we have relatively greater efficiency and import
the goods in which-other countries have relatively greater efficiency. The key word
is relative. It is inconceivable that one country can have a comparative advantage in
nearly everything it produces. It is implicit in the theory of comparative advantage
that a country's exports and imports of goods and services will be within reasonable.
overall balance, allowing for the fact that some countries should be capital exporters and others capital importers. The concept of comparative advantage cannot be
stretched to explain the enormous trade surplus of Japan and Germany and the
even larger trade deficit of the United States.
On November 1; 1978, the Secretary of the Treasury and the chairman of the
Federal Reserve System announced their policies to support and strengthen the
246
dollar. That has involved a tightening of monetary policy and the accumulation of
large resources for intervention in the market in collaboration with the monetary
authorities of Germany, Japan, and Switzerland. The policy has succeeded in halting the depreciation of the dollar and in bringing a considerable recovery in its
foreign exchange value. In the three months to February 2, 1978, the dollar rose by
7.8 percent against the D-mark, by 12.6 percent against the yen, and by 14.2 percent
against the Swiss franc. Relative to the currencies of the Group of Ten and Switzerland, the dollar rose by an average of 7.9 percent over this period.
This has given the dollar an extra element of strength by inducing exchange
traders to cover their short positions. The dollar can continue to be strong, however,
only if there is clear evidence that the trade deficit will be reduced substantially.
There has certainly been enough depreciation of the dollar to give the United States
a much better price competitive position in world trade. The slower growth of
output in the United States and perhaps the faster growth of output in other
industrial countries should be of help in stimulating U.S. exports and holding down
U.S. imports. If the trade balance is reduced substantially, the inflow of foreign
funds will become adequate to finance the U.S. current account deficit and U.S.
foreign loans and investments without a renewed depreciation of the dollar.
The United States is not without fault in its serious payments difficulties. It has
not done enough to slow the inflation, it has been too tolerant of the depreciation of
the dollar, it has become too dependent on imported oil, and it has been too passive
about the trade deficit. The Administration is now dealing more forcefully with
these problems. It has placed primary emphasis on slowing the inflation, even
though this will require a more modest growth of output and some increase in
unemployment. An essential element in achieving the price and cost objectives of
the Administration is to avoid a further depreciation and, if possible, to facilitate a
continued recovery in the foreign exchange value of the dollar. Intervention to
support the dollar can be helpful for a time. In the end, the strength of the dollar in
the exchange market will depend on restoring an acceptable trade balance. If this
does not occur in the next few months, it may be necessary to reduce the deficit by
limiting imports from the surplus countries.
247
E M B (LTD.)
79/3
1.
DOIlAR EXCHANGE RATES FOR SELECTED CURRENCIES,
1977-78
Per cent change in
value of dollar to
October 31
February 2
1978
1979
Foregin units per dollar
September 30
October 31
February 2
1977
1978
1979
Beigium
Germany
Netherlands
France
Sweden
35.742
2.3074
2.4565
4.9033
4. 8327
27. 580
1.7490
1.8925
4.0025
4.1800
29.670
1.8855
2.0340
4.3250
4.4050
-22.84
-24.20
-22. 96
-18. 37
-13.51
7.58
7.80
7.48
8.06
5.35
United Kingdom*
Canada*
Japan
Italy
Switzerland
1.7465
0.9316
265.45
882.25
2. 3385
2.0770
0.8597
178.95
794.50
1.4963
1.9794
0.8342
201.55
847.38
1.7083
-i5.91
9.75
-32.59
-9. 95
-36.01
4.93
3.06
12.63
6.66
14. 17
-19.67
7.85
Average change#
* U.S. dollars per foreign unit.
# Increase or decrease in average foreign exchange value of the dollar weighted by
the total exports of these ten countries in 1977.
2.
U.S. EXPORTS AND IMPORTS,
1975
1976
1977
1978
107,088
114,694
120,576
141,819
Other
-A
iOAA4^
A
-----chae-L
r-om
P-revxus
p-r
uu
Exports
Imports
Total Agri- Other Total Petro- Other
cult.
leum
DA
Million dollars
Exports
Total
Agricult.
1975-78
-er
Imports
Total Petroleum
Other
22,242
84,846 98,041 27,017 71,024
23,381 91,313 124,047 34,573 89,474
24,336 96,240 151,706 44,980 106,726
29,864 111,955 176,008 42,307 133,701
1977-1
2
3
4
29,477
30,629
31,009
29,461
6,219
6,480
5,974
5,663
23,258
24,149
25,035
23,798
36,502
37,263
38,277
39,664
11,574
11,536
11,306
10,594
24,928
25,727
26,971
29,100
1978-1
2
3
4
30,689
35,092
36,955
39,083
6,485
7,974
7,902
7,503
24,204
27,118
29,053
31,580
41,808
42,812
44,918
46,470
10,020 -31,788
10,588 32,224
10,985 33,933
10,714 35,750
___
cent
8.9 -0.8
7.1 5.1
5.1 4.1
17.6 22.7
11.8
7.6
5.4
16.3
-5.4
26.5
22.3
16.0
1.6
28.0
30.1
-5.9
-7.8
26.0
19.3
25.3
-0.8 4.2
3.9 4.2
1.2 -7.8
-5.0 -5.2
-2.0
3.8
3.7
-4.9
9.6
2.1
4.9
3.6
23.9
-0.3
-2.0
-6.6
4.0
3.2
4.8
7.9
4.2
14.3
5.3
5.8
1.7
12.0
7.1
8.7
5.4
2.4
4.9
3.5
-5.1
5.7
3.7
-2.5
9.2
1.4
5.3
5.4
14.5
12.3
-0.9
-5.0
248
Senator
BENTSEN.
Please proceed, Mr. Perry.
STATEMENT OF GEORGE L. PERRY,, SENIOR FELLOW, THE
BROOKINGS INSTITUTION
Mr. PERRY. It is a privilege to testify before the Joint Economic
Committee on the subject of the President's economic outlook and
economic policies. The emphasis in economic policy has moved
toward fighting inflation and away from expanding employment
and production. This shift in emphasis is appropriate after several
years of recovery during which employment has grown by 10 million and the unemployment rate has declined by 3 percentage
points from its recession high.
It is also appropriate that the administration aims to fight inflation while still avoiding a new recession. Although the changes in
fiscal and monetary policy aimed at slowing aggregate demand
increase the risk of an economic downturn, the administration is
not relying on a weak economy as its main weapon against inflation. In addition to demand restraint, it has instituted a program of
voluntary wage and price standards, proposed an innovative program of real wage and price standards, proposed an innovative
program of real wage insurance to encourage compliance with the
wage standard, and promised to reduce the inflationary impact of
regulation and other activities of the Government.
I would like to address my remarks both to the prospects for
achieving the Government's near-term objectives for employment
and inflation, and to the range of antiinflation policies which are
being pursued and proposed.
OUTPUT AND EMPLOYMENT IN 1979
The administration forecasts a 2 to 2.5 percent increase in real
GNP during 1979-fourth quarter 1978 to fourth quarter 1979.
They also foresee somewhat faster growth during 1980, and thus
forecast no recession any time in the next 2 years. Although recent
developments have increased the probability that the administration will achieve its soft landing, I still expect a recession will start
during the second half of this year. My expectations for monetary
policy are important in making that judgment.
For some time now a central part of a recession forecast for 1979
has been the expectation that high interest rates would lead to a
substantial decline in housing starts and construction activity.
Thus far, the efforts by the Federal Reserve Board and the Federal
Home Loan Bank to limit the outflow of funds from thrift institutions in the face of rising interest rates have succeeded beyond
anyone's expectations. As a result, there is still no sign of a decline
in housing.
Not only has the industry been virtually immune to the rise in
rates that has thus far occurred, but recently the Federal Reserve
has stopped increasing interest rates: The discount rate has not
been raised since its historic leap of 100 basis points in early
November, the Federal funds rate is only one-fourth point above its
'The views expressed are my own and are not necessarily those of the officers, trustees, or
other staff members of the Brookings Institution.
249
early November level, and market rates declined during most of
January.
If interest rates do not rise substantially further, or steps are not
taken to limit directly the availability of funds for mortgages,
consumers, or business borrowers, I believe the recession could be
avoided. I continue to forecast a recession because I expect that the
authorities will make tight money bite on the real economy either
through higher rates or limited availability, or both. And when
they do, it will be hard to take just a nip that slows the expansion,
but stops short of causing a recession.
Fiscal policy is not a major source of weakness in the very shortterm outlook. But under present budget plans it will be by 1980.
Although it is hard to anticipate developments that far ahead, I
expect that a distinctly easier monetary policy will be needed to
achieve the administration's output goals for next year, even if a
recession is avoided in 1979.
The situation in Iran raises some important uncertainties about
economic prospects for this year and next. Neither the basic administration forecast nor my own allows for a substantial shortfall of
world oil supplies from world demand. World oil stocks are plentiful by historic standards and other producing nations have the
capacity to make up much of the loss in Iranian production. But
whether they will do so, for how long, and at what price are all
important questions to which we cannot have certain answers.
We do have time to do some contingency planning for some
possible bad outcomes even if they are unlikely. Such planning
should look for ways to maximize our own fuel production, minimize the impact of higher energy prices on our wage-price spiral,
and insulate output and employment from the depressing effects of
a large increase in imported oil costs.
INFLATION IN 1979
The administration forecasts a rise of 7.25 percent to 7.5 percent
in the GNP price deflator during 1979. This would represent a
slowdown of about 1 percentage point from the 1978 increase of 8.3
percent. And they project a comparable slowdown in 1980 as well.
I find this forecast reasonable. Barring bad news on food prices
or surprising increases in energy prices, the forecast is realistic and
could even come out high.
I agree with the Council of Economic Advisers assessment that
compensation per hour in the nonfarm economy will rise about 8.5
percent during 1979, and agree also with the reasons for their
assessment: Compared with 1978, when hourly compensation rose
9.8 percent, this year the wage-price restraint program will moderate average wage increases; the rise in payroll taxes and the minimum wage will be much smaller; and the upward pressure on wage
increases that comes from declining unemployment will be absent.
Based on what has happened in both the recent and distant past,
an 8.5 percent rise in hourly compensation should lead to a rise of
6.5 to 7 percent in the price deflator for the nonfarm sector-again
excluding any exceptional increases in energy costs. Last year the
price deflator rose 1.75 points less than hourly compensation, and
that was a year in which the declining value of the dollar put some
250
extraordinary upward pressure on prices in export- and importcompeting industries.
Thus, there is room in the administration's overall price forecast
for some extra price inflation from domestic energy prices or form
food prices rising a bit more than the average price level. But I see
no hope for keeping the average price level within the forecast if
food or fuel prices rise a great deal.
POLICIES FOR INFLATION
FIGHTING
We can stop inflation if we care about nothing else. Inflation
remains a problem because policymakers do care about other
things. They care about the inefficiencies, inequities, and bureaucracies that would be part of a system of rigid wage-price controls.
And they care about the loss of output, employment, profits, and
investment that would result from applying large doses of fiscal
and monetary restraint until inflation was wrung out of the
system. The administration's diversified attack on inflation is an
attempt to deal with the problem while avoiding these extremes.
To most disinterested observers, the least controversial part of
the administration's program is its promise to reduce the impact
on costs and prices of regulation and other activities of the Government. These other activities range from agricultural programs to
import policies to payroll taxes. There is plenty of scope for affecting the price level, and hence the inflationary spiral, through these
activities of the Government. But until interested parties, including
the Congress in many cases, are persuaded, this part of the program may promise much more than it delivers. In some cases it
may also deliver more than it should-the point is not to abandon
the goals of social regulation, but to pursue them more efficiently.
The most visible parts of the program are the voluntary standards for wage and price restraint. By directly orchestrating a slowdown in the inflationary spiral, these standards can speed up the
process of disinflation and reduce the real loss in employment and
production that accompanies it. We cannot judge how successful
the administration's voluntary standard will be, although the early
returns seem favorable. There is no verdict from either the past or
from economic theory that tells us it is not an attempt worth
making.
Real wage insurance is the most innovative part of the administration's program and the most controversial. I am aware of many
specific criticisms of that proposal. But I am far more impressed
that it is basically on the right track: it encourages the slowdown
in wage inflation without intruding on the market economy in a
way that should seriously concern anyone. We have no precedent
from which to estimate what effect real wage insurance will have
on this year's inflation. But even if it takes only a couple of tenths
of a point off average cost increases this year, it is worth doing.
And if experience with such a program teaches us how to improve
it in 1980 and subsequent years, we may evolve a really significant
new tool for slowing the present inflation and for reconciling prosperity and price stability in the future.
Attempts at direct wage-price restraint are always messy and
always generate skepticism and criticism. The critics often stop
251
short of describing what other alternatives we have. Realistically,
the alternatives are letting inflation continue and possibly worsen,
while pursuing high employment; incurring huge real costs in lost
output and employment in order to slow inflation through demand
restraint alone; or muddling through with something in betweena stop-go policy that leaves us dissatisfied with both inflation and
unemployment.
Popular slogans, such as eliminating Federal deficits, are not in
the running as an inflation cure. Deficits are not the cause of
inflation or even a cause of inflation.
Commonsense tell us this: A dollar of Government spending is
neither more nor less inflationary than a dollar of private spending; and a dollar of either is neither more nor less inflationary if it
is financed by borrowing rather than spent out of savings or
income.
Our own experience tells us this: Except for wartime, when the
Government budget has contributed to excess demand inflation,
deficits have been largest when economic activity and inflationary
pressures have been weakest.
A comparison across countries tells us this: Germany has lately
slowed its inflation, yet their government sector deficit is proportionately many times larger than ours.
The planned reduction in the deficit proposed by the administration makes sense as a fiscal policy for slowing the growth of total
demand. As such, it has a relevant place in the overall strategy for
slowing inflation. But the planned deficit has no special impact on
inflation beyond that. In particular, if the economy falls into the
.recession that the administration hopes to avoid, the deficit will be
larger; that will provide no reason for limiting expenditures still
further and thus making fiscal policy still tighter.
Even people who should know better are touting balanced budgets as the cure for our inflationary ills. The risk is that slogans
will prevail and will get in the way of choosing among the realistic
options. Today the mixed strategy of the administration is our most
attractive option and deserves support. Thank you.
Senator BENTSEN. Thank you very much, Mr. Perry.
Mr. Bernstein, in your closing statement you said that if we are
not able to get an acceptable trade balance in the next few months,
it may be necessary to reduce the deficit by limiting imports from
the surplus countries.
Would you elaborate on that statement?
Let me say, first, I will put a 10-minute rule in here for e few of
us Congressmen. We may have some others appearing, even though
the snow has given us some problem, but if you would elaborate on
that, I would appreciate it.
Mr. BERNSTEIN. Senator, there is a close connection between the
deficit of $34 billion that the United States had in trade in 1978
and the surplus of $24.7 billion that Japan had last year and the
surplus, which I estimate at a little over $22 billion, that Germany
had.
As I said, I don't want to sound too pessimistic, but if the improvement in our trade balance isn't up to the expectations of the
market, the dollar is going to be under pressure once more. I don't
think we can afford to have the dollar depreciate further.
252
The depreciation of the dollar affects every aspect of our economy. In December, after we put in our program of support of the
dollar in the exchange market, the Federal Reserve raised the
discount rates by 1 percent in a single step, the first time that such
an increase had been made by the Federal Reserve since the gold
crisis of September 1931, when England went off the gold standard.
Even though everybody was worried about how high interest
rates would go, I published a paper in December in which I said
that if the dollar appreciated in the exchange market remains
strong, interest rates would stop rising, and might even fall, and
the closing sentence was that the fall couldn't be very much unless
the Federal Reserve accepts this as a reason for easing monetary
policy.
This is why interest rates declined in January. The dollar
became strong. The interest rate in the Eurodollar market,
dropped, and the fall was transmitted to the United States. The
Federal Reserve also made it easier for American banks to draw
funds, if they wanted to, from the Euro-currency market.
I think we have to pay attention to the improvement in our
trade balance in the next few months unless we want to reverse
the rise of the dollar we had from November 1 to February 2,
unless we want to see the value of dollar bonds, the value of dollar
stocks, the value of other dollar assets, and that is why I think we
must not wait too long.
Senator BENTSEN. Well, Mr. Bernstein, we had Bill Miller, Chariman of the Federal Reserve, here and he made a somewhat similar
comment, that we had the choice between finally going to even
higher interest rates or some kind of surcharge, and he would opt
for the surcharge on imports from countries that had a substantial
trade surplus. It seems to me that at the time someone makes that
comment, they put a black hat on and they start talking about the
smooth falling in 1929, but we ended World War II by giving some
very significant concessions to some of these countries and we did
it rightfully at that time, I think, to help restore their economy.
We had the Marshall plan and then we went to trade and now
AID and we have expanded, and we have been working somewhat
away from that, but still it is very substantial.
I think it is a tool that can be used from time to time and has to
be used, not that it is a violation of the trade agreement. That is
just not true. That is one of the provisions that you put on, as I
recall, and it could go as high as 15 percent for a period of 150 days
in trying to take care of that kind of a serious deterioration in the
value of the dollar.
I further think that it was effectively used in 1971 to try to bring
about some agreement on floating rates. Wasn't it used at that
time?
Mr. BERNSTEIN. Yes, sir, I think it was the main inducement to
the Europeans and to Japan to agree to an appreciation of their
currencies relative to the dollar. They agreed to a lot of other
things, some of which I didn't like, even though they accepted
them. They agreed to undertake responsibility for supporting the
new exchange rate that came out of the Smithsonian Agreement.
In my opinion a country like the United States can't say that the
253
responsibility for maintaining the value of the dollar depends on
what other countries are willing to do.
Senator BENTSEN. You want to comment on that, Mr. Perry?
Mr. PERRY. Senator, I really do disagree. It is not an appropriate
policy for us to impose trade restrictions on imports. One cannot
assume that others would not retaliate in that case. We have based
our policy in this area on trying to expand-trade, on free trade, and
I think that thrust of American policy is an appropriate one. It is
the one that we want to continue to aim for in the long run, and I
just don't see anything about the current situation that would
allow us to reverse ourselves on that matter without getting serious repercussions from our trading partners that would damage
our long-run aims.
Senator BENTSEN. Let me say, Mr. Perry, that I think that some
of these types of actions are strong, and I can understand that, but
I think we have reached that position, and I don't think we can
stand a further deterioration of the dollar, and I don't believe that
the $30 billion is going to cut it unless we bring about a dramatic
change in the trade surplus of this country, and I don't buy this
idea that it is good for the world for us to continue to have a
substantial trade deficit, as I hear some of the economists proposing. By the same token, why is it so good for the world to have
Japan and Germany with a very substantial trade surplus? They
talk about the fact they have taken care of inflation in their
countries. One of the reasons is because they have a strong mark
and a strong yen, and part of that is because they have a very
substantial trade surplus.
Now, the Japanese are tough, hard traders, and they are still one
of the most protectionist countries around, and when they try to
run their ads in this country and tell us it is an open market, that
just isn't true.
You know, the United States is still the great frontier for business, if you are a Japanese businessman; and, when push comes to
shove, we can handle that kind of a fight about as much as anyone
can.
Now, we have to do something to get the Japanese to remove
some of their tariff barriers, and I think it takes that kind of a
dramatic action to bring that about. I don't think they are going to
do it otherwise.
Mr. BERNSTEIN. Senator, may I answer Mr. Perry?
I wrote the report, at the request of President Truman, which
was entitled, "A Trade and Tariff Policy in the National Interest."
I am a great believer in free trade.
Senator BENTSEN. Mr. Bernstein, I am running into more ex-freetraders in the last few months than I have ever seen.
Mr. BERNSTEIN. Senator, I am a free-trader still.
Senator BENTSEN. I still am, too, frankly. I want to sit down and
reason it out, but I think you have to show some muscle and some
willingness and not so much passive response.
Mr. BERNSTEIN. I think it is important to explain to economists
like Mr. Perry the economics of our trade balance under present
circumstances.
Senator BENTSEN. Let me get that again.
What are you going to explain?
47-106 0 - 79 - 17
254
Mr. BERNSTEIN. I want to explain to Mr. Perry, as I do to all
other economists who jump on me, the economics of the present
trade balance of the United States.
As I said, I wrote the report on "A Trade and Tariff Policy in the
National Interest." I took leave from the International Monetary
Fund to do this for President Truman. The concept of free trade as
beneficial for the whole world is unexceptional under the following
circumstances: If countries export the goods in which they have a
comparative advantage, if they import the goods in which other
countries have a comparative advantage, we will have higher levels
of income in both the exporting and the importing countries.
Now, it is unfortunately not true that when a country like Japan
provides 40 to 60 percent of the imports of the United States in a
wide range of finished manufactured goods, from automobiles to,
say, cameras, and many other goods in between, that its exports
are based on comparative costs. Not at all.
As I said before, the reason why we are flooded with these
imports from other countries is that the level of real wages, is too
low for their productivity; the level of real interest rates is too high
for their savings.
If we had a world in which wages in each country reflected in
real terms its productivity, then, while Japan would have a surplus, it wouldn't be a surplus of $25 billion, and it wouldn't have
half of it with the United States.
Our current account deficit with Japan is as big as it was last
year with OPEC. This is a trade relationship that cannot reflect
comparative advantage.
Senator BENTSEN. Mr. Bernstein, my time has expired, and I
know Mr. Perry wants to respond again, and so do I, but I defer to
Congressman Wylie.
Representative WYLIE. Thank you very much, Senator.
I will take my 10 minutes, and I assume we will get back to you
because we will have some more time since all of the Members are
not here.
I would like to say at the outset, Senator, this is my first appearance as a member of the Joint Economic Committee.
Senator BENTSEN. We are pleased to have you.
Representative WYLIE. I am certainly very, very pleased to be
here, and I am really thrilled by the great opportunity this allows
me to address some of the very serious economic problems facing
the Nation.
Senator BENTSEN. We have had an unprecedented number of
Members on the House side and Senate side that sought Joint
Economic Committee membership this session and, unfortunately,
we could only accommodate two.
Representative WYLIE. And I am one of them.
Senator BENTSEN. We are delighted to have you.
Representative WYLIE. Thank you very much.
Mr. Perry, I do not mean to be presumptious when I say that I
find myself in some disagreement with your statement in that I
feel the real culprit in our economic problems is deficit Government spending.
I would like to refer to your statement, because I think for me
there is some non sequitur reasons there. Certainly deficits tend to
255
be higher during recessions, but that does not negate the fact that
in periods of high demand, high capacity utilization, and high
output, Federal deficits do cause inflation. At least that is my way
of thinking. At least I think the key as far as Germany is concerned is that they have a high savings rate, or at least this is
according to the German Federal Reserve Board that testified the
other day, so they finance their deficits through borrowing instead
of printing-press money.
I think the only way to strengthen the dollar is to curtail the
dollar supply, and I would like for you to expand on that a little bit
for me, if you would, please.
Mr. PERRY. I would be happy to.
In the first place, I think we must differentiate between our
monetary policy and the state of the Government deficit. These two
things are unrelated. The relationship between monetary policy
and inflation is also frequently misunderstood.
Representative WYLIE. You say you think that monetary policy
and inflation and fiscal policy and inflation are unrelated.
Mr. PERRY. Monetary policy and Federal deficits are unrelated. If
we want to look at the record, sir, when deficits are largest, once
again, we tend to have low growth in the money supply or monetary aggregates.
The contention that somehow a deficit forces monetary policy to
print a lot of money, more than we otherwise would like, really
doesn't square either with how the Federal Reserve operates or
with historical facts on money growth.
The money supply does tend to grow, roughly speaking, along
with the gross national product. It is not related to how large the
Federal deficit is. It is a totally independent policy decision.
Thus, we could, and, in fact, we generally do have slow money
growth when there are large Federal deficits, rapid money growth
when there are small Federal deficits.
The relation can go any way at all in the normal course of
things. So the concept that a Federal deficit forces the money
supply or some other measure of liquidity to grow faster than we
would like is one I disagree with.
That still leaves the question of how fast the money supply grows
and whether that is connected with inflation; that is a rather
complicated issue. By and large, the Federal Reserve expands liquidity-money supply, if you like, or some other measure of it-in
a sort of pragmatic way. They find themselves partially accommodating, partially not accommodating an inflationary condition. It is
not in their power simply to stop the inflation by not expanding
the liquidity in the economy.
It is in their power to drive interest rates up and slow down
gross national product by not supplying liquidity. Then we have to
ask how does that get converted into real output, employment, and
into price level effects. The reason inflation is a very difficult,
almost intractable, problem is because you don't get any large
response on the inflation rate.
If you did, we wouldn't wrestle with the problem of inflation for
so long and we wouldn't find other countries wrestling with it so
long.
256
Representative WYLIE. I think we might have a point if we were
talking about the short run, but over a period of time the Fed
tends to buy a bigger and bigger share of the national debt and
when the new debt is large, the buyers buy a bigger share. Of
course, if the Federal deficit is large, then it seems to me the Fed
takes a larger share of that. I think that you may be accurate in
the short run, but what about over the long run where over the
years the Fed has been attempting to help in this problem of the
decline in the dollar and financing the public debt and acquiring
money to pay for our bills which we haven't been able to pay
through the collection of taxes or to balance the budget by reducing the amount of expenditures.
Mr. PERRY. I see no presumption that we would be in any different position with respect to the money supply or any other measure of liquidity had we traveled the same path of total employment
and output with a very different pattern of deficits in the past, or
perhaps with no deficits or with surpluses in the past.
The Federal Reserve would still have had to accommodate the
"needs of trade," if you like, through its expansion of liquidity. It
might have, as an independent decision, quite unrelated to the
deficit, chosen to accommodate less. We would have then had
higher interest rates for a time, less GNP growth, and we would
have had as a consequence a combination of both less real production and less inflation.
Representative WYLIE. I want to get on to another question and I
have a question of Mr. Bernstein and the time is going quite
rapidly here, which it usually does.
Historically, the Federal Reserve, in order to help stabilize the
Government bond market has gone to the market in an attempt to
stabilize the deficit and to try to make up the difference between
the amount of money that is coming out and the amount of money
which is going out.
They have gone into the marketplace, it seems to me, each time
there is a deficit voted by Congress, so to me that means they are
directly connected with the money supply problem. But I will leave
that there, I think, and go to a statement in your oral statement,
Mr. Perry.
As I said, I don't mean to be presumptuous, but I am in disagreement with you.
You said:
I continue to forecast a recession because I expect that the authorities will make
tight money bite on the real economy either through higher rates or limited availability or both. And when they do, it will be hard to take just a nip that slows the
expansion, but stops short of causing a recession.
I assume this means you are forecasting a higher monetary
policy and higher interest rates.
Mr. PERRY. Yes, sir.
Representative WYLIE. This surprises me some and I would like
to expand on what you have said there because press reports just
this morning have focused on the so-called repurchase agreements
used by large corporations and large banks which purportedly are
not affected by monetary policy.
Does your forecast include any thoughts about repurchase agreements and their effects on the money supply, and I asked this same
257
question of Bill Miller, the Chariman of the Federal Reserve Board,
just last week.
Mr. PERRY. The use of repurchase agreements is something that
has expanded greatly recently and I think it has affected the
precision with which the Federal Reserve can conduct its own
operations.
It is a way of making money work more efficiently rather than
lying idle and not earning interest.
I am glad that you raise the question you did because I would
like to clarify that a recession is very much a forecast. We don't
have, I think, any evidence in the current numbers of a recession
already underway or about to happen.
I expect as the economy shows little sign of slowing or slowing as
much as had been anticipated, the Fed will feel that it has to do
something in order to get some control over how fast GNP is
growing.
I think we were all surprised at how fast GNP grew in the fourth
quarter, and if this continues, there will be no evidence of policy
restraint beginning to act. I simply believe they will work harder
to make it act and they will work harder through one of a variety
of channels. The repurchase agreements, as I understand them, are
an institutional change which has complicated how we read the
numbers. But regardless of whether the Fed will have trouble
deciphering the figures it gets, it still knows which way tighter istighter is higher interest rates. If it isn't seeing a response in the
real economy, it is very likely to move interest rates up higher in
the months to come.
This is very much a forecast.
There is no sign of a recession yet. We have to try to anticipate
policy moves as well as the basic strength of the economy.
Representative WYLIE. Thank you.
I believe my time has expired. I find this very interesting and I
want to try to absorb it.
Senator BENTSEN. We will limit the next round of questions to 5
minutes.
Congressman Brown is on his way over here.
Mr. Perry, if the dollar drops some more in value this year andfor example, I heard this morning that the price of oil went up
some more, but let's suppose the $30 million is not effective and is
not sufficient to shore it up-unless we make some significant
headway, I don't see how you can turn it around.
But if we don't achieve that and you are opposed to a temporary
surcharge-I will try to put a shock to you-what would you propose? Are you talking about higher interest rates.
Mr. PERRY. I think higher interest rates-Senator BENTSEN. You prefer that to growth?
Mr. PERRY. It is not a question of preferring it. I think if you ask
what one prefers, one might say that the worst of a bad lot of
choices is to let markets move the dollar somewhat further.
Most people believe that the dollar is already properly valued or
perhaps is already on the low side of where it ought to be, and that
speculators, those who operate in foreign exchange markets, will
come to recognize this and consequently will not speculate against
the dollar and drive it down.
258
At any point in time, that is a very chancy judgment to make. I
don't make it, because I don't study this particular aspect of the
economy enough to make that judgment. I can imagine a lot oil
events that could occur in 1979 that would put further pressure on
the dollar, not perhaps out of any very rational calculation, but
because in past years, the dollar has come under pressure whenever uncertainty has arisen in certain areas.
Now, if the oil situation worsens substantially, and oil prices are
raised a good deal further than we now expect on the world
market, it would not surprise me if the dollar came under pressure
under those circumstances.
Senator BENTSEN. Now, there are some who say, "All right, one
of the things we do is we put a substantial increase on the tariff on
the importation of oil."
Why can we selectively choose a commodity but we can't selectively choose a country that has substantial export surplus with us
and restrains much more import trade than we do in this country?
Mr. PERRY. I don't know that there is an absolute way to answer
that. I think it has to be answered in the context of the politics of
the international trade community.
I think that a limitation on oil imports would be understood and
appreciated perhaps by other countries. Certainly it would help
them. The less oil we import, the more everybody else in the world
likes it-everyone except the oil exporters-because it reduces
upward price pressure on oil and they are all consumers of that
product.
I am not sure that trade restraints against other importers
would be accepted in the same way. I think there is a real risk that
we would see a spiral of trade restraints around the industrial
world and then nobody gains.
If it were not for that fact, if we could somehow do this in secret,
perhaps you could make a slightly stronger case for it.
Senator BENTSEN. I think to the contrary. I think it is something
that should be highly profiled if we do it and the reason is that
there are restraints against our products in some of those countries. They have a very substantial surplus with us and, frankly,
this economy can't withstand it and the dollar continues to go
down and will go down. Once it is corrected, they are really going
to take that restraint out.
I am not talking about a zero trade balance, but you have such a
disparity here. The Japanese had a surplus of almost $10 billion in
1977 and they corrected it. They corrected it up to almost $20
billion last year, a 100-percent increase.
Mr. PERRY. There are many things behind that.
I think everyone agrees the failure of some of our trading partners to go as well as we have is an important factor in the difference of their trading accounts than ours.
I certainly agree in terms of any bilateral negotiations with the
Japanese, for instance, concerning a trade policy. I suppose anything is fair gain to the extent that we can legitimately put restrictions on their part. I think we have a good bargainingship to try to
reduce those restrictions.
I am speaking against the general propositon of trade restrictions.
259
Senator BENTSEN. I think I agree with you and my history is of
agreeing.
Mr. PERRY. We should understand, of course, that imports are
useful to us in that they do subject domestic industries to competition that might not otherwise exist; and when we are trying to
fight inflation, we should not remove the pressure of that competition.
Mr. BERNSTEIN. By the same token, we ought to improve the
competition with the-Mr. PERRY. I didn't follow that.
Mr. BERNSTEIN. I think a $50 billion trade deficit would increase
the competition even more.
Mr. PERRY. The $50 billion trade deficit is not itself a source of
competition.
What we are talking about is if we protect the automobile industry from foreign competition, your forecast and mine is the same:
domestic car prices would rise faster than they otherwise would.
If we protect the domestic steel industry from foreign competition, your forecast is the same as mine: steel prices would rise
faster than they otherwise would.
Senator BENTSEN. Gentlemen, that is on your time.
Mr. PERRY. I rarely get a chance to argue with Mr. Bernstein. It
is only in a formal setting like this.
Mr. BERNSTEIN. I don't like this ad hoc approach to what will
happen to the dollar-that if the speculators have a gloomy day,
the dollar will go down.
We have to look at the basic things first, and the basic things are
the following: The dollar can be stable only if there is inflow of
foreign funds equal to the current account deficit of the United
States, plus the loans and investments of the U.S. Government,
U.S. banks, and U.S. business.
I am saying that the experience of the last 3 years shows that
you cannot have an inflow of funds from abroad without governmental intervention that will balance our payments when you have
a trade deficit of the magnitude we have had in the last 2 years.
And it is hopeless to expect that if this trade deficit stays anywhere near what it is today, enough money will be brought into
the United States even at higher interest rates.
It really runs the other way. An improvement in our trade
balance will strengthen the dollar and put downward pressure on
interest rates.
May I submit for the record that article that I published in
December saying that interest rates would go down, that money
market rates would go down if the dollar appreciates in the exchange market?
Senator BENTSEN. We would be pleased to have it.
[The article follows:]
THE BALANCE OF PAYMENTS, THE EXCHANGE MARKET, AND INTEREST RATES
*
(By Edward M. Bernstein)
Traditionally, a balance of payments surplus has been associated with lower
interest rates and a deficit with higher interest rates. Under the gold standard, a
balance of payments surplus meant that the receipts of a country from its exports of
goods and services and from capital inflow exceeded its payments for imports of
goods and services and for capital outflow. The excess supply of foreign exchange
was bought by the monetary authorities and converted into gold by the deficit
country. The surplus country then issued its own currency against the gold. Thus,
the money supply and the reserves of the banking system increased in the surplus
country and decreased in the deficit country. This change in the monetary situation
tended to lower interest rates in the surplus country and raise them in the deficit
country.
The automatic effect of gold flows was reinforced by the action of central banks in
raising or lowering the discount rate when there was an outflow or inflow of gold.
So well established was the policy, at least in the United Kingdom, that it came to
be regarded as part of the "rules of the gold standard game". In fact, it was not as
widely followed as the practice of the Bank of England would suggest. In the U.S.,
the effects of the outflow and inflow of gold on bank reserves were moderated by an
offsetting change in borrowing at the Federal Reserve Banks initiated by member
banks. This was by far the most important form of Reserve Bank credit in the 1920s
when open market operations were small and were mainly designed to make the
discount rate effective. The passive attitude of the Federal Reserve to gold flows, its
failure to ease monetary policy in response to an increase in U.S. gold reserves, was
characterised by Keynes as the replacement of the gold standard by a dollar
standard [Tract on Monetary Reform, London 1924, p. 198).
It is worth noting that, although the Federal Reserve was reluctant to see a
multiple expansion of credit on the basis of an inflow of gold, it did tighten credit
when the reserve ratio approached the legal minimum or when there was a threat
of a large outflow of gold. In 1920, when the ratio of gold reserves to liabilities of the
Federal Reserve Banks fell to 40.9 percent in May, the discount rate was raised
from 6 percent-7 percent on June 1. An increase of 1 percent in a single step is very
rare and indicates great concern by the Federal Reserve about the monetary situation. In 1931, when the gold reserve fell by $600 million in September and October
(one-sixth of the total) after Britain abandoned the gold standard, the Federal
Reserve raised the discount rate from 11/2 percent to 21/2 percent on October 9 and
to 31/2 percent a week later, in spite of the severe depression. This was the last time
the Federal Reserve raised the discount rate by 1 percent until its action on
November 1 this year. As this indicates, the U.S. attitude toward the gold standard
was quite different after 1934. Whenever the gold reserve approached the legal
minimum, either because of a decrease of reserves or an increase of the money
supply, the gold reserve requirement was reduced and finally abandoned.
The effect of the balance of payments on the monetary situation is the same if
deficits and surplusses are settled in other reserve assets instead of gold, but
different if they are settled by the accumulation of reserve currencies. Thus, if the
U.S. draws on the International Monetary Fund, say, in D-marks or in yen, as it has
recently, and sells these currencies in the exchange market for dollars, the money
supply and bank reserves would be reduced in the U.S. and increased in other
countries. That would also be true if the U.S. sold Special Drawing Rights for these
currencies and used the proceeds to support the dollar in the exchange market. In
the U.S., the dollars derived from the sale of these currencies would be withdrawn
from the money supply and from bank reserves. In Germany and Japan, the Dmarks and yen acquired by U.S. drawings on the IMF or by the sale of SDRs would
be created by their monetary authorities and their sale in the exchange market by
the U.S. would increase and the money supply and bank reserves in these countries.
If a U.S. payment deficit is settled by the accumulation of dollars by the surplus
countries, it has the same effect on their monetary situation as the accumulation of
other reserve assets. Their monetary authorities would buy the dollars in the
exchange market with their own currencies and this would increase the money
supply and bank reserves in the surplus countries. The accumulation of dollars by
foreign monetary authorities, however, would not affect the monetarv situation in
the U.S. When the dollars are invested in U.S. Government securities or other
assets in the U.S., the reserves of the banking system are restored. There could be a
minor effect on the money supply, depending on whether the assets acquired by
foreign monetary authorities were sold by banks or nonbanks. Drawings by the
Federal Reserve under its reciprocal currency arrangements have precisely the
same effect on the monetary situation in this country and abroad as the accumulation of dollars by foreign monetary authorities. This is explained in an article in the
Quarterly Review of the Federal Reserve Bank of New York, Winter, 1977-1978,
Vol. 2, No. 4, "Monetary Effects of Federal Reserve Swaps".
It is implicit in this analysis that the structure of the balance of payments does
not of itself have a significant effect on the U.S. monetary situation if the deficit is
settled by the accumulation of dollars by foreign monetary authorities. Prima facie,
261
it would seem that a deficit arising from an increase in the net outflow of U.S.
funds for foreign loans and investments should raise interest rates, even if there is
no effect from a deficit due to a deterioration in the current account. This need not
be so. A larger outflow of U.S. funds for foreign loans and investments, with no
change in the inflow of foreign private funds, means that the supply of domestic
savings relative to domestic investment is being reduced. Similarly, an increased
deficit on current account means that supply of domestic savings has been reduced
relative to domestic investment and is inadequate to finance such investment. In
both instances, the deficit will be financed by the accumulation of dollars by foreign
monetary authorities and the consequent inflow of foreign official funds will offset
the deficiency in the U.S. savings.
On a quite different track, it is sometimes said that an inflow of foreign official
funds that goes into the U.S. money and capital markets, mainly in the purchase of
U.S. Government securities, must have a considerable effect in holding down interest rates. As the inflow of foreign official funds has been enormous at times, the
effect on interest rates, if there were one, would be expected to be large. In 1971, the
inflow of foreign official funds amounted to $27 billion. The inflow was more
moderate from 1972 to 1975, but rose again to $18 billion in 1976 and $37 billion in
1977. In the first three quarters of 1978, the inflow of foreign official funds was
about $15 billion. There is no statistical evidence that the level of interest rates was
affected by the inflow of such funds, although there may have been a marginal
effect on some money market rates relative to others because of the strong foreign
preference for U.S. Treasury bills. An analysis based on savings and investment
indicates that, regardless of the magnitude of the inflow of foreign official funds, it
has no direct effect on the level of interest rates. It merely supplies the deficiency in
U.S. domestic savings necessary to finance domestic investment.
In the national income and product accounts (NIPA), the gross savings of an
economy must be equal to its gross investment. The gross savings of the private
sector consist of personal savings, including those unincorporated business and
nonprofit organizations, the undistributed profits of corporations adjusted to a NIPA
basis by deducting inventory profits and the difference between depreciation at
replacement cost and original cost, and corporate and noncorporate capital consumption allowances, both adjusted to a replacement cost basis. In the public sector,
the deficit of the federal government on a NIPA basis is classified as negative
savings although the surplus of state and local governments on a NIPA basis is
classified as savings, although most of it consists of social insurance funds. The
gross domestic savings are used to finance the gross investment of the economy,
which includes residential structures, producers' durable equipment, investment in
additions to business inventories, and its net foreign investment. In the national
accounts, net foreign investment is the same as the balance on current account
excluding reinvested earnings of incorporated affiliates of U.S. and foreign direct
investment enterprises. Net foreign investment has been negative on a large scale
since 1977.
Some of the savings are used for self-financing of investment, as in the case of
owner-occupied homes or business investment financed out of retained earnings and
capital consumption allowances. Much of the gross savings, however, is transferred
from savers to investors through financial markets in some instances with the
intermediation of financial institutions. The amount of savings in each category is
net of negative savings. Thus, the borrowing for personal consumption expenditures
is deducted from personal savings. The same groups may be both lenders and
borrowers. Thus, the corporate sector is not only a large borrower of funds, but also
a large lender. Similarly, some state and local governments borrow for current and
capital expenditure while they accumulate savings in trust funds. Although the
balance of payments deficit on current account is classified as negative foreign
investment, the funds used to finance it could just as properly be classified as
foreign savings available to finance U.S. domestic investment. It should be noted
that net foreign investment is not the same as the deficit on an official reserve
basis-the overall payments deficit.
In a system of floating rates in which the dollar is not convertible into other
reserve assets, the inflow of funds from abroad must equal the balance on current
account plus the foreign loans and investments of the U.S. government, banks, and
business. If the inflow of private foreign funds is inadequate to finance the U.S.
balance on current account and the outflow of U.S. capital, the dollar will fall and
the monetary authorities will intervene to avoid an excessive depreciation of the
currency. To the extent that the intervention is by foreign monetary authorities, it
will result in their accumulation of dollars that they use to acquire assets in the
U.S. An increase in the inflow of foreign official funds may be the result of a larger
262
deficit pn current account, increasing the demand for loanable funds; a larger
outflow of U.S. funds or a small inflow of foreign funds, both of which diminish the
supply of loanable funds in U.S. financial markets.
Changes in the inflow of foreign official funds do not change the relationship of
the supply of to the demand for loanable funds and, therefore, have no direct effect
on the general level of interest rates. If there were such an effect, it would be shown
as a movement of interest rates in the opposite direction from the change in the
inflow of foreign official funds. As can be seen from Chart 2, between 1975 and 1978,
the yield on three-month Treasury bills tended to move in the same direction as the
inflow of foreign official funds. This may have been because cyclical factors acted
coincidentally on both series. From the second quarter of 1975 to the first quarter of
1978, the balance on current account tended to fall as U.S. output and income
expanded. The deterioration in the balance on current account was accompanied by
an increased inflow of foreign official funds, although to an exaggerated extent in
the fourth quarter of 1977 and the first quarter of 1978. The yield on Treasury bills
tended to decline until the first quarter of 1977, but rose thereafter in spite of the
very large inflow of foreign official funds. That was because the Federal Reserve
tightened monetary policy, at first for domestic reasons and later in response to the
deterioration of the balance of payments.
Although the balance of payments does not affect the general level of U.S.
interest rates directly under a system of floating rates, it may do so indirectly
through its effect on the exchange markets. With floating rates, exchange rates may
change in response to differential rates of inflation without a prior or concomitant
change in the balance of payments. In fact, such a change in exchange rates is
necessary if a country is to maintain the same competitive position in world trade.
Furthermore, interest rates must differ among countries by about as much as the
prospective change in exchange rates in order to make the holding or assets equally
attractive in the major currencies. Finally, the premium or discount on forward
exchange relative to the spot exchange rate for two currencies should equal the
difference in money market rates in the two currencies and the difference in their
rates of inflation. Changes in exchange rates which reflect this pattern do not have
an independent effect on interest rates-that is to say, they are an adjustment to
changes in underlying economic conditions including national monetary policies.
The impact of the U.S. balance of payments on exchange rates differs considerably from time to time. It depends not only on changes in the balance on current
account, but on the outflow of U.S. capital and the inflow of foreign capital.
Sometimes the exchange market pays little attention to the change in the balance
on current account, and capital flows are responsive to other factors, perhaps
changes in interest rates, but even more to expectations regarding the future rates
for the dollar. For example, in the first quarter of 1977, the U.S. trade deficit
suddenly increased to $7 billion from $3.6 billion in the previous quarter; and
current account, including reinvested earnings, shifted from a small surplus to a
deficit of over $2.7 billion. Nevertheless, the dollar rose against the D-mark and the
Swiss franc in the first quarter of 1977, although it fell against the yen. The reason
for the modest strength of the dollar relative to the European currencies was the
large decline in U.S. capital outflow. The dollar depreciated moderately in the
second and third quarters of 1977, as the current account deficit changed very little,
but the outflow of U.S. funds relative to the inflow of foreign funds, including errors
and omissions, increased to a considerable extent.
263
RATES,
1977-78
1.-BALANCE OFPAYMENTS AND CHANGES INEXCHANGE
dollars
Billion
Current
Trade account
balance balance
Foreign
U.S
capital capital
1977:
197:,
2.
3 ........
4.
-7.02
-6.63
-7.25
-10.21
1
2.
3...........
Oct.
-11.20
-7.80
-7.79
4- 2.45
Percent
change
indollar
quarter
fromprevious
Errors
Official
and Deutsche
Yen
funds omissions mark
-2.96
6.18
6.00
4.52
5.45
7.88
8.25
15.54
-6.86 -15.04
2.34
4-5.07
45.15
15.76
4-5.11
-2.75 -1.33
-2.68 -12.00
-2.87 -6.62
-6.97 -14.70
1.11 -5.23
1.59
0.62 -2.12 -3.53
-0.84
4.77 -1.31
-9.57
1.60 -8.77
Swiss
franc
3.75
-3.21
-4.97
-14.48
1978:
4-3.16
4-3.75
44.48
3.80 -3.90
3.19
48.19
-6.61
-9.76
-7.33
-7.96
-8.10
-4.87
-6.57
-0.55
16.72
-3.31
areseasonally
adjusted.
andcurrent
account
Trade
balance
foreign
official
funds.
Excluding
quarter.
tolastdayofcurrent
quarter
From
lastdayofprevious
4 Estimate.
The greatest impact of the balance of payments on the exchange rate came in the
fourth quarter of 1977 and the first quarter of 1978. That was due to the sharp
increase in the trade deficit to $11.2 billion and in the current account deficit to $6.9
billion in the first quarter of 1978. There was also a very large outflow of U.S. funds
in these two quarters, mainly to foreign commercial banks to enable them to engage
in covered interest arbitrage in connection with forward exchange transactions. The
reported inflow of foreign capital, excluding official funds, also declined in these two
quarters, probably because of expectations of a depreciation of the dollar. In fact,
the dollar depreciated by 20 percent against the Swiss franc, by 16 percent against
the yen, and by 12 percent against the D-mark in these two quarters. This occurred
in spite of an inflow of $31.3 billion in foreign official funds.
The current account deficit fell considerably in the second quarter of 1978 and
there was a large net inflow of capital, including errors and omissions. The dollar
recovered against the D-mark and changed very little against the Swiss franc,
although it depreciated further relative to the yen. With the more favorable exchange market, foreign official holdings were reduced by $5.1 billion in the second
quarter. In the third quarter, however, the dollar again depreciated rapidly and this
continued in October. There was no change in the trade balance in the third quarter
and the current account deficit apparently increased. Full data are not available on
capital flows, but the outflow of U.S. funds increased considerably, particularly
claims of U.S. banks. That was probably mainly to finance covered interest arbitrage by foreign commercial banks, including the foreign branches of U.S. banks, in
connection with forward exchange transactions. Astonishingly, the accumulation of
foreign official funds was very small in the third quarter, although the dollar
depreciated nearly as much as in the fourth quarter of 1977 and the first quarter of
1978. From the end of June to the end of October, the dollar fell by 20 percent
relative to the Swiss franc, by 16 percent relative to the D-mark, and by 13 percent
relative to the yen. The decline was halted only by the Treasury announcement that
large resources were available to support the dollar and by the increase in the
Federal Reserve discount rate.
The depreciation of the dollar after the first quarter of 1977 generated forces that
caused U.S. interest rates to rise. When the dollar weakened, forward sales for the
strong currencies increased, and as the demand exceeded the supply, the forward
rates rose relative to the spot rates. The difference between the forward rate and
the spot rate was the forward premium on these currencies (forward discount on the
dollar), expressed in percent per year. The forward premium measures the expectation of the exchange market on the appreciation of the strong currencies and tends
to be equal to the difference in interest rates on funds denominated in dollars and
in other currencies. In the first quarter of 1977, the three-month forward yen was at
a discount of about 1 percent per year while the three-month forward D-mark was
at a premium of slightly less than 1 percent per year. Actually, the dollar rose
264
relative to the D-mark, but fell relative to the yen in this quarter. By the fourth
quarter of 1977, and throughout 1978, the forward premium was greater on the yen
than on the D-mark, and this reflected the behavior of the exchange rates for these
currencies-that is, a larger appreciation of the yen than of the D-mark.
1977-78
2-3-MONTH FORWARD DISCOUNT ONDOLLAR AND EURODOLLAR RATE,
Percent
perannum
'
0-mark
Yen
Swisn
franc
Eurodollars
1977:
................
January ........
February.................................................
March .......
.................
April.......................................................
May .......
.................
June ........................
July ........................
................
August ........
September ..........
..............
October..................................................
November .........
...............
...............
December .........
-0.68
-0.57
-0.73
-0.84
- 2.30
-1.95
-2.28
-2.43
-2.97
- 2.96
-2.79
-4.78
+ 0.69
+ 1.02
+ 1.51
+0.32
- 0.22
+0.16
-0.11
-0.89
-2.42
-3.27
-3.25
-5.19
-3.82
-2.66
-2.10
-1.98
- 2.03
-2.58
-3.34
-4.27
-4.38
-5.21
-4.27
-5.86
5.25
5.13
5.19
5.19
6.13
5.75
6.19
6.25
6.88
7.19
6.88
7.19
January..................................................
February.................................................
March....................................................
.................
April .......
May ........................
June ........................
July .
August ......
..............
September .......
..............
October ......
..............
November ......
..............
-4.37
-4.34
-4.20
-4.45
-4.70
-5.29
-4.91
-5.57
-5.95
-7.84
- 7.78
-7.36
-4.15
-4.72
-6.13
-5.62
-5.19
-5.56
- 6.57
-6.34
-6.66
-8.79
-10.08
-8.48
-6.50
-7.36
-7.08
-6.94
-6.95
-7.10
-6.87
-8.28
- 8.54
-11.32
-11.09
7.38
7.38
7.44
7.63
7.88
8.63
8.38
8.88
9.44
11.56
11.75
-11.10
11.31
1978:
December
2............................................
Eurodollar
deposits.
Discount
on3-month
forward
dollars
inthese
currencies
atannual
rates.
Interest
rateon3-month
2Dec.15,1978.
When the forward premium for the strong currencies rose sharply, the banks
entered into the exchange market to supply the deficiency in forward exchange.
They bought the strong currencies spot with dollars and sold them forward for
dollars. The return to the banks was the forward premium plus the interest on the
strong currencies; the cost to them was the interest that they paid on borrowed
dollars or that they could have earned on their own dollars. When banks engage in
such forward exchange transactions (covered interest arbitrage), they bid up interest
rates on the dollars they borrow to buy spot exchange and accept lower rates on the
strong currencies they hold as cover for their forward sales of exchange. Interest
rates rise in dollars not because the supply has been decreased relative to demand,
but because the demand schedule for dollar loans has been raised by those engaged
in forward exchange transactions as can be seen in Chart 3; the three-month
Eurodollar rate rose almost parallel with the three-month forward premium on the
D-mark. It rose considerably less than the forward premium on the yen, but that
was because the short-term interest rate on yen funds fell much more than the rate
on D-mark funds.
The same forces that caused interest rates to rise on dollar funds caused them to
fall on D-mark and yen funds. That was not only because of covered interest
arbitrage by commercial banks, but also because official intervention in the ex-
265
change market resulted in an expansion of the money supply and bank reserves in
Germany and Japan. Chart 4 shows the monthly average of short-term interest
rates in Germany and Japan published in the Federal Reserve Bulletin and the
yield on three-month U.S. Treasury bills. Interest rates fell in Germany and Japan
almost coincidentally with the rise in the U.S. It is not suggested, of course, that all
of the rise in interest rates in the U.S. and the fall in Germany and Japan are
attributable to the changes in exchange rates. Obviously, the monetary authorities
of these countries adjusted monetary policy on the basis of domestic and international conditions. Their policies added to and intensified the effect of the depreciation of the dollar and the appreciation of the D-mark and the yen on interest rates
in these countries.
At any given time, the forward premium on strong currencies (the discount on
weak ones) tends to be about equal to the difference in the interest rates paid on
funds in these currencies. This will remain so, however, only if exchange rates on
these currencies are expected to rise (fall) at a rate equal to the forward premium
(discount). If the U.S. payments position were to improve, the dollar could not be
expected to fall relative to the strong currencies at the rate previously assumed, and
the forward premium on the strong currencies would become excessive. Under such
circumstances, the demand for forward dollars would tend to reduce the premium.
It would then become profitable for banks to buy dollars spot with foreign exchange
and to hold them for forward sales. Such covered interest arbitrage would raise the
spot rate for dollars, but it would also tend to reduce interest rates on dollar funds
and raise interest rates on funds in the strong currencies.
Since the new program to support and strengthen the dollar was announced on
November 1, the dollar has recovered considerably relative to the D-mark, the yen,
and the Swiss franc. The recovery has been due to the covering of short positions in
the dollar, the inflow of funds in response to higher interest rates, and the intervention by the monetary authorities. The recovery of the dollar has not brought as
large a decline in the forward discount as might be expected. From the end of
October to December 12, the forward discount on the dollar in D-marks (three
months) fell from 7.84 percent per year to 7.36 percent. The forward discount in
Swiss francs fell from 11.32 percent per year to 11.06 percent. On the other hand,
the forward discount on the dollar in yen rose from 8.79 percent per year at the end
of October to 9.01 percent on December 12. Nevertheless, in the past two weeks the
forward discount on the dollar in terms of the yen declined by more than 1 percent
from the level at the end of November (10.08 percent). In the meantime, the interest
rates on three-month Eurodollars rose from 11.56 percent at the end of October to
11.75 percent at the end of November, but fell to 11.31 percent on December 15.
The OPEC announcement of the increase in the price of oil has caused renewed
selling of dollars. While the dollar has fallen relative to the European currencies
and the yen, the decline has been limited by official support. The forward discount
on the dollar for the strong currencies, however, has changed very little. The largerthan-expected increase in the price of oil will hold down the improvement in the
trade position in 1979. If the trade deficit is nevertheless reduced considerably, it
will strengthen the dollar not only in the spot market, but also in the forward
market. Under such circumstances, U.S. interest rates will tend to decline, although
the reduction would be limited unless the Federal Reserve regarded the strengthening of the dollar as a reason for relaxing the present high-interest rate policy.
266
2. INFLOW OF OFFICIAL FUNDS AND
SHORT-TERM INTEREST RATES
Quarterly, 1975-78
Billion
dollars
+15 .
Foreign
official
Ponds
3-onth
Treasry
bills
-7
+10 -
+5 -
-5
.4
0
-5 1975
Per
Cent
9.0
4.
1977
1976
1978
SHORT-TERM INTEREST RATES
Monthly average, 1977-78
Per cent per annu
.'
8.0United
States
7.0-
Japan
6.0
5.0-
4.0 -
Getmany
1977
. ,, §I . ,
1978
.
.. . I1
-I . ,I. .
267
Mr. BERNSTEIN. As for the notion that if we do something to
restrain imports we are touching off a trade war, I would like to
make a few points on that.
First, the Reciprocal Trade Agreement Act is a very generous
act. We have, in fact, been giving away more under this act than
we have been given.
Let me see if I can give an illustration that might persuade my
fellow economist.
When the United States reduced the tariff on Brussel's carpets
in return for a reduction by Belgium in machine tools, we both
gained. That is to say, we had a little bit more of the machine tool
market and they had a little bit more of the carpet market.
When the Common Market was established and Germany paid
no duty, why, then we got very little out of the benefit of a tax
reduction from 25 percent to 15 percent in the duty on machine
tools that Germany could bring in for nothing. The compensating
adjustments made by the Common Market were not adequate.
As for the Japanese case, it is ridiculous to say that trade between Japan and the United States in any way reflects the kind of
economic relations that we as professors of economics used to
teach-that is to say, free trade based on comparative costs.
In Japan, a former director for Japan at the International Monetary Fund having fallen in love with his American automobile-I
think it was a Mustang-decided to bring it back to Japan. He
couldn't get it out of customs for 2 years. This is an executive
director for Japan at the International Monetary Fund.
Now, Mr. Chairman, I used to explain at the International Monetary Fund when I was Director of Research what are and what are
not restrictions and in my opinion any country which requires a
license for imports is restricting because the requirement of a
license holds down imports even if you are generous in granting it.
I don't expect any repercussions from a restriction on imports of
goods from the surplus countries. I will go further than that. I will
say that in my opinion the the Bundesbank and the Swiss National
Bank and maybe even the Bank of Japan would be willing to see
us restrict imports if that would have a favorable effect on our
trade balance and stabilize the exchange rate.
I see no danger of a trade war. What is Japan going to do to us?
Representative WYLIE. Mr. Bernstein, if it is all right, Senator-Senator BENTSEN. Congressman Wylie.
Representative WYLIE. You say the reason for the decline in the
dollar is because of an unfavorable trade deficit.
Mr. BERNSTEIN. That is the main cause, yes, sir.
Representative WYLIE. Mr. Greenspan disagrees with you, as you
know. He says the real culprit is inflation and that the trade
deficit is only a secondary cause. I am sorry to see you fellows
disagreeing among yourselves here because that makes it all the
more difficult for us.
Mr. BERNSTEIN. I don't think there is any disagreement. I would
like to explain. In a world where you have differential rates of
inflation, then you need depreciation of the currency with the
greater inflation, to neutralize the rise in its relative costs.
268
That means, if the United States has 5 percent more inflation
than Germany, then a depreciation of the dollar by 5 percent
relative to the deutsche mark would keep the price competitive
position the same.
Incidentally, you would need an equivalent difference in money
market rates because if you had a 5-percent difference in the
money market rates in Germany and the United States, then there
would be no inducement to move money out of the United States,
even when the dollar is depreciating because what you would gain
on the appreciation of the deutsche mark you would lose in interest rates.
When I speak about the trade deficit causing a drop in the
dollar, you will find in the article which I have submitted to you,
that I am talking about a drop in the dollar in excess of the
relative rate of inflation.
It is in excess of that. I won't say that if we have a bad piece of
news on inflation speculators won't sell some more dollars, but the
basic fact is that it is the trade deficit that caused the big depreciation of the dollar.
Representative WYLIE. Isn't the decline in the value of the dollar
a cause as well as an effect on inflation in the United States?
Aren't people overseas dumping their dollars because they feel
there might even be more inflation and decrease in the value of
the dollar here?
Mr. BERNSTEIN. Let me put it this way, Congressman.
There are 15 major industrial countries. Half a dozen of them
have had big trade problems. This half dozen includes countries
like France, Italy, Sweden, the United Kingdom, Denmark, and the
United States.
In all of these countries, the inflation has been as high as in the
United States and, yet, here we are the only country that has made
no improvement in its trade balance.
In Italy, France, Denmark, in Sweden and the United Kingdom,
the trade balance has improved materially even though their inflation rate stayed as high as or higher than ours.
The Senator made a very important point before too.
Half of the difference in the rise of prices, the consumer price
index, in Germany and in the United States last year was attributable to the depreciation of the dollar and the appreciation of the
deutsche mark. It kept their prices down by 2 percent or more; it
raised our prices by 1 percent.
The difference between the two was roughly on the order of 5 to
6 percent.
Representative WYLIE. A very elementary question: What do you
think about the constitutional amendment to balance the budget?
Mr. BERNSTEIN. I am not in favor of it. I'd like to say to Mr.
Perry I enjoyed his exposition. I don't think there is anything in
the proposition of balancing the budget by constitutional amendment.
Incidentally, I think we often make a mistake in believing that
the budget ought to be the regulator of the level of output and
employment, without regard to other factors.
For example, I think if we are going to use a stimulus program
of $16 billion to offset a deterioration of the trade balance by $18
269
million, then our trade deficit, which Mr. Perry says is due to the
high level of output in the United States compared to other countries, will be reinforced by our budget deficit.
I am not at all against having a budget deficit when it is helpful
to the level of output and employment because of a cyclical fall in
domestic demand. I think it is a reasonable thing. And I am
against saying that the budget must be balanced at all stages.
On the other hand, I don't hold to the view that you can ignore
what is going on in the economy and say, well, as long as there is a
little more unemployment than we wanted, we ought to remedy it
with the budget.
Representative WYLIE. But I don't think it ought to be an ongoing pattern of life to have a budget out of balance.
Mr. BERNSTEIN. I don't think it should be either, Congressman,
and I would note this: If you have a trade deficit of the magnitude
we have now, the pressures to make it a way of life will be
extremely great.
The 1978 Economic Report of the President mentions the trade
deficit as a reason for having a budget deficit. I had explained this
doctrine to the International Monetary Fund at a luncheon of its
economists, including visitors in November 1977, that we were
allowing ourselves to impose a budget deficit on the country to
offset the trade deficit with which we ought to be dealing.
Representative WYLIE. Mr. Perry, I am going to ask you to comment on what you think about a constitutional amendment or you
might even comment on a law which would say that we will
balance the budget except in time of war or in case of economic
necessity, by a two-thirds vote of the Congress.
Mr. PERRY. I disagree entirely with that Congressman.
Representative WYLIE. I had a feeling you might.
Mr. PERRY. I disagree not only because I don't think it deals with
our problem, but because it would be quite counterproductive. It
would exacerbate swings in the economy; and it would be a constitutional amendment that we would be violating all of the time
even if we were to attempt to live by it.
Senator BENTSEN. That we would be what.
Mr. PERRY. We would be violating it all of the time, even if we
attempted to live by it; it would be a good deal worse than prohibition.
Representative WYLIE. I am sorry, I didn't catch that last comment.
Senator BENTSEN. He said it is a good deal worse than prohibition.
Part of the problem would be definition, wouldn't it, whether you
are in violation or not?
Mr. PERRY. Well, we add up numbers pretty well in this town. I
think the Office of Management and Budget can always tell us
whether we had a deficit or surplus in any one year; we could give
them a set of definitions and they could give us a set of numbers to
correspond to it.
Mr. BERNSTEIN. I thought Mr. Perry was making the point that
even if we passed what was called a balanced budget the behavior
of the economy might unbalance it.
Is that what you had in mind?
47-106 0 - 79 - 18
270
Mr. PERRY. That is a part of it.
Representative WYLIE. Well, the fact is, we might have more
production, more sales, more economic activity in the private
sector-that is what you are saying-and, therefore, more taxes,
depending upon the viability of the private sector.
Mr. PERRY. We do have uncertainties in economic events and if
the economy was somewhat overheated we might find ourselves
with a large surplus; if we tried to eliminate that to get a balanced
budget, it would overheat it worse. If the economy fell into a
recession, it would give us a large deficit, and if we tried to live by
the Constitution, we would worsen that recession.
Representative WYLIE. We could make it effective October 31,
which we must do by law. If, during that year, something happens-if they declare an economic necessity-we could vote a deficit, so there are some safeguards. My bill contemplates a two-thirds
vote of the House and Senate to set aside the balanced budget
during these emergency periods.
Mr. Perry, you said that you favor the real wage insurance
program of the President. What if wages are held to 7 percent and
prices rise to 9 percent. Real wage insurance would give a 2 percent rebate, in effect, in the first year.
What about the second year then if wages start out at year "2"
at a level 2 percent below prices compared to the previous year
starting points?
Mr. PERRY. As I understand the bill that is being proposed, you
start all over again the second year. You might have precisely the
same law on the books or you might alter the numbers somewhat.
If we imagine keeping the same law on the books, once again the
wage standard is 7 percent, real wage insurance would kick in if, in
that second year, prices rose more than that.
But if the thrust of the question is do you make up for the 9percent inflation of the previous year the second time, I think no,
that's not the intention of the bill.
Representative WYLIE. Either we let wages catch up or we have a
permanent rebate or we hurt workers permanently.
Mr. PERRY. There are times when that is unavoidable. I think
part of the problem and part of the reason that we are still mired
in the inflationary spiral that we are in is that wages cannot catch
up with some of the price increases that have occurred. When the
price of oil jumped a great deal in 1974 and 1975, it was wages
trying to chase that oil price increase that exacerbated the inflation.
Now, it is not hard to show that there is a real loss to wage
earners in that kind of situation and it can't be made up. And the
best you can do is try to diffuse it so as not to let it feed into a
wage-price spiral.
In the situation you are describing, I think that would have to be
the aim of the policy once again. Should we get a big shock in
prices this year, we really do have to try to diffuse that and not let
it get into the wage rounds, and not let it exacerbate inflation over
years to come.
I think life is tough when that happens. But it has to be the
objective of policy to isolate that extraordinary price increase and
not let it get down into the basic wage-price spiral.
271
Mr. BERNSTEIN. Mr. Chairman, I think the term "real wage
insurance" is a misnomer. I would have preferred if they had
called it compensation, because the truth of the matter is, there is
no way of insuring real wages. If the growth of productivity is less
than had been expected, if crops are poorer than had been expected
in this country or abroad, if the dollar depreciates or the price of
oil rises even when the dollar doesn't depreciate, there really isn't
any way in which you can maintain the real wages of the worker.
You can give him something back and make him happier.
I don't try to justify this policy as a piece of fancy economics. I
think it is justified as a practical proposition that if this will
encourage workers to be more moderate in their wage demands, it
is good for the economy.
You are quite right. You can't make up the loss in real wages
that arises from the real factors that I mentioned.
Senator BENTSEN. Congressman Brown.
Representative BROWN. Let me hit two points with you, one in
the monetary area and the other with reference to unemployment.
We have achieved under the Carter administration, or whoever
gets the credit for it-it usually falls to the administration in
power-a reduction in the unemployment rate over the last few
years, but with that, we still have a massive structural unemployment problem-the blacks, the ghettoes-women are higher in unemployment statistics than other categories because women have
been entering the market in unprecedented numbers-and we have
a very high entry rate of people seeking jobs, and I think one of the
highest rates we have ever had historically in terms of the number
of people. The participation rate-I think that is the technical term
used for it-is very high.
What are we going to do about this structural unemployemnt
problem?
Perhaps where there is a second wage earner in the household as
a matter of convenience or when the children leave home and the
woman wants to look for a job to get her out, it isn't quite as much
of a problem.
But for some families, it may make the difference when they pay
the mortgage on the new house. And for teenage blacks, it may
make a difference when they survive or go into a criminal career,
and a lot of other social impacts that we have to deal with in a
budgetary way of public spending.
We have tried the public employment program and it seems to
have its downside impacts.
I guess what I am really asking is do you see a method by which
we can better translate some of those people from structurally
unemployed into the work force in the private area, where they are
a tax contributor rather, than a tax drag?
Mr. PERRY. I consider that still our most urgent problem. It is
unfortunate that we have been calling it an- urgent problem for as
long as we have and we have still not solved it..
But I think it is our No. 1 economic problem even though our
attention has turned, in a political sense, I suppose, to fighting
inflation. There are people that work very hard at this and I am
sure you know the record better than I do.
272
Some of the things we are doing right now are useful things. I
would hope that in the name of tight budgeting, we do not eliminate any programs that have any usefulness in this area, because I
think that would be a very poor form of economizing.
We should also recognize, in the process of slowing the general
economy, that we are going to exacerbate the problems you have
described, even though these problems are inherently structural in
that they exist even when general employment conditions are good;
they still worsen when general employment conditions are bad.
Consequently, I think that if some of the more pessimistic forecasts come true, the problems you have described are going to
worsen and I don't have any easy answers for this. But I think
some of the structural employment programs and youth employment programs and some of the money we have been putting into
the urban areas really represents money very well spent.
Representative BROWN. Let me suggest one that might not be
easy, but might be a little different in terms of emphasis.
We had one of the alumni of your organization, Charlie Schultze,
up the other day, and he pointed out that in the President's
budget, there is an increase of the funds allowed for the tax subsidy for hiring the structurally unemployed.
I raised a question with him whether a tax subsidy was really
the way. I mean, I have a little business and our accountant at the
end of the year takes something of our income and he can look
through our statistics and find we hired some additional personnel
and all of that, but that is the accountant making a tax decision at
the end of the year, rather than hiring at the point where the
person is brought into the plant.
I would like to suggest, and I wish you would think of it, a
program similar to one that we had a few years ago where the
company is actually given a subsidy of a portion of the wage of the
structurally unemployed indivdiual that reduces over a period of
time, so that he or she is brought on as an employee, trained on
the job, and when the subsidy disappears, he is getting full-time
wages for full-time work, presumably a trained and capable employee, and you have done both things, you have provided the job
and you have provided the training and you have reduced unemployment.
Mr. PERRY. I think, in principle, that is an excellent approach. I
suppose that the problem comes in defining who is eligible and
avoiding a break point.
Representative BROWN. Maybe it would be someone who is ineligible for unemployment compensation that goes back to work after
the kids left the house, or the youngster who has never been able
to find a job, or the person who has had a job making bridles and
harnesses, and now that is a pass6 occupation.
Mr. PERRY. These are all categories that deserve the kind of
attention you are describing. I think the opposition to such a
measure as a step in the correct direction would come from someone not eligible for the subsidy who felt he was unfairly competing
for a job.
Representative BROWN. I just described that person that would
be eligible for unemployment compensation and would have the
273
skill to get a job, and so when he exhausts his compensation
payment or benefits, then, he becomes ineligible, or does he?
Mr. PERRY. I think that kind of approach is a useful one.
Representative BROWN. Then, the OIC and the National Association of Businessmen and some of these other institutions bring the
company and the unskilled trainee together. Then we might have
something.
Mr. PERRY. The subsidy might have to be very large in some
cases, but it is still money well spent. Any time you consider the
alternative, almost anything you do to put some of these groups
into the work force is a tremendously good investment.
Representative BROWN. I have another question, but my time is
up.
Senator BENTSEN. Why don't you go ahead.
Representative BROWN. Thank you, Mr. Chairman.
Let me ask one other thing. The staff advised me that you made
a remark that we can still avoid a recession if interest rates do not
get higher. Are you suggesting that money is tight now, but not to
a critical point, or are you suggesting that you would encourage
money growth sharply?
In other words, the Fed loosens up on the money supply, even
though it might raise inflation and raise interest rates in the long
run.
Mr. PERRY. If the object is to avoid a recession, then, I think the
present posture of policy is about right; that is, interest rates do
not seem to be high enough to seriously hamper borrowing, they
have not affected the parts of the economy where you expect tight
credit conditions to appear, and my guess is that they have had a
gradual, modest effect here and there but nothing to really hold
the economy back sharply. However, we are at a difficult point in
time. The object of the policy is clearly to slow the expansion; it is
quite a narrow line between that and causing a recession that is
larger than you would like.
Representative BROWN. Slow the expansion or slow the demand
for money?
Mr. PERRY. I do not think slowing the demand for money by
itself is a productive exercise. It is my view that that is neither
worth doing nor worth not doing.
Representative BROWN. When you say expansion, what do you
mean?
Mr. PERRY. The growth of the gross national product, employment and output. That is what stabilization policy is trying to
contain in terms of the anti-inflation program.
Now, anytime you have an ideal path that you think is just
about where you would like to go, you have to recognize that there
are substantial risks that you come out well below that path or
well above that path. Today I believe policy is quite concerned not
to come up well above the path, and for a large number of reasons,
most of which I would agree with.
Senator BENTSEN. May I interrupt there and thank you very
much. Let me just add to the points that Congressman Brown
made on the question of tax credit for employment, since I was the
author of that amendment in the Finance Committee in the
Senate, that the one in 1976 was opposed by the administration,
274
and we passed it anyway, and then it became one of the best kept
secrets. The administration gave it no publicity whatever, but the
Senator from Wisconsin said it was his consideration that it created employment for some 400,000 more.
Now, I, frankly, believe that the targeted unemployment we
passed in 1978 is an improvement and that it really does get to
some of these people that Congressman Brown is talking about,
and his accountant better tell him about it ahead of time because
we are talking about a very substantial concession. You see, that
allows for up to 50 percent of the first year's salary to a maximum
of $6,000 tax credit and 25 percent of the second year's salary up to
$6,000. So, it is a very major consideration in the hiring of people
and employees in the private sector, and I think it will have a
significant effect-at least I hope so. You cannot say to 30 or 40
percent of a group like the young blacks, "You know, society has
no role for you to fulfill." You do not put them on a shelf for 3 or 4
years. If you do that, we pay a terrible price, a social price, an
economic price, and a political price. I think we are just in total
agreement on this committee that this is one of the most terrible
problems the country has today.
We have kpet you gentlemen a long time, and we are very
appreciative of your testimony and the comments. I guess we would
keep you all afternoon if we could, but thank you very much.
We will go ahead with Mr. Stein now and his testimony. Thank
you, Mr. Perry and Mr. Bernstein.
Mr. Stein, we are delighted to have you back. You have either
lost a lot of weight or you got yourself a better tailor. You look
very good.
STATEMENT OF HERBERT STEIN, A. WILLIS ROBERTSON PROFESSOR OF ECONOMICS, UNIVERSITY OF VIRGINIA; SENIOR
FELLOW, THE AMERICAN ENTERPRISE INSTITUTE; AND
FORMER CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS
Mr. STEIN. I have lost a lot of weight, and I lost it the hard way.
I apologize for being late. There was some misunderstanding. I
was scheduled to appear here and the House Budget Committee
both at 10 o'clock this morning. That didn't prove feasible, so I
have just run over from their hearing. I will try to say something
that is a little different from what I said to them but not too
different from what I said to them.
As I said at the House when I saw what the farmers were doing
here, I said to myself, "Where are the taxpayers' tractors?"
I am intending to appear here as a small excuse for a taxpayers'
tractor.
I will make a brief statement, as you have requested. I attach to
this statement copies of two recent articles written for the AEI
Economist, which explain my views further and which I would like
to have included in the record.
I would like to take this occasion to compliment the Council of
Economic Advisers on their annual report for 1979. Although there
are many points on which I disagree with the administration's
policies, I regard the report as a long step towards realism in the
appraisal of our economic situation. I especially welcome the em-
275
phasis on the need for moderation in setting goals for economic
expansion, for unemployment, and for government spending.
With respect to the economic outlook for 1979, I share the view
that is expressed in the report and, I believe, common in the
economic profession, that both GNP in current dollars and GNP in
real terms will rise less than during 1978 and that unemployment
will rise a little. Whether the rise of real GNP during the year will
be 2.2 percent, as the administration estimates, or 2 percent, or 1
percent, is a question on which I have no comment to make because I don't know, I don't think anyone else knows with any high
degree of confidence, and I don't think the answer is very important.
Also, I think the question whether, when history is written, 1979
is designated as a year of recession or not is a trivial question,
because the line between slowdowns that are recessions and those
that are not recessions is subjective, arbitrary, and devoid of policy
significance.
What is significant is that the economy must slow down, it will
be better from every standpoint if the slowdown begins sooner
rather than later, and apparently the slowdown is going to begin
this year. It is important that the slowdown should begin soon
because that will increase the chance of making a smooth transition to a lower inflation rate.
I do believe that the administration's forecasts of the inflation
rate during 1979, and at the end of the year, are too low. I would
expect the rate at the end of the year to be more like 8 percent
than the 7-percent the administration is suggesting. Of course, the
record is that we forecast the inflation rate poorly, and I would
make no point of this difference if it did not reflect a major
difference in the evaluation of economic policy. As I see it, the
administration's inflation forecast is predicated on a high degree of
success in the so-called "voluntary" price and wage control program. My estimate assumes zero success, which I firmly believe to
be the assumption better supported by experience and analysis.
In my opinion, the important questions today relate to the desirable behavior of the economy after 1979. The slowdown of 1979 will
make little or no contribution to the fight against inflation if it is
followed by a rapid expansion of demand. The inflation rate is
going to respond slowly to the moderation of demand. We need
several years iii which the rate of growth of nominal GNP declines,
in which real output rises slowly, and in which unemployment is
above the present rate. This will lead to a decline of the inflation
rate which will be slow at first, but which will gather speed as
experience demonstrates the strength of the Government's determination to check inflation.
The administration's longer run plans and targets for the overall
performance of the economy are hard to tell now, partly because
the projections in the Economic Report and the budget are warped
by the need to conform to the arbitrary assumptions of the Humphrey-Hawkins Act. In this way the act has turned out to be an
obstacle to long-run thinking about economic policy.
However, even aside from the artificialities imposed by Humphrey-Hawkins, there does seem to be a feeling in the Government
and in the country that after a brief and shallow slowdown of the
276
economy in 1979 or the first half of 1980 we can pump the economy
up to rapid growth, even exceeding our long-run growth rate, and
still see the inflation rate consistently and comfortably decline.
This is a terrible mistake. It is a mistake that was made by previous administrations, including the one of which I was a part. I
hope that our mistake may be forgiven as due to lack of experience. But that the same mistake should be repeated by successive
administrations is unforgiveable.
I would like to summarize in a few words the prescription I
would offer for overall economic policy today:
One: The Government should announce its intention to bring
about a steady decline of the rate of growth of GNP in current
dollars, as the essential step to reduce the inflation rate. Currentdollar GNP rose by more than 12 percent during 1978. That should
be gradually reduced to about 6 percent in, say, 5 years. The
Federal Reserve should be guided by this target.
Two: The administration should terminate its so-called "voluntary" wage and price control program. This would be the clearest
possible sign of the end of illusion and of commitment to a realistic
attack on inflation.
Three: The Government should make as binding a commitment
as it can now make to the gradual reduction of Federal spending
relative to GNP over the next 4 or 5 years. An appropriate vehicle
for this would be the Spending Limitation Act, S. 34, proposed by
Senator Roth and Congressman Kemp. This would limit outlays
approved by Congress in the Second Concurrent Resolution on the
Budget each year to 21 percent of GNP for fiscal 1980, 20 percent
for fiscal 1981, 19 percent for fiscal 1982, and 18 percent for fiscal
1983.
Four: With such a commitment in place, the Government could
with some confidence enact legislation this year providing for a
gradual phase-in of tax reduction which would still yield a balanced budget in, say, 1982. With expenditures in that year equal to
19 percent of GNP, there would be room for a tax cut which in
1982 would amount to about $60 billion.
This kind of economic policy would, in my opinion, go far to
relieve the two great anxieties of the American people-inflation
and taxation. It would also contribute strongly to a revival of real
economic growth, increasing opportunities for all and helping to
reestablish the conditions in which, in President Kennedy's
phrase-and I don't quote him very often-"a rising tide lifts all
the boats."
[The two articles attached to Mr. Stein's statement follow:]
277
the 2i economist
American Enterprise Institute for Public Policy Research
December 1978
The New Economic Policy:
What Is It? Will It Work? What Next?
Herbert Stein
We have had so many presidential addresses on
inflation in the past ten years, so many bold new
programs, so many promises. And still the inflation has continued and accelerated. There is no
wonder that new programs are greeted with yawns
and skepticism.
Still, there is no experience of inflations that go
ont accelerating forever, and hardly any continue at
a high level for a very long time. Big inflations
tend lo conue to an end. Some end in economic collapse, some end with pressure imposed by a
Foreign powver, some end with a radical change of
overnment, and some end with a change of policy
by an existing government, supported by a change
of public attitudes. Whatever the mechanism, inflations do come to an end, or at least slow down.
And that will be true of the current American inflation also, some day.
So one cannot exclude the possibility, despite all
grounds for skepticism, that the new policies announced on October 24 and November I will begin
the end of this decade's round of inflation. Probably no one thinks that the odds on that are high.
Even the administration is modest in its claims.
But it is worthwhile to try to evaluate the probability, and ask what are the key variables on which
success depends, and what options are available if
the present effort does not succeed.
Evaluation of the present program is made an
unusually speculative endeavor by the uncertainty,
which persists more than a month after the President's announcement, about the nature of the program. The administration is still in the process of
drafting the wage and price standards to which it
expects unions and businesses to conform. The
program depends in key respects on congressional
action which is far from assured. The intentions of
the Federal Reserve and the administration in the
field of monetary policy are unclear. All one can
do at this point is to consider the possible implications of alternative meanings of the administration's program.
The Underlying Rationale
Although the administration's reasoning has not
been explicit on all points, it seems to run about as
follows:
We have a built-in rate of inflation which is very
insensitive to reductions of demand or increases of
unemployment from the present level. This built-in
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278
rate of inflation is the result of our past history, the
expectations of wage increases it has generated, the
patterns of wage increases in one industry following
increases elsewhere or following cost of living increases, the pricing policies of business, the costraising policies of government, and so on. This builtin rate is not the actual rate of the past few months,
which, as measured by the Consumer Price Index,
has been around 9 percent. The actual rate
presumably reflects some temporary factors, in this
case the rise of mortgage interest rates, which might
not continue if the rate of inflation levels out. The
built-in rate is, therefore, not directly visible, and one
can only speculate about what it is. But there is some
evidence to suggest that the administration thinks it is
about 7½/kpercent. An attempt to reduce this rate by
restricting demand would have little effect on the
inflation rate hut a serious effect on output and
employment.
The present unemployment rate is about 6 percent,
and growth of output at the rate of about 3 percent a
year would keep the unemployment rate around that
level. Growth of demand (total spending for goods
and services, or nominal GNP) at a rate of about
MOA/z
percent a year would be consistent with this rate
of growth of output and the built-in inflation rate.
Unless something else is done to reduce the built-in
inflation rate, a slower growth of demand would not
significantly reduce the inflation rate but would raise
unemployment and impair output. On the other
hand, faster growth of demand would accelerate the
inflation without increasing output and employment
much.
While the built-in rate of inflation is given by the
historical background and present institutional
conditions, it is not economically necessary, either to
allocate scarce supplies or to evoke more output.
Therefore, inflation can be suppressed below this
built-in rate without adverse economic consequences.
This can be done in the private sector by persuading
or threatening businesses and labor into raising prices
and wages less than they would have spontaneously
done. In the public sector it can be done by a reordering of priorities which would rule out many costraising actions. Results from such a policy would
come slowly, and it would not succeed at all if it were
accompanied by excess demand. However, such a
policy can be expected to reduce the inflation rate in
the next year by about one-half percent below the
built-in rate-to about 7 percent. If, then, demand
increased at a rate of 10 percent a year this would
permit a 3 percent growth of output, holding
unemployment steady and avoiding so strong a
pressure of demand as to frustrate the direct inflaiton-restraining policies. In subsequent years
2 / TheAEt Elvnv..isi / Dembwr 1978
¾
further reduction
achieved.
of the inflation rate can be
Given this reasoning the appropriate strategy has
two parts. The first is a fiscal and monetary policy
which will prevent excessive speed-up of demandthat is, which will keep unemployment around 6
percent, real growth around 3 percent a year, and
total spending (GNP it current dollars) rising
around 10 percent a year. The second part of the
strategy is direct action to slow down price increases which would otherwise continue at a high
rate even though market conditions would not
require them. This direct action consists of an
"incomes policy" to slow down price and wage
increases in the private sector and intensified
resistance to federal policies that raise prices or
costs.
This is the same kind of reasoning and strategy
that has inspired the administration's antiinflation program for the past year. Only matters
of degree and intensity have changed. The administration has always believed that although
some fiscal and monetary restraint was needed, the
current inflation rate was not caused by excess
demand and that the rate could and should be
reduced by direct action on prices and costs.
However, at the beginning of the year the administration thought that reduction of the inflation rate would be consistent with economic
growth of almost 5 percent in both 1978 and 1979
and budget deficits of $60 billion in FY 1979 and
almost $40 billion in FY 1980. Now it thinks
reduction of inflation will require holding
economic growth to 3 percent in 1979, after about
4 percent in 1978, and holding the deficit to $30
billion in FY 1980, after $40 billion in 1979. At the
beginning of the year the administration thought
that inflationary private behavior could be controlled by vague exhortations to slow down, addressed to no one in particular. In April this was
escalated to the Robert Strauss effort at
salesmanship and arm-twisting, but the standards
remained imprecise and the application was
spotty. Now the incomes policy has been escalated
much further: the standards have become more
specific, the application in principle more comprehensive, the sanctions more powerful, and the
governmental machinery more elaborate.
The administration's defense of its present
mixture of demand restraint and incomes policy is
reminiscent of Goldilocks and the Three Bears.
K-
279
Goldilocks tasted Papa Bear's porridge and found
it too hot. She found Mama Bear's porridge too
cold. But Baby Bear's porridge was "Juuust
right." So the administration finds suggestions for
a tighter fiscal and monetary policy to restrain
demand are prescriptions for recession, or even
depression. And suggestions for stronger incomes
policy are really prescriptions for mandatory
controls, with all their inequities and inefficiencies. And suggestions for either less fiscal
and monetary restraint or less stringent incomes
policy are surrenders to inflation. But the administration's combination is "Juuust right." Its
fiscal and monetary policy is just right to restrain
inflation without causing a recession. Its incomes
policy is just right to deter inflationary private
behavior without incurring the evil consequences
of mandatory price and wage controls.
Of course, no one, in or out of the administration, knows enough to say whether the
present program is just right. The fact that the
administration has made radical changes during
the year, in programs that were once described as
just right, is evidence enough of that.
The New Incomes Policy
The program for inducing business and labor to
restrain price and wage increases below what they
would freely decide on in existing market conditions is the most conspicuous part of the new antiinflation effort. This program differs from
previous "voluntary" incomes policies in this
country, and probably from incomes policies in
other countries, in a number of respects:
* The standards, or guidelines, are to be spelled
out in advance more specifically and precisely than
has usually been the case.
* The coverage of the guidelines is intended to
be complete except for specified exclusions, such
as agriculture, imports, and low-wage workers.
* The sanctions for noncompliance are spelled
out clearly in advance. These include loss of
government contracts, unfavorable treatment by
government regulators, and exposure to public
condemnation by the government.
* A fairly large staff is to be created to implement the program.
* Congress is asked to enact a "real wage insurance" program, which would give to groups of
workers whose wage increases do not exceed 7
The administration's defense of its present
mixture of demand restraint and incomes
policy is reminiscent of Goldilocks and the
Three Bears. Goldilocks tasted Papa Bear's
porridge and found it too hot. She found
Mama Bear's porridge too cold. But Baby
Bear 's porridge was "Juuust right. "
percent compensation in the form of tax rebates if
the cost of living rises by more than 7 percent.
In general, the new incomes policy comes about as
close to mandatory controls as it is possible to
come without statutory authority.
There would probably be widespread agreement
among students of the matter that such programs
have rarely restrained inflation significantly for
very long. There would be disagreement over
whether such programs have ever worked, or could
ever work. However, it is not necessary to resolve
this disagreement in order to evaluate the present
incomes policy. We can look at the specific content
of this policy and at the surrounding circumstances
and judge whether it is likely to be among the more
successful of such policies or not.
From the limited perspective of five weeks, one
must say that the new program has not started off
well and does not show great promise of success.
There are several signs of this:
* Although opinion polls indicate that the
public supports the idea of incomes policy, the
present program does not seem to have aroused the
public enthusiasm that would assure the President
of overwhelming support in a contest with a
recalcitrant business, labor union, or Congress.
The program did not start in a dramatic way.
After the President announced it in a speech on
October 24, nothing happened. As far as the manin-the-street is concerned, nothing has happened
yet, unless he knows that an increase in the price of
Hershey bars has been approved. The public attention focused on the program by the President's
speech has been allowed to wander. Also, the
program is not structured so that the consumer can
see any benefit from it. That is, he cannot go into a
store and see what the permitted price of any item
is, and therefore he cannot see that anything is
being held down to its permitted price. Moreover,
Th, AEt E1onou / Decembe, 1978/ 3
280
the program has no spokesman capable of
communicating with the public and arousing
support.
* The program has been rejected by the top
leader of American labor, George Meany.
Moreover, a number of leaders of national unions,
including Frank Fitzsimmons of the Teamsters,
have opposed the wage guidelines. The case of Mr.
Fitzsimmons is especially important because the
Teamsters will have major contract negotiations
early in 1979 and because the President had
publicly referred to Fitzsimmons as an example of
cooperation.
* The nature of the program gives some substaniceto the usual labor complaint that the application of the standards will be one-sided.
Employers, at least the large ones, will know the
standards for permitted wage increases and will
use the standards to hold down increases. But no
private purchaser, not even a very large one, will
know the permitted price for anything he buys.
That is because the price standards apply to the
average price of a seller's entire line and do not
limit the price of any particular item. Thus, the
concern of purchasers cannot police the price
standards in the same way that the concern of
employers will police the wage standard. Only the
government agency receiving reports from business will be able to tell whether businesses are complying, and they will be able to tell for a significant
number of businesses only if the agency has many
employees.
* By the administration's own forecasts the
inflation rate will probably not get down below 7
percent until late in 1979. This means that during
the whole first year of the program labor will be
asked to accept wage increases of 7 percent despite
cost-of-living increases which have been running
and are still running more than 7 percent.
* Whether the administration may legally use
its various powers, as it proposes, to enforce
compliance with the guidelines is in doubt.
Congress has given the executive power to let contracts, to adjust tariffs within certain limits, to
bring suits for antitrust violators, and so on. These
powers are given for certain purposes and usually
are to be exercised according to certain standards.
Where Congress has wanted a power to be used for
something other than its primary purpose, that has
been specified. Can the President legally use these
powers for a purpose-enforcing his guidelines4 1 TheAEl Econon-..h/ December1978
that Congress has never specified, in contravention
of standards that Congress has specified? This
question becomes even more acute when asked
about the "independent" regulatory agencies,
which used to mean independent of the President.
The question of the legality of enforcing price
and wage standards by the use of powers not
granted for that purpose will be tested in the
courts. If the administration loses such a test, it is
doubtful whether the program could be
reestablished on a "truly voluntary" basis.
* The "real wage insurance" tax rebate now has
a key role in the administration's progiam,
because the President has held it Out as the carrot
to induce labor to sign contracts calling for no
more than a 7 percent wage increase. However,
congressional approval of such a plan is highly
doubtful. Apparently the administration did not
obtain assurances of support from the
congressional leadership before it announced the
proposal, and the chairman of the House Ways
and Means Committee has already revealed his
skepticism about it.
There are many reasons for expecting difficulty in
the Congress. The plan is likely to become the
focus of labor's objections to the whole incomes
policy, which labor apparently had no adequate
opportunity to express to the President. Labor will
not buy the plan's implication that it is "entitled"
only to keep up with the cost of living, without any
real wage increase, which means a net decrease of
after-tax income. Many congressmen will find the
numbers in the administration's proposed taxrebate proposal-7 percent wage increase and 7
percent price increase-too arbitrary to incorporate in a tax law. There will be reluctance to
provide real income insurance for workers when
there is no insurance for others who may be
equally in compliance with the guidelinesfarmers, other small businessmen and selfemployed people, recipients of interest and
dividends, retired people on annuities, low-wage
earners, and, reportedly, persons earning more
than $15,000 or $20,000 a year. Even some
workers who get less than a 7 percent wage increase will be left out of the insurance plan if they
are members of a group of workers who on the
average get more than 7 percent.
Also there is concern about the possible effects
on the budget deficit if inflation does exceed 7
281
percent and large payments have to be made under
the real wage insurance program. This concern is
sometimes answered by pointing out that the
inflation would yield revenues which could be used
to pay the itsurance. The implication is that some
taxpayers would be exposed to additional burdens,
as a result of inflation, in order to protect others.
There are many congressmen who think that a
fairer use of the excess revenues generated by
inflation would be to return them to the taxpayers
who bore the burden, through a general tax indexation scheme.
. . .probablv a fatr judgment is that the
present -voluntary " incomes program will be
irrelevant to the cottrse of the inflation.
The new guidelines program has many obstacles
in its way-public indifference, labor opposition,
possible upset in the courts, possible rejection of a
key element by Congress. Of course, the program
is young yet, and it may gather strength later. But
that is not the most likely development. Such
programs are generally more effective and impressive at first than later. They tend to run
downhill rather than up.
There are many uncertainties in such an
evaluation, but probably a fair judgment is that
the present "voluntary" incomes program will be
irrelevant to the course of the inflation. The
program will undoubtedly cause some price or
wage increases to be smaller than they would
otherwise have been. But these cases will probably
not be numerous. There will probably be some
other cases in which price increases and wage
increases are enlarged as the guidelines come to be
regarded as setting a floor under increases.
Moreover, everyone now agrees that the conquest
of inflation is going to take a long time at bestfive years or more-and the present program is
unlikely to survive for any large part of that
period.
Targets for Demand Management
If the preceding appraisal is correct, the new incomes policy will not make a significant con-
tribution to reducing inflation. In that case one
must ask whether the more restrictive demand
management policy-that is, the tighter fiscal and
monetary policy-involved in the administration
program will by itself suffice to reduce the inflation rate.
That isa difficult question because the degree of
monetary restraint incorporated in the new
program is not known. However, the question may
be approached indirectly. The administration is
forecasting a condition in which real output rises
at an annual rate a little under 3 percent, the
unemployment rate is stable around 6 percent, and
the inflation rate, aided by incomes policy,
declines to 7 percent or less by late 1979. This
forecast is not described by the administration as
its target, and surely no part of the forecast by
itself would be a target. However, the use of these
numbers implies that the combination of growth
rate, unemployment rate, and inflation rate is
feasible-given the incomes policy. It further
implies that this is regarded as a satisfactory
combination, if not the best of all feasible combinations. Othewise the administration would take
action to bring about some other combination.
Is the combination of 3 percent growth, 6
percent unemployment, and inflation declining to
7 percent by the end of 1979 a feasible combination, on the assumption that incomes policy
does not work? A year ago tsost economists would
have said that 3 percent growth and a stable
unemployment rate did not go together. It was
thought that the increase of the labor force and of
productivity required around 31/2percent growth
of output to keep unemployment stable. But the
old relationships on which economists have relied
have not worked well lately. Unemployment has
fallen faster than we would have expected with the
rise of output actually achieved. So it is not impossible or even highly improbable that 3 percent
growth would yield astable unemployment rate.
A more critical question concerns the relationship between inflation and the unemployment rate,
because unemployment is likely to be a more
important target for the government than is
growth of output. There are many reasons to
doubt whether an unemployment rate of 6 percent
will be compatible with a decline of the underlying
inflation rate. A simple piece of evidence is that as
the unemployment rate fell from 7 percent to 6
percent in 1977 the inflation rate accelerated. More
sophisticated evidence is provided by the study of
The A El E-n-l
/ De-ember 1978/5
282
Phillip Cagan, in Contemporary Economic
Problems /978 (published by AEI), which found a
tendency for the inflation rate to decelerate only
when unemployment is in excess of 6 percent.
Econometric models in common use show the
inflation rate falling as low as 7 percent in the next
two years only in association with unemployment
rates above 6 percent.
Forecasts of the inflation rate have been
notoriously unreliable for the past ten years or
more. Still, one must say that the odds are against
a decline of the underlying inflation rate in the
near future-say, the next year or two-if fiscal
and monetary policy are directed to keeping the
unemployment tae at 6 percent. This may not
become evident in the early part of 1979. inflation
will be running below the double-digit rates we
have experienced in much of 1978. But this will not
really mean any progress. Some of the temporary
factors, which have already been discounted in
estimates of the underlying inflation rate, may
have vanished. But the underlying rate will not
have been affected.
As between the other two options of tighter
demand management policies and mandatory
controls, the governments choice ayear orso
from now cannot be predicted. That is
probably the most hopeful sign in the whole
picture. Two months ago one would have
predicted the move to mandatory controls as
the next step after the voluntary system.
Nevertheless, the government now seems to be
aiming at, or at least willing to accept, a level of
unemployment and a rate of economic growth
much closer to compatibility with reduction of the
inflation rate than its targets of 1977 and early
1978. This gradual scaling down of growth ambitions during this year has been the most encouraging recent sign that the inflation may be
brought under control. If this adjustment of
ambitions has not yet reached the point at which a
slowdown of inflation may be confidently expected, neither has the adjustment necessarily
reached an end.
One of the key determinants of the success of
the anti-inflation effort will be how these targets
6 / The A~tElo
E--w,
/ D-nb=, 1978
are modified as we go through 1979 and 1980. We
have suggested that a fiscal and monetary policy
aimed at 3 percent growth and 6 percent unemployment, accompanied by the incomes policy now
being instituted, will not be compatible with a
reduction of inflation. In the past the administration has responded to a similar situation
by moving in two directions. It has both reduced
its output and employment targets and tightened
up the screw of incomes policy. Next steps in either
direction will be much more difficult. The output
and employment targets cannot be lowered
without espousing an actual increase of the
unemployment rate, something no administration
finds it tolerable to do. On the other hand, there
seems to be no room for tightening the incomes
policy without crossing over the faint line which
divides "voluntary" from mandatory, and this the
President has said he will not do.
There may be a third option for the administration next year. It may point out that the
rate of price increase has fallen from the 9 to 10
or 8 percent,
percent suffered in 1978 to, say, 71/½
declare victory in the war against inflation, and go
on to other things. This tactic might have some
short-run political advantage. However, there
would be great dangers in it. The view, already too
widespread, that the government would not firmly
resist a gradual upward ratcheting of the underlying inflation rate would be further confirmed.
As between the other two options of tighter
demand management policies and mandatory
controls, the government's choice a year or so
from now cannot be predicted. That is probably
the most hopeful sign in the whole picture. Two
months ago one would have predicted the move to
mandatory controls as the next step after the
voluntary system. Today one cannot be so sure.
The recent moderation of the government's output
and employment targets, and the signs of tighter
fiscal and monetary policy, raise the possibility
that the government will go further in the direction
of what was called five years ago "the old time
religion" asawayofcurbinginflation.
Targets and Policies
The new anti-inflation program must be defined
not only in terms of its targets but also in terms of
283
its policies for achieving those targets. If we are
going to achieve something like a 3 percent growth
of output and a 7 percent inflation rate, the growth
of nominal GNP must be slowed down to
something like 10 percent a year. This would be a
big cut from the 11.7 percent actual increase of
GNP between the third quarter of 1977 and the
third quarter of 1978.
The government's new, more restrictive fiscal
and monetary policies are intended to bring about
the slowdown of GNP. There are, as often in such
cases, two views dissenting from the government's
assurances that its new policies will be just right
for keeping the economy on its desired path.
One view is that the new policy is too restrictive
and will soon plunge the nation into a serious
recession. The other is that the policy is or will be
too loose, that it will not slow down the rise of
demand, and that the underlying inflation rate will
continue unrestrained or even rise.
Unfortunately, not much can be said about this
subject because little is known about the future of
monetary policy. The administration's overall
plans for budget policy have been described with
some precision, but that is not true of monetary
policy. The Federal Reserve's announced targets
for the growth of various monetary aggregates in
the next year cover a range of possibilities from
severely restrictive to moderately permissive.
The President has said that his budget for fiscal
1980 will have outlays not exceeding 21 percent of
GNP and a deficit not exceeding $30 billion. Much
has been made of the "austerity" of the new
budget plan, and no doubt the administration is
having difficulty in meeting its goals. However,
this program is austere only in relation to the
profligacy of fiscal 1978. Before this administration, expenditures had exceeded 21
percent of GNP only in years of war or severe
recession. Also, holding the deficit to $30 billion in
1980 will be difficult only because little progress
has so far been made in reducing the deficit from
its level of $45 billion in 1977, despite the recovery
of the economy.
Such observations do not deny the fact that
achievement of the President's budget goals for
fiscal 1980 would be a significant move toward
restraint, compared with where we are in 1978.
Still, the move does not by itself seem so massive
as to create the risk of pushing the economy below
the administration's growth targets.
The greater uncertainty is about monetary
policy. The increase of the discount rate by one
percentage point on November I and subsequent
increases in other rates led some observers to
believe we were entering a regime of monetary
tightness that would cause a recession. While that
may yet occur, for the present the judgment seems
premature. When account is taken of recent rates
of inflation and of the rates of inflation that
prudent lenders and borrowers must be counting
on, present interest rates are not high in real terms.
Moreover there are no signs of the lack of
availability of credit which has been encountered
before recessions in the past.
On the other hand, there are many skeptics
about whether significant restraint is going to be
exercised from the monetary side. A new theory of
the ineffectiveness of monetary policy (the latest in
a long series) has surfaced. This holds that
restrictive monetary policy has worked in the past
through imperfections in the credit markets which
no longer exist. In the past when interest rates rose
certain sectors of the economy were unable to
obtain credit because of legal or institutional
inhibitions on the interest rates they could pay or
charge. The chief victim was the housing industry.
It was this choking off of the supply of funds,
rather than the unwillingness of borrowers to pay
higher interest rates, which made tight money
effective. But now we are approximating a
situation in which everyone who is willing to pay
the going rate can get the money. Representative
of the changes that have brought this about is the
new six-month certificate of deposit at a rate tied
to the Treasury bill rate, which thrift institutions
have been permitted to offer. This enables those
institutions to continue to attract funds in a time
of rising interest rates. So, it is said, what happens
now is that interest rates rise across the board, but
credit is generally available and borrowers are
willing to pay because they expect inflation to hold
down their real debt burden.
There is some point to this argument. It does
imply that a rise of nominal interest rates, which
only keeps up with inflation and which is not a rise
of real interest rates, will no longer have a
restrictive effect. But it does not dispute the effectiveness of restraint in the supply of money,
which would be accompanied by a rise of real
interest rates.
The more serious question is whether the
The AEI Eo-.ou,, / December1978/ 7
284
monetary moves announced on November I-not
only the discount rate increase but also the increase
of reserve requirements for certain classes of
deposits-signal future restraint of monetary
growth. Since that time there has been a slowdown of the money supply, but the monetary base,
which influences future monetary expansion, has
continued to rise rapidly. In any case, the time has
been too short to attach much significance to these
movements. Also, as already noted, the targets for
future monetary expansion announced by the
Federal Reserve include at their upper edge rates of
growth sufficient to finance a rapid inflationaside from the fact that the Fed has in the past
frequently exceeded even the upper limit of its
target range.
unanimous. As far as any present evidence goes,
the recession commonly forecast for the next year
or two is not so certain or so severe as to call now
for any departure from the long-run trend of antiinflationary policy. Neither does it seem likely that
the forecast recession will significantly or durably
reduce the inflation rate. Fromnthe standpoint of
the long-run effort to reduce inflation-and also
to maintain high employment and growth in the
future-the main importance of a recession in
1979 or 1980 is the danger that it would generate
an overly expansive policy reaction. That would
derail the present effort and require the whole
thing to be started over again later and from a
higher inflation rate.
Summing Up
Much has been made of the
austerity" of
the new budget plan, and no doubt the administration is having difficulty in meeting its
goals. However, this program is austere only
in relation to the profligacy offiscal 1978.
Skepticisns about monetary restraint basically
derives from past experience. The governmenttaking all parts of it together-has in the past been
so concerned by what it regarded as high interest
rates and risks of recession that a consistently antiinflationary monetary policy has been impossible.
Projection of this record makes anti-inflationary
monetary policy in the future uncertain. The
question is whether something changed radically
on November 1. No one, at least no one outside
the goverrtment, can yet answer that. But neither
can one rule out the possibility of a basic change of
attitudes and policies.
The concern that demand management policy
may be too expansive is not inconsistent with the
possibility that we will have a recession in 1979 or
1980-in other words, that growth would fall for a
time below the desired rate. As a general
proposition one can say that we have not entered
an era in which there will be no more recessions
and also that forecasts of the time and character of
coming recessions are not very reliable, even when
agreement among economists is nearly
8 / Tre AEt El onEomis/ De-en.
1978
Where does this speculation leave us? Probably
one must say:
* The new incomes policy will not make much
contribution to reducing the inflation rate.
* A demand management policy aimed at 3
percent growth and maintenance of 6 percent
unemployment, which seem to be the administration's targets, is probably too expansive to
bring about a reduction of the underlying inflation
rate in the next several years.
* It isat least doubtful whether monetary policy
is going to be sufficiently restrictive to slow down
the rise of demand in the degree necessary for a
successful anti-inflationary policy.
On the other hand, it is possible to say two optimistic things:
* Attitudes in the country and in the government seem to be moving in the direction of
moderating near-term goals for economic growth
and unemployment, and while this process has
probably not yet reached the point necessary to
reduce inflation the process may continue until
that point is reached.
* Although there is still no evidence in deeds, as
distinguished from words, monetary policy may
yet change, in a way consistent with reducing
inflation.
Thus, we probably do not now have a reliable antiinflationary policy, but the chances have improved
that we will get one.
285
the iJ
economist
American Enterprise Institute for Public Policy Research
January 1979
The Next "Recession"
Herbert Stein
It is a common, although not exactly sidesplitting,
joke among laymen that economists never agree.
But the fact is that laymen pay little attention to
economists when they do agree. Perhaps they
think that if economists agree they must surely be
wrong, whereas if they disagree there is the interesting possibility that one camp is right. Or they
regard economics as a competitive sport, worth
watching only while the contest is under way.
There is fairly general agreement among
economists today that the growth of the economy
is going to slow down in 1979. This is in itself an
important development. However, public interest
is not satisfied with that proposition and pushes on
to ask more controversial questions. Will there be
a recession? When will it start? What should be
done about it? We shall get to these more exciting
questions later, but first we will discuss the reasons
for the agreement that there will be a slowdown,
since a "recession" is only a particular form of
slowdown, not necessarily very different from
slowdowns that are not recessions.
The Consensus Forecast
A survey taken in December by Robert J. Eggert
shows how solid is the consensus that there will be
a slowdown in 1979. Of forty-five economic
forecasters included in the survey, forty-four expected that the rise of real output between 1978
and 1979 would be smaller than the rise between
1977 and 1978. The same forty-four out of fortyfive expected that the demand for output, as
measured by expenditures for goods and services
in current dollars, would also rise less between
1978 and 1979 than it had between 1977 and 1978.
And forty-five out of forty-five thought that the
average unemployment rate would be higher in
1979 than in 1978. On the question of the inflation
rate there was more disagreement, but, still,
twenty-seven of the forty-five forecasters thought
that the price level would rise more between 1979
and 1978 than it had between 1977 and 1978,
whereas five thought the increase would be the
same, and thirteen thought the inflation rate
would decline.
Although economic forecasts at this time of year
are commonly stated in terms of the change expected from last calendar year to this calendar
year, such figures are not the most revealing ones.
Part of the change between the two calendar years
lies behind us, in the change between the average
position of 1978 and the position at the end of
1978. An estimate more closely related to the
future is given by the forecast change between the
end of 1978 and the end of 1979, which is the
change during the year we are just entering.
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47-106 0 - 79 - 19
286
I do not have available a similarly comprehensive survey of forecasts on that basis, but there is a
good deal of evidence to suggest that there is also a
strong consensus on the general outlines of the
changes to be expected during the year. These
changes relative to those of the preceding year
would look much like the changes based on the
A recession is only a particular form of
slowdown, not necessarily very different
from slowdowns that are not recessions.
calendar year comparisons, except in the price
dimension. That is, both current-dollar GNP and
real GNP would rise less during 1979 than during
1978, and unemployment would be higher at the
end of 1979 than at the end of 1978. However,
prices would rise less during 1979 than during
1978. The range of forecasts shown in the third
column of the table would probably encompass the
opinions of a large majority of all forecasters.
The Evidence for the Forecast
There are two main routes by which one can arrive
at the conclusion that the rate of increase of
nominal GNP, or of total spending, will be less
during 1979 than it was during 1978. One is to
analyze each of the major categories of expenditure on the basis of the evidence available. The
other is to attempt to deduce the behavior of total
spending from the recent or expected behavior of
the money supply, on the hypothesis that the
money supply exercises a dominant influence over
what individuals and businesses spend.
When the first of these approaches is taken, the
following conclusions are usually reached:
* The demand for resources for residential construction, which was approximately flat during
1978, will decline substantially during 1979. The
main reason for expecting this is the high level of
interest rates and the possible effects of high interest rates in reducing the supply of funds to the
institutions that supply the bulk of the money for
residential mortgages.
* A rise of business investment in plant and
equipment was a strong contributor to the expansion of the economy in 1978. Its contribution to
demand for output is expected to be much less in
1979, the main evidence for this being the inten2 / The AEt &Eo.-omst/ January 1979
tions of businesses as reported to the Department
of Commerce and several private agencies.
* The rising burden of consumer debt, and the
associated need for repayment, will restrain the
rise of consumers' expenditures compared with the
rise that occurred in 1978. Some forecasters see the
effect of this restraint being offset through all or
most of 1979 by the tax cut that took effect January 1. They expect the slowdown of consumers'
expenditures to come late in 1979 or in 1980.
* Business inventories at the end of 1978 were
not so large, in relation to sales, as to be an independent drag on production. -lowever, they
were large enough so that a moderate slowdown of
sales arising from other sources would make
businesses want to reduce inventories, and that
would make the slowdown more serious than it
might otherwise have been.
* The behavior of the other two categories of
demand-government purchases of goods and services and net exports-is uncertain, but increases
of a sufficient magnitude to offset the negative
factors, notably housing and business fixed investment, are not likely.
If we look at the future through a more
"monetarist" glass, a basic factor is that in the last
three months the money supply has been rising
much more slowly than the average of recent
years. The rate of growth of the money supply is
always variable, and the evidence of three months
by themselves is not conclusive. However, the
marked reduction in the rate of monetary expansion is given added weight by the apparent intention of the Federal Reserve to slow monetary
growth, which enhances the probability that recent
experience is a forerunner of what will happen in
the future. In that case the behavior of the money
supply will be working in the direction of slowing
down the growth of demand.
The evidence from specific sectors of demand
and the evidence from the money supply tend to
confirm each other now, which is not always true.
It is conceivable that a decline in the rate of growth
of the money supply would not lead to a slowdown
of demand, if other forces make individuals and
businesses willing to increase their spending
substantially relative to their money holdings. In
other circumstances, what looks like a weakness of
private demand may not materialize in a slowdown
of actual spending. If the money supply is rising
287
MAIN ECONOMICVARIABLES:
ACTUAL AND FORECAST
(percent)
Economic Variable
Nominal GNP, change
Fourth Quarter
1976 to
Fourth Quarter
1977
Actual
Fourth Quarter
1977 to
Fourth Quarter
1978
Estimated
Fourth Quarter
1978 to
Fourth Quarter
1979
Forecast
12
12'!
8½ to10
Real GNP, change
5su
3¾.
Prices (GNP
deflator), change
6
8'!
7!. to08
Unemployment rate, end
ofperiod
6¾
5Y,
61 to7
rapidly, this, combined with weak demands, may
cause a drop of interest rates which supports investment and may even stimulate consumption.
However, the situation foreseen for 1979 is one in
which the money supply is rising relatively slowly
and is not offset by willingness to spend more inspite of reduced money growth.
The fact that forty-four out of forty-five
economists expect a slowdown of real output and
of total spending does not mean that the odds are
44 to I that such a slowdown will occur. It doesn't
even mean that economists think the odds are 44 to
1. If each of the forty-four economists thinks that
the odds are 60 to 40 in favor of a slowdown, we
will get the survey results Eggert obtained in
December. But the odds in favor of a slowdown
are not better than 60-40, even if all the economists
are right in their present estimates of the probabilities.
Many qualifications must be attached to the
forecast of a slowdown in demand. For example, a
key element in almost all forecasts is an expected
decline in the demand for new houses, largely as a
result of the rise of mortgage interest rates. But
similar forecasts made at the beginning of 1978
turned out to be quite wrong. And it is important
to emphasize that even present mortgage rates are
not high "real" rates if recent increases in house
prices are expected to be repeated. The expectation
of a slowdown in business investment expenditures
for plant and equipment, based on surveys of
businesses, is at variance with the strong pace of
equipment orders and construction contracts this
fall. The typical forecast of restrained consumer
expenditure may underestimate the willingness of
1t02
households to incur debt in an inflationary environment, especially in view of the tax deductibility of interest. GNP in current dollars has been
rising faster in the last two years than would have
been predictable from the behavior of the money
supply, for reasons which are not entirely clear,
and this pattern could be accentuated in 1979.
Moreover, despite the administration's recent performance and statements of intentions one cannot
yet take a substantial deceleration of the money
supply as assured.
Thus, the forecast slowdown of nominal GNP
growth should not be regarded as certain. On
balance, however the probabilities are on the side
of that happening.
How Much Output? How Much Inflation?
As a matter of arithmetic, a slowdown in the rise
of nominal GNP must be reflected in a slowdown
in the rise of real GNP, or in the rise of prices, or
in both in proportions which add up to the total
slowdown of nominal GNP. An important feature
of the forecast for nominal GNP in 1979 is that
most of the slowdown is seen to be reflected in real
output and relatively little in the inflation rate. The
typical forecast has the rise of real output during
1979 falling two to three percentage points below
the rise during 1978, while the rate of inflation
falls by around I percent. Forecasts of the relation
between output growth and the inflation rate have
been notoriously poor in the past, and these
figures should be understood to be quite uncertain.
Nevertheless, they do reflect something that is probably quite real in our present condition.
The A
E,,aeiuI
/ January 1979 / 3
288
Several specific reasons can be adduced for the
likelihood of a small drop in the inflation rate and
a larger drop in the real output growth rate, and
the reasons are important for deciding how to
evaluate the development and what response it requires. Basically, these reasons can be divided into
supply-stickiness and price-stickiness. Thus, if
nominal GNP is forecast to rise by 8V/2percent,
real output by I percent, and prices by 7½1percent,
either of two extreme explanations can be offered.
One can say that the 7 ½6percent inflation rate was
determined independently of the growth of demand within a significant range, so that if demand
grew by 8 ½i percent real output could only rise by
I percent. Or one can say that the rise of real output by I percent was determined independently of
the growth of demand within a significant range,
so that if demand grew by 8½2 percent prices would
have to rise by 7½2 percent. Probably most
economists would take a somewhat intermediate
position, expecting both prices and output to respond to the growth of demand, but there would be
important differences among economists in the
location of the emphasis.
The more common view is probably that the inflation rate is given, or sticky, especially since inflation is expected to remain little affected at a
high rate while unemployment is rising above 6
percent to 6½2 or 7 percent. Economists have not
been used to the idea that demand can be excessive
and inflationary in such conditions. They have
sought an explanation for the continued high inflation in nondemand factors, such as wage increases
embodied in long-term contracts, the tendency for
new wage increases to follow the pattern set by
earlier ones, and government actions such as increases in minimum wages and social security.
To explain the combination of slow output
growth and rapid inflation now forecast for 1979
on the basis of a limitation on our ability to raise
output more rapidly, one would have to start with
the proposition that at the end of 1978 output was
"too high" relative to its trend and unemployment
was "too low." Unemployment was "too low" in
the sense that it could have been maintained at its
end-1978 level only by continuously accelerating
inflation, which is impossible. This does not mean
that 6 percent unemployment will always be too
low. It means only that in the demographic and institutional conditions of 1978 and 1979, and with
the historical background of this period,
unemployment can be kept at 6 percent only by a
rising inflation, which leads workers to think they
are getting higher wages than they really are.
Later, after inflation has been stabilized at a low
level, and is expected to remain there, wage
demands may become more realistic and unemployment of 6 percent or less may again be consistent with feasible price-revel behavior.
If that is the case, the economy must move, at
least for a while, to a higher unemployment rate,
and in the transition total output will rise slowly
and may decline. If during this period the demand
for output continues to rise rapidly, inflation will
continue at a high, or even increased, rate.
As recently as a year ago this explanation of
what is going on in the American economy would
have seemed outrageous to most economists and
would have been summarily rejected by administration economic officials. But acceptance of
the idea that we are at or above sustainable levels
of output or rates of growth increased in a year in
which inflation accelerated markedly while
A better substitute phrase for "recession"
would be "homely baby." The line between a
homely baby and a plain one or a pretty one is
entirely subjective.
unemployment was in the neighborhood of 6 percent. This change of thinking-including, apparently, thinking within the administration-is one
of the most significant economic developments of
1978. But there is still much disagreement about
this issue among economists, and it would be
misleading to say that we now know which view is
correct. In fact, their disagreement about the
reasons for the forecast performance of the
economy in 1979 is much more important than
their disagreement about what that performance
will be.
What Is a Recession?
While reminding ourselves of the uncertainty attached to the consensus forecast for 1979 and early
1980, we may now turn to the question whether
that forecast means there will be a recession. Unfortunately, to answer that question we must go
through the pedantic process of asking what is
meant by recession, and that in turn leads to the
question, "Why do we care?"
The AEt E-ro-W,
/ Januay 1979/ 4
289
The American economy grows at an irregular
pace, rising and falling, sometimes slowly and
sometimes rapidly. For descriptive and analytical
purposes it is convenient to classify the phases of
economic movement into a few categories and to
give them names. One of these categories is called
"recession." Students classify certain phases of
our history as recession and then seek to discover
common characteristics of all such episodes in an
effort to learn something about their frequency of
occurrence, duration, causes, and so on.
A recession is generally understood to be a
decline of economic activity of substantial duration, depth and breadth, or comprehensiveness.
This definition does not tell how substantial the
decline must be to qualify as a recession. Obviously, there have been many declines that did not so
qualify, such as the tiny decline of real GNP in the
first quarter of 1978. Economists still disagree
about the classification of several past episodes.
By convention, economists leave to the National
Bureau of Economic Research, a private scholarly
organization, the decision whether to call a certain
economic development a recession. The National
Bureau has studied economic fluctuations extenWhat we are really interested in, or should be,
is whether the forecast condition of the
economy is satisfactory or whether some additional or different policy action needs to be
taken.. .. There can be recessions about
which nothing need be, or should be, done.
sively in the past, and there is confidence in its objectivity. The National Bureau does not classify a
period as a recession until it is over.
Thus, to ask whether the forecast for 1979 is for
a recession is to ask whether the National Bureau
will call it a recession when it is over. In close cases
there is no way to answer that, and the forecast
behavior of the economy for 1979, if realized,
would certainly constitute a close case.
There is some tendency, particularly in the
press, to take a shortcut to a definition by saying
that two consecutive quarters of decline in real
GNP constitute a recession. This is based on the
observation that since World War 11 the National
Bureau has declared the existence of a recession
whenever there have been two quarters of decline,
and only when there were two quarters of decline.
However, the two-quarters decline does not constitute a definition of a recession, and the National
Bureau does not accept the two-quarters decline as
a sufficient test of one. There is no assurance that
the National Bureau would designate an episode as
a recession simply because there was such a
decline, especially if the decline were very small.
A large number of forecasts for 1979 and 1980
do include two consecutive quarters of decline in
real GNP. If real GNP is going to rise at an
average rate of I to 2 percent for a period of, say,
six quarters, quite ordinary fluctuations of the
quarterly rate around that low average could yield
two consecutive quarters of negative growth.
However, most of the forecasts which do show
such negative quarters show them to be very small
declines-smaller than occurred in any of the six
postwar recessions so far identified by the National Bureau.
One can think of other rules of thumb by which
to predict what the National Bureau will call a
recession. For example, the National Bureau has
not defined any episode of the postwar period as a
recession unless it contained at least one quarter in
which real GNP was lower than it had been a year
earlier. But the forecasts for 1979 and 1980 do not
generally show this condition to be met.
So, if the most common forecasts come true, it
is unclear whether the experience will, in
retrospect, be "officially" designated a recession.
Does It Matter?
All of this would be of interest only to economists,
and probably to only a few of them, if the word
"recession" were not commonly understood to
mean a bad situation which must be prevented or
corrected if possible. That is why policy makers
and their critics are eager to demonstrate that there
will or will not be a recession. However, nothing in
the "scientific," National Bureau concept of recession implies that anything needs to be done
about it. If "recession" means "something to be
prevented or corrected," then surely the National
Bureau is not the judge of that. To give them such
a role would be to assign them some of the functions of the president, the Congress, and the
Federal Reserve. The National Bureau has never
claimed any right to make the policy judgment involved in this decision.
Recognizing, belatedly, the emotional, political,
and policy connotations of the word "recession,"
Alfred Kahn has suggested using the word
The AEI Economsuf/ Ionuav 1979/ 5
290
"banana" instead. This is progress, but does not
deal with the whole problem. A banana is a discrete thing, identifiable by all experts, and not part
of a continuum which slides off on one side into
flashlights and on the other side to sweet potatoes.
But a recession is one of a continuum of economic
conditions with no objective dividing lines.
A better substitute phrase for "recession"
would be "homely baby." The line between a
homely baby and a plain one or a pretty one is entirely subjective. Different people will draw the
line differently; the parents will have a different
view from strangers. And the designation carries
no policy implications; we don't put homely babies
on the mountainside to die.
The Optimum Long-Run Path
What we are really interested in, or should be, is
whether the forecast condition of the economy is
satisfactory or whether some additional or different policy action needs to be taken. This question is not answered by deciding whether the
forecast condition of the economy is a recession.
There can be recessions about which nothing need
be, or should be, done.
If we abandon the notion that the line between
"recession" and "not recession" is the line between needing action and not needing action, we
shall have to find some other test. We shall have to
arrive at some notion of the path we would like the
economy to take, so that we can judge whether the
economy is likely to be in a satisfactory relation to
that path. After twelve years of stubborn and accelerating inflation it is quite likely-indeed,
highly probable-that the desirable path of the
economy will be one of slow or even negative
growth for a time.
The administration seems to have concluded
that a path of slow growth, probably not excluding
slightly negative growth for a time, is not only acceptable but also desirable in 1979. That is, in my
mind, substantial progress, although many will
disagree. But what is now missing is any conception of the desirable path of the economy beyond
1979 or the early part of 1980. No reasonablejudgment can be formed about the course of the
economy in 1979 without a clear idea of what is intended to follow. If the 1979 slowdown is to be
followed by a vigorous effort to pump the
economy up again and get on the path to the 4 per-
6 / Th, AEl Eco-o-al / January 1979
The administration seems to have concluded
that a path of slow growth, probably not excluding slightly negative growth for a time, is
not only acceptable but also desirable in
1979. That is,in mymind, substantial progress.
cent unemployment goal specified in the Humphrey-Hawkins Act, the expected performance of
the economy in 1979 can be judged unsatisfactory
from any point of view. On the one hand, it can be
said that the slowdown of 1979 is unnecessary and
pointless, because it will not have left any lasting
mark on the rate of inflation. On the other hand, it
can be said that the expected slowdown is much
too small and that a sharper contraction is needed
to wring some of the inflation out of the system
before expansionist policy is resumed.
However, if the 1979 experience is viewed as
part of a long-run effort to reduce the inflation
rate gradually, the forecast for 1979 looks much
more satisfactory. The exact contours of such a
long-run effort and how the effort would be implemented are subjects too large for this essay. But
the effort would surely include a gradual diminution of the rate of growth of nominal GNP from
the 12percent of 1978 to something like 5 percent,
to be achieved in, say, five years. This would leave
room in the end for an inflation rate of about 2
percent and annual real growth of about 3percent,
which may then be the normal long-run growth
rate. In the course of this slowdown of the growth
of demand, output would grow slowly and might
be negative for a time, and unemployment would
rise at first. But later normal growth would be
resumed, the rise of unemployment would come to
an end, and the unemployment rate would regain
whatever level turns out to be consistent with a
stable noninflationary economy.
If that is the path we seek, the forecast performance of the economy seems to be moving
along it. And if that is the path the administration
and the Federal Reserve seek, it would be desirable
for them to make that known. Assurance that we
are on the way to a distinctly lower inflation rate
would shorten the period and reduce the pain required to get there, by moderating the skepticism
which now obstructs all efforts to check inflation.
291
Senator BENTSEN. Mr. Stein, we are very pleased to have you.
Mr. Eckstein is at 16th and K. He was also supposed to be here,
and his plane was diverted from National to Dulles, and he has
been skiing into Washington.
Mr. STEIN. I was disappointed to see he wasn't here because I
thought we would have the unusual Stein combination-Eckstein,
Bernstein, and Herb Stein.
Senator BENTSEN. Without objection, I will place Mr. Eckstein's
prepared statement in the record at this point.
[The prepared statement of Mr. Eckstein follows:]
PREPARED STATEMENT OF OTTO ECESTEIN, PRESIDENT, DATA RESOURCES, INC., AND
PAUL M. WARBURG PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY
THE INFLATION PROBLEM AND ECONOMIC POLICIES FOR 1979-1980
The Administration has made the fight against inflation its number one priority.
Budget and monetary policies have shifted from expansion to restraint, and the
anti-inflation program potentially goes quite far for a "voluntary" program. We are
defending the exchange rate of the dollar, both to honor our commitments to our
creditors and to bring to an end the inflationary impact of surging import prices.
The Administration believes that the shifts in policy can be accomplished without a
recession, but is willing to run considerable risk.
The shift in policy was overdue and needed desperately. The United States confronts an inflation problem which is the most serious in its modern history. Over
the last two years, the inflation rate accelerated from 4.8 percent to 9.1 percent. The
price increases were very general, with energy prices actually rising less than the
average.
While the United States was suffering accelerating inflation, our principal competitors in world trade achieved dramatic reductions in their inflation. More conservative demand management policies, weak labor movements and the fruits of rising
currencies brought Germany s and Japan's inflation rates down to 2.4 percent and
3.5 percent in the past year.
TABLE 1.-CONSUMER PRICE
INFLATION
[Percent
change]
12months
ending
December1975
West Germany .3.6
Japan ................................
United Kingdom .................................
United States .................................
-1.2
16.1
6.7
1976
3.9
10.4
15.1
4.8
1977
3.5
4.8
12.1
6.7
1978
2.4
3.5
8.4
9.1
It is no wonder that enormous imbalances developed in international trade. While
the U.S. suffered a current account deficit of $17 billion last year, West Germany
had a surplus of $8.4 billion, and Japan of $16.6 billion. imbalances of such magnitudes can ultimately unhinge the world monetary system.
Equally serious, the poor inflation performance of the last few years has changed
the attitude of American consumers. Inflation is now so accepted that consumers
are accelerating their purchases. DRI estimates that 9 percent of all single homes, 4
percent of automobiles and 3 percent of-other durables were purchased because of
inflation, bringing consumer credit burdens to an all-time peak and lowering the
saving rate to 4.8 percent for the most recent quarter, the second lowest reading
since 1963. There is nothing irrational in this behavior. Consumer borrowing rates,
which are always high, have not risen as much as the inflation, and so the real cost
of borrowing today is very modest. This behavior is a sharp shift, however. Traditionally, American consumers have turned cautious when prices got into rapid
motion. Knowing that the inflation would be brought to an end through recession,
they raised their savings, paid off their credit and got ready for a period of trouble.
Once inflation inflames demand, however, a dangerous new loop of instability is
created. An upward breakout of demand inflation becomes a real possibility.
292
There are other signs of boominess in today's economy. We make much of the
well-balanced character of the expansion, and it is true that inventories look moderate, the rate of investment is if anything on the low side, and business liquidity is
generally good. But the DRI Boom Monitor, a composite measure of the degree of
imbalances of an expansion, is near the flash point. The components which have
raised it are principally slow vendor performance in industrial markets, consumer
credit, the capacity utilization rate of materials industries, and the DRI index of
labor market tightness. The money figures help hold it down.
TABLE 2.-THE ORIBOOM MONITOR
3 Boomperiods,
average
values
64:12to 67:12to 72:6 to
66:12
69:11 7311
boom
index
............ 67.18
1. TheDRIcomposite
2. Ratio of consumer credit ext. to disposableincome
........................176
Index' (weight=.105) ............. 63.09
3. Percapitacar sales
.......................
.
071
Index
n (weight=.105) .............72.82
4. Ratioof housing
starts to adult population ........
...............
.011
Index(weight=.095) ...............35.58
5. TheDRIindexof labor market tightness 65.309
Index(weight-.154) ...............67.80
6. Realmoney
supplygrowth . .................. 2.833
Index(weight=.100 ................. 66.43
7. Capacity
utilization-materials ................ . 901
Index(weight .153)...............72.94
8. Ratioof capital spending
to realtrendlineGNP
.......................
.
114
Index(weight .187)...............75.55
.697
9. Vendor
performance .......................
Index(weight=.100) ...............70.99
64.73
71.99
Allbeam Historic Third
periods, average quarter
1978 OctoberNovemberDecember
average47 to 18
66.83
50.00
59.40
60.96
61.48
61.45
.181
.192 .172 .164 .208
61.08
65.74
63.03
50.00
73.59
.070
.078
.068
.059
.070
68.26
79.26
69.99
50.00
55.65
.207
.208
(.208)
71.41 73.40 (73.07)
.069
.068
.069
53.22
51.59
54.03
0.12
42.04
68.513
71.62
3.101
68.26
.890
68.71
.015
59.43
59.833
61.25
.830
52.76
.870
61.36
.017
76.59
64.726
67.10
3.847
73.35
.912
76.91
.014
55.81
66.319
69.00
2.694
65.48
.892
69.49
.013
50.00
50.412
50.00
.425
50.00
.839
50.00
.014
58.07
54.921
55.39
1.340
56.25
.860
57.55
.015
61.83
62.371
64.29
.261
48.88
.874
62.84
.015
60.14
62.744
64.73
-. 478
43.84
.876
63.58
.111 .109 .112 .103 .107
.107 .108
(.108)
69.18
62.64
69.60
50.00
59.01 59.73
60.66 (60.66)
.582 .799
.669
.512 .623
.680
.660
.680
57.93
82.60
67.74
50.00
62.61
69.04
66.77
69.04
I Indexreflectstrendadjustment
of baseseries.Figures
in parentheses
areDRIestimates.
293
Chart I
The DRI Composite Boom Index
(Shaded areas represent boom periods)
I
1945
1950 1955
1960 196S
1970
1975
The condition of the economy is only a partial explanation of the pickup of
inflation, as Table 3 shows. Demand is a factor, but program decisions on social
security, the agricultural reserve and price policies, as well as the drop of the dollar,
also played important roles.
TABLE
3.-What made inflation worse? (Consumer prices, percent change)
1978
Trend inflation rate.............................................................................................
Trend inflation rate was aggravated by:
Food prices.....................................................................................................
Policy ..........................................................
Livestock .........................................................
The dollar's decline......................................................................................
Minimum wage .........................................................
Social insurance tax increases...................................................................
Homeownership.............................................................................................
Demand...........................................................................................................
5.3
.7
.3
.4
.4
.1
.3
.6
.3
Actual change in consumer prices....................................................................
7.7
,For further analysis see "Why Inflation Became Worse," Data Resources U.S. Review,
January 1979.
Recession?
The DRI forecast projects a mild recession to begin in the second half of this year.
The logic is this: current inflation brings renewed pressure on the dollar and forces
the Federal Reserve to raise interest rates for some additional quarters. The interest-sensitive categories of outlays are pushed down. At some point, consumers decide
to repay the excessive credit burden. With sales prospects lowered, business fixed
investment begins a modest decline.
stlll
posl
t294
It is still possible that the slowdown will be accomplished without a genuine
recession. The financial system has adjusted remarkably to high interest rates, both
through its own adaptation and through the various measures taken to insulate the
housing industry's supply of mortgages. But we will require more than our recent
quota of luck.
Whether there will be recession depends on two issues: is the economy vulnerable
to recession? Will there be shocks? The vulnerability grows mainly out of the high
interest rates, the inflation expectations and the consumer debt burden. The potential list of shocks includes an oil supply disruption; an automobile or other strike or
a major financial failure at home or abroad. The DRI forecast assumes an automobile strike as the shock that tips the slowdown into recession, but it could as well
be an oil supply disruption, a financial difficulty or something else.
The money data
The money supply and other monetary aggregates are showing extremely moderate behavior since September, and if they played their traditional indicator role, one
would have to conclude that the slowdown is already upon us. However, the disparity between the money data and the other evidence about the economy is enormous.
Payroll employment, the single most reliable indicator for monthly aggregate activity, was up 325,000 in January, and an average of 257,000 over the last six months.
These are clearly unsustainable rates of gain. Automobile sales in January were
11.0 million. Housing was still at 2.125 million starts in December, and what little is
known of business fixed investment also suggests continued forward momentum.
Clearly, 1979 is off to a fast start.
The money data are currently exceptionally difficult to interpret because of a
variety of regulatory changes and adaptations to the high inflation. Treasury operations, the growth of overnight repurchase agreements, automatic funds transfer,
and a large float are all obscuring the meaning of the figures. While monetary
policy has stiffened even on monetarist criteria, with the growth of the monetary
base down to 6.9 percent over the last 13 weeks from a 52-week average of 8.8
percent, one cannot get much information from the money data about the behavior
of the economy itself because of the measurement problems. In assessing the nearterm economy, therefore, policy has little choice but to look at the measures of real
activity and nominal demand, which are looking too strong.
The DRI forecast is summarized in Table 4. Table 5 compares the forecast to the
official Administration projections. DRI forecasts no growth over the next four
quarters compared to the Administration's 2.2 percent gain. But by the end of 1980,
the faster recovery that we project brings the economy to almost the same place as
the official figures. Thus, the disagreement between the Administration and private
forecasters such as DRI is quite limited, and confined to the severity of the temporary slowdown.
OFTHEU.S. ECONOMY-CONTROL 0122
FORECAST
TABLE 4.-DATA RESOURCES
IV
I
Real GNP growth rates:
2.6
6.1
Gross national product ......................
3.0
6.8
Total consumption ......................
4.1
5.2
Nonresidential fixed investment ..........
2.5
0.7
Residential fixed investment ...............
-0.5
5.0
Total Government ......................
5.9
5.8
Unemployment rate (percent) ....................
8.9
8.6
CPI-all urban consumers I......................
10.5
10.9
Wholesale price index '......................
11.3
8.5
Compensation per hour I......................
10.52
9.58
Federal funds rate (percent) ......................
9.52
9.19
New high grade bond yield (percent) .........
Inventory investment (in billions of
12.0
12.4
dollars)...................................................
-6.7
Net exports (inbillions of dollars) .............-6.9
Federal budget surplus (NIA, (inbillions of
19.7 - 26.0
..................................
dollars) )......
6.0
39.3
......................
Profits after tax .
5.8
5.1
disposable income I......................
Real
3.7
7.0
Industrial production I......................
10.9
11.1
Car sales (million units) ......................
2.04
2.13
Housing starts (million units) ....................
rateofchange.
' Annual
11
Years
1980
1979
1978
III
IV
I
11
III
IV
1977
1978
1979
1980
1981
1.4
1.5
1.3
-10.7
-0.6
6.1
8.2
8.8
8.7
11.38
9.64
-0.3
0.9
-2.8
-18.0
1.5
6.4
7.8
7.6
8.6
11.30
9.56
-3.8
-1.1
-7.6
-19.7
1.9
6.8
7.4
6.5
8.2
10.31
9.23
6.7
4.6
5.9
-1.6
2.3
6.9
7.0
6.8
10.4
9.31
9.12
3.4
2.8
1.2
16.3
2.4
7.0
6.9
7.0
8.5
9.02
9.33
5.6
4.5
7.6
27.8
2.1
6.9
6.8
7.2
8.6
9.11
9.48
5.9
5.4
8.3
23.0
2.9
6.8
6.8
7.4
8.7
9.31
9.51
4.9
4.7
9.1
20.5
2.4
7.0
6.5
6.2
8.0
5.54
8.06
3.9
3.9
7.8
3.6
2.2
6.0
7.7
7.7
9.2
7.93
8.86
2.6
3.2
3.0
-5.0
1.8
6.3
8.6
9.1
9.3
10.88
9.49
2.7
2.6
1.3
-0.5
2.0
6.9
7.2
7.1
9.0
9.19
9.36
4.2
3.8
5.9
12.5
2.3
6.6
6.8
7.0
9.0
9.95
9.55
16.6
-6.6
14.7
-4.0
-0.3
0.0
16.2
-0.3
18.9
0.3
24.1
-1.2
26.6
-2.2
15.6
-11.2
15.7
-11.8
10.8
-4.3
21.4
-0.9
27.7
-1.6
- 25.3
-3.9
2.7
-1.2
10.7
1.86
-35.1
-12.5
2.9
-6.4
10.2
1.67
- 49.4
-28.0
-0.2
-14.5
9.3
1.58
59.0
1.9
19.2
11.0
1.69
-38.2
35.8
10.8
3.4
4.8
10.8
1.83
-34.9
21.7
6.1
6.0
10.8
1.97
30.7
17.1
5.6
9.0
11.1
2.06
-48.2
11.4
4.1
5.6
11.2
1.97
-29.7
15.4
4.2
5.8
11.3
2.01
-34.0
6.8
3.9
1.9
10.3
1.79
-34.9
9.3
2.7
2.7
10.9
1.89
-24.2
15.2
3.9
6.0
11.1
2.03
n
296
1979-80
TABLE 5.-COMPARISON OFFORECASTS,
Forecast
Actual
1978
Percent change 4th quarter over 4th quarter:
Real GNP:
Growth ....................................................
Level (in billions of dollars, 4th quarter) ....................................................
Annual percent change:
Real GNP.................................................
Real consumption expenditures................
Real business fixed investment...............
Real State and local purchases...............
Consumer price index..............................
Unemployment Rate (Level in 4th quarter) .........................................................
Annual average:
Housing starts (million units).................
Net exports (inbillions of dollars) .........
Unemployment rate (percent).................
90-day treasury bill (percent) ................
1980
1979
Administration DRI
DRI
Administration
4.3
2.2
0.0
3.2
1412.2
1443.3
1411.6
1489.5
5.4
1487.7
3.9
3.9
7.8
4.2
7.7
3.3
3.2
5.8
2.3
8.2
2.6
3.2
3.0
2.5
8.6
2.5
2.0
3.7
1.8
6.7
2.7
2.6
1.3
2.5
7.2
5.8
6.2
6.8
6.2
6.8
1.810
-4.0
6.0
8.8
1.788
-4.3
6.3
9.4
1.800
2.0
6.2
7.6
2.009
-11.8
6.0
7.2
1.887
-0.9
6.9
8.1
A fiscal policy of restraint
Will a budget policy of restraint make a difference to the inflation? It is true that
one year of budget policy has only a small effect, one likely to be swamped by the
uncertainties surrounding energy and agricultural prices. Similarly, one year of
mild recession will do little more than provide temporary relief through cyclical
responses of the sensitive prices, and perhaps some slight moderating effect on the
1979 wage round.
The potential benefit of a policy of restraint is only achieved if it is pursued for
several years. Table 6 summarizes some model simulations which measure the
impact of different fiscal policies. An expansionary policy was defined as an increase
in real government spending of 3.7 percent a year after the current one year
moratorium-a return to the growth rate of the period 1971-1979. The restrictive
path holds the spending trend down near the 1 percent figure of the current budget
for three additional years. The result is a 0.7 percent reduction in the rate of
inflation, albeit at the expense of an increase in unemployment. These results are
for the first three years of the exercise. If the exercise is continued further, the
improvement in inflation would continue, whereas the unemployment would gradually improve.
TABLE 6.-EFFECT OF BUDGET RESTRAINT ONINFLATION AND UNEMPLOYMENT
Inflation.....................................................................
Unemployment...........................................................
3
Year
Year
2
YearI
0.0
+0.2
-0.2
+0.5
-0.7
+0.6
points.
pathresults,percentage
andexpansionary
restrictive
between
Note.-Difference
The figures in Table 6 are not enough to assure success in the campaign against
inflation. Other factors could more than undo the effects of the policy of restraint,
including program decisions. On the other hand, the policy of restraint is a relatively mild one. Some of the proposals now being advanced are a lot tougher than the
policy analyzed here.
Monetary policy
Fiscal and monetary policy must move in harmony. At this time, this requires the
monetary policy be restrictive. Indeed, we have been so successful in insulating
housing from high interest rates that the bite of the monetary brakes has not yet
297
been felt. Interest rates probably will have to go higher to assure that the economy
will slow down and leave the dangerous boom territory in which it now finds itself.
The Federal Reserve raised interest rates sharply on November 1 as part of the
defense of the dollar. Since then, little more has happened. The dollar appeared to
be strong and the money figures actually fell below the short-run targets. But this
pause of policy cannot be continued much longer. The events in Iran and the
continued poor inflation performance in the opening months of this year will bring
the dollar under renewed attack. Until the economy has been safely decelerated,
both in terms of real activity and prices, interest rates should be moved higher in
careful, orderly fashion.
The limits of macro policy and the President'santi-inflationprogram
The experience of 1977-1978 has taught us that the economy can suffer accelerating inflation as unemployment moves into the 6 percent to 61/2 percent range. I do
not believe that our society can accept unemployment figures of that magnitude as
the limits of our abilities.
The inflation bias in this business cycle upswing did not principally originate in
the labor market. Government policies, the legacy of poor inflation expectations, the
decline of the dollar, and some capacity limitations were far more important. The
response of wages to inflation has, if anything, been incomplete. The economy
developed accelerating inflation before full employment was reached.
The President's anti-inflation program is an attempt to supplement the macro
demand management policies with other measures to reduce the economy's inflationary bias. The wage and price standards are designed to bring the wage-price
spiral down through moral suasion, government pressure and perhaps improved
expectations. The intention to improve government regulatory policies and to take a
tougher look at proposals in such fields as payroll taxes, minimum wages, agricultural policies and trade restrictions will, if nothing else, help neutralize the government's usual proclivities to make inflation worse.
It clearly would be quite inappropriate to pursue restrictive macro policies without supplementing them with the micro approach. We must do everything we can to
bring the inflation rate down, and not just pursue the anti-inflation goal by creating
unemployment and idle capacity. It is too early to assess the program. It has been
three months since it was set up, and inflation has become worse. There have been
no major cases that test the program. Perhaps it is too flexible. I hope the Congress
will stand behind the program when the real test comes.
In the long run, the development of effective programs to bring the unemployment rate down without pumping up the economy must be put back near the top of
the nation's agenda. We are in a period of budget retrenchment, and we are
disappointed that the earlier programs seem to have had rather fleeting results. But
the challenge remains and we will have to return to it.
Fight recession?
The recession, if it comes, will be a policy-induced response to inflation. Given
that circumstance, the Congress or the Administration should not rush into antirecession programs. A mild recession would be reversed by the natural forces of
recovery once the financial pressure can be relaxed. The psychological gains on the
price front would be surrendered through hasty anti-recession actions. Should the
recession be deeper or longer, stimulus would have to be undertaken, but so far
there is little reason to expect a more severe setback.
Senator BENTSEN. Congressman Brown.
Representative BROWN. Thank you, Mr. Chairman.
Mr. Stein, it is always a pleasure to see you, and I hope that
whatever the reason for your svelte figure that there are no problems associated with that and that you are back in fine fettle. Your
sense of humor, of course, is always appreciated and we have
always enjoyed it.
Your growth rate alternatives, as given in your statement, seem
all to be on the down side and your inflation rate estimates are
higher than the administration estimates-I guess one could say on
the up side, although I guess the up side in this case is the down
side, but if what you suggest is the case, the lower growth rate
than the administration anticipated and a higher inflation rate
than is anticipated in the Economic Report.
298
What do you think the impact of that would be on the Federal
budget in terms of total deficit?
Mr. STEIN. Well, I think it is going to make the deficit for fiscal
1980 somewhat larger. I made some calculations on the basis of
what I consider to be a feasible impact path of the economy-Senator BENTSEN. Mr. Stein, I am called to another committee. If
you will forgive me, Congressman Brown will assume the chair.
Mr. STEIN. I made some rough calculations on the basis of what
seemed to be a more realistic path of the economy, not only for
fiscal 1980, which depends very much on calendar 1980, but also on
subsequent years, and what I come out with is a somewhat larger
deficit for fiscal 1980, more like $35 or $36 billion, and a slower
decline of the deficit than the administration proposes on the basis
of its policies and with approximate balance reached in fiscal 1982
rather than fiscal 1981.
Representative BROWN [presiding]. You have looked at the
budget in detail, I assume, and made some kind of an assessment of
both the political and economic reality of the expenditures indicated, and among those items there may be some that are unrealistic
in the political sense.
Every administration since Eisenhower, I believe, has tried to get
rid of impacted aid to schools and a few other things, and those
also are being undertaken by the Carter administration in this
budget and are woven into the fabric of the budget and deficit, as if
they could be accomplished in Congress.
Do you feel that the budget for the most part is realistic in terms
of its reductions with reference to both what the Congress is likely
to do and the uncontrollable expenditures, that are now so much a
part of our total Federal outlays?
Mr. STEIN. Well, I won't make any prediction about what Congress will do. Undoubtedly there are many cuts that are proposed
that Congress will not enact, and I hope there are some expenditures that are proposed that Congress will accept. I have not tried
to make any estimate of the true levels of the uncontrollables. In
the figures I have just given you I tried to allow for effects of
somewhat higher price level and somewhat higher employment
rate on the expenditures and of a somewhat lower nominal GNP
on the revenues, but I have not made the kinds of or tried to check
their calculations on what the built-in expenditures will be for
social security and such.
Representative BROWN. To get to your $36 billion of deficit, what
did you anticipate in terms of unemployment?
Mr. STEIN. I thought the unemployment rate would be in the
neighborhood of 6.5 to 7 percent.
Representative BROWN. As an average for the year?
Mr. STEIN. That we would work up to that by the end of calendar
1979, but that would be pretty much the average for fiscal 1980.
Representative BROWN. In your listing of items that ought to be
undertaken, I guess I am troubled as much as anything else with
semantics. You said, "The Government should announce its intention to bring about a steady decline of the rate of the growth of
GNP in current dollars, as the essential step to reduce the inflation
rate. Current-dollar GNP rose by more than 12 percent during
1978."
299
But, of course, in real dollars it was quite limited, and the real
dollar figure in 1979 is what, would you estimate?
Mr. STEIN. For 1978, during the year, from fourth quarter to
fourth quarter, it was about 4 percent or 3.8.
Representative BROWN. So we have an 8-percent inflation rate
and the anticipation in 1979 is that there may be as high or higher
an inflation rate, with a lower real growth rate. Is that what you
are suggesting?
Mr. STEIN. Right.
Well, the administration forecasts of the nominal GNP for calendar 1979 is 9.8 percent, which, in their estimation, includes 2.2
percent of real growth and something like 7.5 percent inflation.
The point I would like to make is that I don't have any great
problem with calendar 1979 prospects. What disturbs me is the
estimate that after calendar 1979 then we can resume a much
higher rate of growth, getting up to 3 percent and then 4 percent
and more than that, and at the same time the inflation rate will
continue to decline. I don't think that is a likely probability. I
think we are going to have to have several years of rather slow
growth.
Representative BROWN. We have had a history of undertaking
the expansion of the economy by expansion of the Federal budget,
the Federal expenditures and then hoping that the result of an
accelerating economy would catch up faster than our budgetary
increases on an annual basis; that is, that it would increase the
revenues so that you would have declining deficits.
It seems to me that the proposal that you suggest in S. 34 is the
opposite of that, trying to hold down expenditures so that the
growth would catch up with the expenditures of the Federal Government and give us a balanced budget, and, hopefully, then stimulate further growth, providing this surplus were a tax cut, and that
that becomes a strategy for returning as an injection into the
economy of the dollars through tax reduction.
The question I want to ask is one of timing, politics, humor, and
economics. Maybe it is very important as to what timing is. Should
the tax cut come before the spending reduction? Should it come
concomitant with the spending reduction or should it be a follow
on of the creation of the surplus as a result of the spending
reduction and the increase of the income of the Federal Government through growth? In other words, what really fires the further
expansion of the economy? Is it tax reduction or the reduction in
Federal expenditures?
Mr. STEIN. Well, in my view it isn't either of those things. I think
the notion that we manage the overall growth of the economy by
managing the Federal budget is becoming less and less credible,
except that you can have some longrun effect on the raise of
growth or potential output via the tax system, which can either
depress or encourage savings, investment, effort, and so on, but
those, I think, are longrun consequences.
I would say that the economy will grow and we can bring about a
desirable path of growth by the management of monetary policy,
and that we should operate so that along that desirable path we
will approach the balanced budget over the course of several years,
3 or 4 years.
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I would not want to endorse the proposition that we should wait
until we have a surplus in hand before we cut taxes because the
experience is that the spenders always get to the surplus before the
taxcutters do and there is no surplus left by the time the taxcutters get around.
This was Mr. Eisenhower's problem always after the 1954 tax
cut. He kept saying we are going to have another tax cut as soon as
we build up the surplus that the growth is going to generate for us,
and then we will have a tax cut, but every year the spending
increase was absorbing that surplus and he never got to make the
tax cut. That blessing was left for his successor to confer.
I think a reasonable procedure would be to make the kind of
longrun commitment I am suggesting to expenditure restraint and
to make a tax cut phased in gradually that will bring us to a
balanced budget in fiscal 1982. From my standpoint the year is not
as important as the fact we have a commitment to a path that will
get us there in some foreseeable year.
Representative BROWN. I am going to ask you about the tax cuts
in a minute, but I will yield, because my 5 minutes are up, to
Congressman Wylie, who is the new minority member on the
House side of the Joint Economic Committee, a colleague of mine
for some time in the Congress and also a neighbor physically in
terms of his location in our area.
Congressman Wylie.
Representative WYLIE. I might say, Mr. Stein, it is a pleasure to
be in your presence again and I read your column for food for
thought because many of your ideas parallel some of my own,
which have developed over the years.
Congressman Brown referred to the fact that this is my first day
here, which it is, and I am pleased to be a member of the Joint
Economic Committee. It is a very stimulating experience and one
which I look forward to.
I might also say, even though Congressman Brown and I are
from adjoining districts or contiguous districts in Ohio, he is better
known than I am. Very frequently I get mixed up with Clarence
Brown.
Just the other day I was going down the street and I heard a girl
say to the other one: "Do you know who that is?" and she said:
"Yes, that is Congressman Brown," and some fellow walking
behind her I have known for 25 years said: "Hi, Clarence." So what
price fame?
Mr. Stein, there is an obvious growing sentiment in this country
for a balanced budget amendment. Do you favor this constitutional
action?
I asked Mr. Perry that question and Mr. Bernstein, and you
might have anticipated what their answers were without having
heard them.
Mr. STEIN. Well, that is-Representative WYLIE. I would like to have an answer coming
from a little different direction.
Mr. STEIN. That is a very hard question for me because I suppose
if the world were divided into two parts-those that were for it and
those that were not-I would be on the side that is for it, but it is
not my preferred approach to this problem. I think that expendi-
301
ture limitation is the key problem and that that ought to be
approached directly. I think we can be more confident about how
expenditures ought to behave than we can be about how the budget
deficit ought to behave.
I think we can be more confident that we want expenditures to
grow more slowly than we can be about wanting the deficit to be
zero every year.
I am also concerned about the constitutional amendment
method. I think that there are still avenues open to the Congress
for bringing about a restraint of expenditures and a limitation of
deficits which have not been used. I would like to see those avenues
tried or at least thoroughly explored before we go to an amendment which would commit us for a long time to a policy whose
implications we can't quite foresee, and which involves the kind of
technicality specification of terms which is not usual in the Congress.
I wouldn't like to have the Supreme Court decide, for example,
whether the Federal financing bank is part of the budget or not
part of the budget. I think we could handle those questions in a
less legalistic way. But I would go further and say that I think that
we still have an opportunity for Congress to demonstrate that it
can control the budget more effectively than it has so far by its
own actions. If that turns out to be impossible, I think that controlling the budget is so important that an amendment would be a
necessary step.
Representative WYLIE. What would be your visceral reaction to a
law-not a constitutional amendment, but to a law-which would
say that the Government cannot spend more than it takes in in
any fiscal year except by declaration of economic necessity or in
time of war by a vote of two-thirds of both Houses?
Mr. STEIN. Well, I wouldn't object to that. I would want to pause
a little bit over that. I don't know how much of a limitation it
would be and, you know, I would want to approach this situation a
little-Representative WYLIE. Pardon me for interrupting, but the point
is that it would take a two-thirds vote, which is a little discipline
over a 50-percent vote.
Mr. STEIN. I think the fact is we have only just moved to the 50percent requirement in the Budget Reform Act. Before the Budget
Reform Act any combination of minorities could bring about that
result and now we are trying to see whether 50 percent works and
I think there is room for doubt about whether 50 percent works, so
I would not object to that.
I would not want to see it in fiscal 1980 because I would be a
little concerned about going from a deficit approaching $40 billion
to a deficit of zero between one year and the next. I think that is
too sudden, but I would like to emphasize that I think that our
important requirement is to get the expenditures down in relation
to the GNP and the taxes down in relation to the GNP and the size
of the deficit worries me less than these other two numbers.
Representative WYLIE. We are searching very diligently for answers and I say "we" generically. I know my constituents are very
concerned about inflation and they think that government deficit
spending and government fiscal policy are the real culprits, as you
47-106 o - 79 - 20
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do. Is that a fair statement? Mr. Bernstein thinks it is our trade
balances.
Mr. STEIN. I don't think the deficit is the main cause of our
inflation. I know that is a radical thing to say on my side of the
aisle, but I don't think it is.
Representative WYLIE. You don't think it is a primary cause?
Mr. STEIN. No. I think it has some indirect consequences, but I
believe that if deficits are financed without excessive monetary
expansion they will not be inflationary and that it is within the
powers of the Federal Reserve to prevent the deficit from being
financed by excessive monetary expansion.
I think the real problem with the deficit is not that it causes
inflation, but that it absorbs private savings that would otherwise
be available for private investment and that would stimulate the
growth of the real economy. That is a serious problem and it is
especially serious in an economy where productivity is growing
disappointingly slow and that is my reason for wanting to get to a
balanced budget, rather than the inflation problem. But I think the
expenditures-and especially the burden of taxes are the things
that bother people. I think people make a kind of emotional connection between high spending, high taxes, and budget deficits, and
those are three rather different things that need to be sorted out.
We need to decide which of them we think is the most important,
and I guess I think the spending and the taxes are the most
important.
Representative BROWN. Mr. Greenspan said that he would favor
a two-thirds vote on each appropriation bill, on every appropriation
bill, which would be an additional discipline, of course.
What would be your response to that idea?
Mr. STEIN. I don't think that is necessary. That is, I think we can
establish the limits on the total, and the appropriate procedure is
to require, as some have proposed, a two-thirds limit on the concurrent budget resolution, which calls for expenditures not to exceed a
certain amount. But I think, having set the limit on the total
budget, we ought to allow the ordinary democratic processes to
work in deciding where we spend the money.
Representative BROWN. Like I say, we are all searching for answers. We know we have a problem. We have a declining dollar in
the world marketplace, food prices are going up even beyond the
inflation rate. Somehow we must come to grips with this problem
and solve it.
We heard Mr. Perry and Mr. Bernstein argue among themselves
here a little while ago-I wish you were here to hear it-but the
fact is, it is very hard to come up with what might be a real
answer. I have been reading in the paper that Mr. Friedman has
indicated that we ought to somehow tie Federal spending to the
gross national product, and in your statement you indicated you
would tie government spending to the gross national product. You
indicate that you favor lowering the ratio of Federal spending to
GNP to 18 percent for fiscal year 1980.
I think that Mr. Friedman has suggested 20 percent perhaps. I
was talking to Bill Simon and that is what he thinks, and that is
what I put in my bill, and President Carter said it should be 21
percent. He stated that as his goal by 1983.
303
How did you fix on 18 percent as compared to 20 or 21?
Mr. STEIN. I said 21 percent for 1980, 20 for 1981, 19 for 1982, and
18 for 1983.
Well, 18 percent is approximately the ratio of Federal revenues
to GNP in the period between the Korean war and the Vietnam
war, and it seemed to me that it would be desirable to get back
there and if we are going to get back there with a balanced budget,
we have to get the expenditures back down to about 18 percent of
GNP, which is approximately also what they were in that interval
between the Korean war and the Vietnam war.
Of course, these particular numbers come out of S. 34 and I say
that is a starting point. One can argue about the numbers, but I
recommended something like this in testimony last year, so the
exact origins of it are not entirely clear, but I don't think we
should be satisfied to settle for a permanent 21 percent of the GNP.
Now, the Friedman thing proposes that the expenditures would
rise at the same rate as GNP except the years when inflation
exceeds 3 percent, then the expenditures would rise a little more
slowly than GNP. So with the current inflation rates or anything
like that, in the course of a few years, the ration of expenditures to
GNP would apply.
Representative BROWN. You picked that period between the
Korean war and the Vietnam war when the economy was moving
fairly rapidly, as I recall.
Wasn't there a lot of production?
Mr. STEIN. Yes; we had very strong economic growth. We had
very little inflation. I would say in retrospect, it was a wonderful
time for the economy.
Representative BROWN. Is there any way we can get some control
over the uncontrollables, or the so-called uncontrollables, in the
budget?
Mr. STEIN. The situation that we always come up to is that in
next year's budget, a large proportion of the total is uncontrollable.
But if you look out now to fiscal 1981, 1982, and 1983, the expenditures to be made in those years are not uncontrollable.
So, the way to get the expenditures under control is to start
making plans for the future. I think that an important deficiency
of the whole budgetary process is that it is too much next-year
oriented.
I just said that in testimony before the House Budget Committee,
that we have given a lot of lipservice in the last 10 or more years
to a long look at the budget. And every year the budget presents
estimates 5 years ahead and the Congressional Budget Office does a
5-year perspective, but nobody ever pays attention to it.
When I was in the Government, nobody on the. executive side
paid any attention to it and I don't think they do now, and I don't
think they do in the Congress. But that, it seems to me, is a way to
get control of uncontrollables because they are not uncontrollable 3
or 4 years ahead.
Representative BROWN. How much effect does our trade deficit
have on inflationary pressures here at home?
As I said, I heard Mr. Bernstein talk before and he said that is
the principal cause of inflation right now, our huge trade deficit,
and that we ought to do like some other countries do, to wit,
304
Western Germany and Japan. They have had inflation pressures,
too, but it hasn't had as dilatory an effect on their economy as it
has had on ours.
Mr. STEIN. I think that is backward. I think the trade deficit is a
result of inflation in large part, rather than inflation being a result
of the deficit, and you can think of ways to control or limit the
trade deficits which, in themselves, would be even more inflationary.
For example, we can put some physical limits on imports or
impose a surcharge on imports which might reduce the trade deficit, but they would be inflationary in the United States.
In a sense, the trade deficit is a way of exporting our own
inflation to other countries and reducing its impact at home by
sucking more goods from abroad which tends to hold down prices
in the United States.
I am sure that all of those Japanese cars are tending to hold
down the prices of cars in the United States. We would have higher
priced automobiles if we didn't have those Japanese cars.
Representative BROWN. That is where I came out. I asked Mr.
Bernstein the same question, "Isn't the declining dollar a cause of
inflation in the United States and a reflection of lack of confidence
in our economy abroad?" And I got a different answer from him
than I did from you, which, as I said, adds to the problems that we
have because you experts are having difficulty agreeing among
yourselves.
But I thank you very much for appearing here. It is a real
pleasure for me to have the opportunity to ask you questions.
Mr. STEIN. Thank you.
I think I have appeared before this committee often enough for
me to be entitled to welcome you, Congressman Wylie.
Representative WYLIE. Thank you, Mr. Stein.
Representative BROWN. Let me ask just a couple other questions
before we terminate.
You talk about phased regular tax cuts, and legislation has been
proposed for the indexing of tax cuts so that individual taxpayers
would not have the impact of paying higher taxes as they are
moved to higher brackets that do not represent real increases in
their wages.
And there also has been legislation proposed to set the real value
of the replacement of productive facilities of manufacturing plants
and other such operations. The depreciation rates are causing businesses to underdepreciate; and therefore they are having to pay
taxes on profits that are unreal and then borrow money to replace
equipment when those businesses want to modernize or expand a
plant. Other items of similar nature have the same impact of
raising taxes.
Now, I am not talking, of course, about indexing the expenditures of the Government as we do in social security, increasing
benefits as rates of inflation go up. That becomes a phasing regular
tax cut.
Would you accept that?
-Mr. STEIN. Yes, I am a strong supporter of indexing the tax
system and I would be for that.
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305
I would hope that we could do more than that, that is, in a sense,
indexing is less a phased regular tax cut than a protection against
a phased regular tax increase.
And certainly that, it seems to me, is the least we should have
and I would hope that we could go further and reduce the tax
burden. You see, that kind of indexing proposal keeps the tax
burden from rising, as I said, and I think we ought to be able to go
further and reduce the tax burden.
Representative BROWN. The phased rate of tax cut is done intrinsically by the Congress. In concurrence, the administration, or vice
versa, winds up being, over a period of years, not a tax cut at all,
but an increase.
We don't seem to have the capacity in Congress or the administration, or maybe I should say, the people don't seem to have the
capacity to force us to keep taxes at a relatively low level. They
seem to always be inching upwards in notched steps.
I can give you an example of what was done last year with the
notorious tax cut that was given to people on their income taxes
last year. And then when they got through with it, they found the
social security increase and the inflation increase had actually
increased their total taxes.
So I am glad'that you support that concept of indexing and I am
glad I got the question without Chairman Bentsen being here to be
able to counter it, because I am having some trouble convincing
him of the wisdom of that position. But prayer and thought, I am
sure, will accomplish that in time.
But I do want to ask the question now for him because I know he
feels very strongly about this and I support him in that position.
Mr. Greenspan pointed out that increases in off-budget borrowing offsets the administration's hoped-for reduction in on-budget
borrowing to fund the deficit and that the pressure on the credit
markets on the private savings that we mentioned a moment ago
will not be less, and the pressure on the Feds to create more money
will not be less, if we have an increase in off-budget borrowing as
opposed to the reductions in on-budget borrowing.
In addition, there is something I am now beginning to refer to as
off-off budget, and that is mandated spending by the Government
in the regulatory area,' pollution control, OSHA, the energy consumption levels of automobiles, and so forth.
That kind of thing, it seems to me, also ought to be put under
some kind of control along with the off-budget items and Senator
Bentsen and I have put in some legislation that would call for a
regulatory budget-in other words, a spending budget for regulation, since the people must pay for this in the higher costs of items
they purchase, just as they pay for the higher costs of direct
Government spending in increased taxes or inflation.
Do you support that kind of concept or do you think there is a
better way to get at it?
Mr. STEIN. Well, I would distinguish, between these two cases,
the so-called off-budget case and mandated spending. I think we do
need more general control of the off-budget operations but I would
not like to lump the off-budget expenditures in with other expenditures or the off-budget deficit in which the budget deficit, because I
think there is a significant difference.
306
That is, the people are concerned about the Federal deficit because it drains funds out of the credit markets. It has to be noted
that most of the off-budget expenditures are awash from that
standpoint, that is, they are a means of raising money through
some Federal or federally assisted agency and putting money back
into the credit markets, maybe into another part of the credit
market, usually the housing markets but they do not constitute a
net drain on the credit market.
Representative BROWN. Except in times of sharp recession, isn't
that true?
Mr. STEIN. Well-Representative BROWN. I am thinking of the housing market, in
particular. When there is not very much expansion in the housing
market and you have had to guarantee or you have had to pick up
guaranteed loans and then the house sits idle for sometime and the
Government is paying, in effect, the mortgage on the house or
paying off the loan, doesn't that really become a drain on the
Federal budget or the credit market because you must borrow that
money to pay back the creditor?
Don't you have to do that?
Mr. STEIN. Well, if the Federal Government is paying the interest, I think that appears in the budget. That is, the off-budget
transactions are essentially capital transactions; they are borrowings matched by loans by the Federal Government and these billions of dollars that the Federal Government is borrowing through
agencies like Ginnie Mae are being put into the credit market. I
think you want to limit the total amount of that because we are
concerned about the extent to which the Government is pushing
money around within the pool of credit, but I don't think it is a net
absorption of funds out of the pool of credit.
Representative BROWN. I think in terms of those little FHA
houses. I had some during the last recession in my district which
would have been occupied by people and maintained, and the lawn
trimmed and so forth, but all of a sudden in the recession those
folks lost their jobs, and the guaranteed loan on that house is then
picked up by the Government.
The Government pays that loan back to the credit institution
that lent the money and the house sits there sometimes for 3 and 4
years unoccupied.
Eventually, the Government may turn the house over to someone else and let them pick up the mortgage, but it is sometimes
abandoned for long enough that the houses are in such bad shape
after that 3 or 4 years that it is not an available item, it is not an
asset to the Government and winds up being turned down, and the
Government has had to pick up that loan.
Now, that is an off-budget item until that occurs but it is a sure
drag on the credit market that is competing against the Government.
Mr. STEIN. I may be wrong about this but it is my impression
when that occurs, then we have a budget expenditure that is not
off-budget. That is, if the FHA pays off the defaulted loan, that we
then have an expenditure in the budget, but that when the guarantee is made there is no expenditure on the budget.
307
In any case, I think most people do not propose to include guarantees with the budget; they include direct lending by agencies but
not guarantees.
Representative BROWN. But, again, the credit is diverted in that
case away from some open market transaction on expansion of a
factory to a social purpose that the administration or the Congress
may feel is worthy with reference to say the housing market or
some other market in the same way. It seems that by requiring
pollution controls or the conformity to OSHA regulations, you are
forcing an industry to make a nonproductive investment-in other
words, an investment that does not increase the productivity of
that industry or its ability to compete with a product, but rather it
is a direct investment that steals money away from putting in a
new blast furnace to make steel or a new stamping plant to make
automobile doors or something of that nature.
Mr. STEIN. There is a diversion, but the usual point that is made
is that the Federal Government in the off-budget transactions is
absorbing funds in the same way it does in its deficit and I think
that is different from saying that it creates a diversion of funds
within the capital market. Some people are concerned about the
Treasury deficit on the grounds that it forces monetary expansion,
because it tends to raise interest rates and seduce or forces the
Federal Reserve into pumping in money to avoid the rise in interest rates.
This diversion of funds by the off-budget loan transactions does
not in itself tend to raise interest rates. It may affect relative
interest rates in different parts of the market but I don't think it
raises interest rates in total.
In fact, there will be some sense-you know we had a committee
to review the budget concept back in 1968-David 'Kennedy was
Chairman-which concluded that the loan transaction then in the
budget should be excluded from the budget.
There is a certain anomaly that we have some transactions in
the budget that are very much like the off-budget transactions but:
whether the ones that are in should be put out or the ones that are
out should be put in it seems to me is rather doubtful.
I don't suppose you are proposing that these estimated costs
imposed by regulations should be included in the budget expenditures.
They are something you want to see. You want to have some
figures on them and estimates. Is it your thought we would make
the $500 billion budget into a $700 billion budget or-Representative BROWN. We should make some kind of regulatory
budget that would limit the amount of required expenditures that
the President said the private industry would have to make so we
would be sure that we were not overtaxing the capacity of the
credit markets in the country vis-a-vis other more productive investments that might be made in a free market circumstance. In
other words, what we are doing by these pollution controls and
others is mandating spending for positive social purposes-I hope
always positiv6-but in doing that we are in some instances reducing the ability of the industry to produce or the municipality to
survive, because we are forcing them to make that expenditure
rather than some other expenditure which might be made in the
308
wisdom of the industry or the municipality that would be more
constructive. It would decrease their ability to compete or their
ability to satisfy the community's requirements, and the result of
that may be that the industry, the municipality would decide to
make both expenditures, which has an impact of enlarging the
credit demands of the society and increasing the inflation rate and
so forth.
Mr. STEIN. I am sure that you want to have some estimate of the
cost of these regulations that you are imposing. I am just raising
the question whether you want to add that estimated cost to what
we consider Federal expenditures and have a budget which says
that we are now spending $700 billion of which $530 billion is paid
out of the Federal treasury and $170 billion is paid out of various
corporations and municipalities at the dictates of the Federal Government. I think those are two rather different things, and you
would have the question of what to put on the revenue side of the
budget to complement those expenditures.
Representative BROWN. Oh, yes, I agree there should be two
different concurrent resolutions and two different budgets, but we
do need them both.
Mr. STEIN. You require the United States Steel Corp. to spend
$100 million for eliminating pollution, and you put the $100 million
on the expenditure side of the budget, and the United States Steel
Corp. raises the price of steel by a nickel in order to cover that.
Representative BROWN. That is the tax.
Mr. STEIN. Then, you have an excise tax imposed by the United
States Steel Corp. on the other side of the budget. Is that the way
the budget would look?
Representative BROWN. In fact, that is the tax levied against the
individual in the cost of steel. I think the question raised beyond
that is, does the expenditure of the $100 million result in some
social benefit that has $100 million-plus for the society, and, of
course, that is the argument about regulation that is made.
When we say we are cleaning up the water, the answer is that
we do it because there is a positive cost saving in terms of people
having less illness or we enjoy the esthetic value of the fishes in
the stream or the rippling brook, being able to see the bottom
when we go out on our walks, and so forth. Now, that is all very
difficult to equate in a dollar sense, but those are the arguments
we are getting, and, of course, you know the Corps of Engineers
sometimes builds dams twice to justify some things they do in that
way. My first step would be just simply to require the Government
to put a price tag-it seems to me it is easily translatable into
dollars-on the things they have mandated the individual and the
company to do.
If it is raising those fire extinguishers another 3 inches to be 48
inches above the level of the floor, why, let's find out what the cost
of that is, and then maybe we will find out it is not worth moving
them up from 45 inches to 48 inches above the floor.
Mr. STEIN. I am all for that. My only doubt is whether it adds to
clarity of thought to call all of those things the same kind of
expenditures as Federal Government expenditures. It is not necessary to put everything in that one big book in order to think about
it, and I would suggest that you might have another book.
309
Representative BROWN. We can put it in a different book, or
maybe it would be in the yellow pages of the budget or something
like that so we will have a clear picture of it, because right now we
mandate all of those things, and nobody seems to have the foggiest
notion in Washington about what those off-budget expenditures are
that we require.
Mr. STEIN. Well, I am 100 percent for that.
Representative BROWN. If I can just get Senator Bentsen to feel
the same way about tax indexing, we could go to lunch together
sometime.
Mr. Stein, thank you. It is always a pleasure to have you. I hope
maybe with your erudite response to that last question, one of the
columns or pieces you can write for AEI might relate to on-budget,
off-budget, and off-off-budget, and, if you think of anything, maybe
off-off-off-budget.
Mr. STEIN. I will write something about that, but maybe you will
not want it.
Representative BROWN. With your style, I am sure I will like it,
but it might not agree with me.
Thank you for being with us, and we will recess the hearing
until February 22.
[Whereupon, at 12:25 p.m., the committee recessed, to reconvene
at 10 a.m., Thursday, February 22, 1979.]
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