The Zero-Sum Society: Distribution and the Possibilities for Economic Change

THE ZERODistribution and the Possibi ities for Economic Change Lester C. Thurow

A Member of the Perseus Books Cmup

Reprint Edition 2803 Copy~ght@ Basic Books, hc., 1980 A11 ~ g h t rewmed s OP CONGmSS CATALOGIMG-IN-PUBLICATIOMDATA

muraw, Lc?sEerC

me zero-sum s i e w . Reprht af the 19W ed. by Basic b h ,New Vwk. hcltldes bibfiopap~cafreferncm and hdex, 2. URited States-Economic p&cy-l7I3. hcome d i s e b u ~ o - u ~ t e d Statcts. I. 'Rtle, [HC206,7.R49 2981] 330.97T092 W-2871 ISBN 04654858&1

Contents

Chapter l

An &onomy That No bnger P e h r m s Chapter 2

Energy Chapter 3

InBation aapler 4

Stow & a n o ~ cGrowth Chapter 5

En\rironmental Problems Chapter 6

Spreading Rdes and Regulations Chapter 7

Direct Redist~butionalIssue8 Chapter 8

Solving the Economic Problems of the 1980s

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The Zero-Sum Socie

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Chapter 1

An Economy That No Longer Per

D E C D B of k ~ e v h gh aeir econami~hwnezabaq, h e r i c m were jolM by the: 1973-74 Arab ail etrrbmgo- The actjons of a few dema sheiks ewld make them line up at the gm pump and substmtialfy reduw their standad of living. Sud&n economic vulnerabifity is disonwrthg, just m &at first small heart attack is dixonce~ing.ft reminds us &at our wanoaoy can be eclipsed, Whm the shutdown of a major oil exprter far just s few mon&s in 1979 once again resulted in the convulsiom of gas lines, it v u a possible tr, ask whether that b t mild h e m attwk wirs not the harbinger of something worse. Seemingly unsolvable problems were emerging evefywhere-infiatban, unemployment, slow growth, environmental decay, imeeoncilable group demands, and complex, cumbersome regulations. Were the problems uns~lvableor were our leaders incompetent? Had Americans lost the work ethie? Had we stopped inventing new prwews and prducts? Should we invest more and consume less? Do we need to junk our social welfare, health, safety, and environmental protection slystems in order to competeWhy were others doing better? Where the U,S. economy had once generated the warXd"s highest starrdard of living, it was now well down the list and slipping fafiher each year. having the fieh Middle East sheikdams aside, we stood fifth among the nations of the world in per capita G M

in 11978, having b e n surpassed by Swimrlrtnd, bnorrark, West Gemmy, and Swedenel Switzerland, which s t d first, actually had a per capita GNP 45 percent larger than ours, And on the outside, the world's fmtest economic runner, Japan, was advancing rapidly with a per capita GNP only 7 prcent below ours. In our entire histoq we have never grown even half as rapidly as the

Japmex. While the slippage in our ecronomic position was first noticed in the 19"1s, our economic status was actually surpassed (after just half a century of delivering the world" highest standard of living) by Kuwait in the early f9SOs.%uwait was ignored, however, as a simple case of a country inheriting wealth (oil in the ground) rather than earning it. We failed to remember that our supremacy had also been based on a rich inheritance of vast mineral, energy, and climatic resources. No one inherited more wealth than we. We are not the little poor boy who worked his way to the top, but the little rich boy who inherited a vast f o ~ u n e Perhaps . we had now squandered that inheritance. Perhaps we could not survive without it, Of course, one can always argue that things are not reafly as bad as they seem. Since many goods are not traded in international markets and may be cheaper here than abroad, per capita GNP may paint too pessimistic a picture of our relative position. A group of American economists argued in 1975 that we stiH had the highest real standard of living among industriafi~dcountries." What we lost in per capita GNP to the two or three countries that were then ahead of us, we more than made up in terms of lower Iiving costs, Whether this is still true today depends upon changes in the terms of tracle-the amount of exports that you have to give up to get a given amount of imports. In SwitzrXand, for exampte, oil cast less in f 978 than it did in 1975.' While the dollar price af oil is up, the value of the Swiss franc is up even more. T%us fewer domestic goods have to be given up to buy a given quantity of oil, The country% GNP simply buys more than it did, In countries like Switzerland, where imports are over one-third af the GNP, changes in the terns of trade can have a dramatic effect on the real standard of living,

kkn Economy That No Longer P e d o m s

while it is ewy to cdculate per capib CMPs, it is nawdawty d=cult to make precise stanwd-of-1ivi;ljlg compmisam mong purc a u n ~ e s ,In each countq, individuals naturdly shB chmes toward &ase items that are relathery cheap in that wunm. Tastes, circ.cumstanees, traditiom, and habits diEer. Individuals do not buy the s m e basket of g and services. What is a neeessiq ia one country may be a l n u q in another, Hedth care may be provided by government in one country and purchased p~vatelyin another. And how do you evaluate vmt expnditures, such as t h m we make on health ewe, where we are spnding more &an the rest of the world but getring less if you look at life expctaney (WeS. mdes we now sixteen& in the world) 2' But whatever our precise ranking at the moment, the rest of the world is catching up, and if they have not dready surpassd us they swn will. From mmy perspectives, this catching-up pr is desirable, Mast rich people find it more comfortable to live in ai nei@brhood with other rich pople. The tensions are less and life is more enjoyable, What is not so codortable is the prospct that our rich neighbrs will continue to grow so rapidly that we slip into relative backwardness. Up to now, we have camfofled ourselves with the belief that the economic growth of athers would slow down as soon as they had cau&t up with us, Xt was simply easier to adopt existing twhnologies than to develop new tecfinologies-or so we told ourslvm. But as otfIer countries have approached our productivify levels, and as individual industrim in these countries have hewn to be more prductive, the ""ctchhg-up" "pthesis becomes less and less prsupsive. In the priod from 1972 to 1928, hdust~;a'prmctivity rose 1 p r w n t per year in the Unitd Stabs, &most 4 percent in West Gemmy*md over S percent in Japtm,@mese countries were introdtucing new prducts and improving the prwess of making ioXd prductrs faster than we were. Mi7ljor h e r i c a n fims were r e d u d to marketing new consumer g d s such as video recorders, which were made exclusively by the Japanese. In many indus~es,such ais steel, we are now the ones w'rth the "eay" Qsk of adoptkg the twhnolltogies developed by others, But we don%"Instead of junking am old, o b l e t e open-be& furnaes a d shifting to the large

into prokction agaimt the "U&&" c m p a ~ o nof J a p m e st-1 w m p e m . The result is at rducdm in real incorn@ as we a l l pay mare for steel than we should, As a rwdt, our wonomy ends up with a weak see1 hdustfy that emnot compte and has no incentive to compte, given its protec~aninthe US.maket, relagve ecanoGc decIhe has; b t b economic and plitical hpacts, Economiedy, b e r i e m fa= a mla~ved s l k e h their stadmd of livhg. How will the merage hericlan react whten it h o m e s obvious to the emual toudst ( f o ~ i p e mhere, h e d c m &ere) that our econamy is fdling b h h d ? Shce we have nrtver haxi that exprience, no oae knows; but if we are like hum= kings in the rest of the world, we won" like it. No one likes ming o&en able to aEord &ings that they cannot. As g a p in living stmdads grow, so does &ssati,sfaction with the p d o m m a of government and economy. The lmger the income gap, the mare revolutianaiv the demands for change. Tday's pwr ~ountdesare in turmofi, h t it should be remembred that &ex caunlries are nat p r compared with the p r centuries ago. They are only pwr relative ta what has k n achieved in tdayk sichi ctomtries. If we b o r n e r e l a ~ d yp s , we are apt ta be just as unhappy. Politically a decliaJng economy means that we have to h willing to make greater sacrifices in our prsonal cansumption to maintain any level of world influence. This can be done, The Russians haye bcome our militav and geopolitical equtllfs despite: a p r capita GNP that is much lower than ours. They shply put a larger fraction of their GNP into defense. But the need to cut consumption creates str&ns in a demaeracy h a t do not exist in a dictatorship. Americans may graduaEly decide that they cannot d o r d to maintain a strategic military capability ta defend countries that are richer than they are, They may decide that they cannot aflord ta Xubrkate Face settlements, such as that bewen Israel and Egypt, with large economic gifts, %me of the intemationd economic burdents could be shifted to our wealthier allies, but this would inevitably mean. letting them make mare of the im-ant, international decisions. In many circumstances (Israel vs. Eept?)

An Economy That No Longer Performs the Cemms m d the Japmes may not m&e &e s m e decisiom that we would m&e, The hard-core c~rrservativesdution is to "likrate free enkrpris," reduce social expnditures, restrwture t a e s to encourage saving and investment (shiNr the: tax burden from &we who save, the riah, to t-bose who consume, the v r ) , and eliminate government rules md regulations that do not help business, Spcificdly, the capital! gains taes that were reduced in 1978 should br= reduced furlher; the "double" "taxatioa of dividends should be ended; income &ansfer payments to the p r and the elderly should t>e frozen; environmentalismshould be smn as ;m economic threat md rolled back, Lager cunres sprout like weeds ta show that tmes shouId be cut to restore personal initiative; Only by returning to the vimes of hard work and free entewrise can the economy Be saved. In thinking a b u t this solution, it is well to rememhr that none of our comptitors became susessful by following this route. Covemment absorbs slightly over 36 percent of the GNP in the United States, but over 50 p r w a t of the GNP in West Gemany. Fifteen other countries collect a larger &action of &eiLf GNP in tmeseB Other governmentss are not ody Xwger; they are more petmasive. Xn West Germany, union leaders must by law sit on e o v r a t e boards. Sweden is fmous for its comprehensive welfxe state. Japm is mark@$by ai degee of mntrd invement pfmning md government cantrot that would an&e my goad capitalist cry. Other governments own or controt major firms, such (as Volkswagen or Renault, Ours is not the economy with the mwt rules and replations; oa the contrary, it is the one with the fewest rules md reguhave dismvered tcl their horro~;it lations. As mmy h e d c m fi simply isn't possible to fire workea abroad as it is here, It is a dubia-us achievement, but nowhere in the vva~Idis it easier to lay off workem, Mar have our campetitors unleashed work effort and savings by increasing &come digerentiafs, Indeed, they have done exactly the opposite. X f you lwk at the earnhgs gap btwmn the top md bottom 10 percent of the population, the West Eemans work hard wi& 36 prcent Iess inequatlity than we, md tfie J t l p m e ~work

encourage individud initiative, we should b full of inidaifive, sinee among Industrialhd countriw, only the French wrpm us in terns aE inequality. Moreover, our own history shows that our ee~nonniepe since the New Deal md the anset of goverment fe~nce"has h e n better than it wais prior to the New &al. Qur best eeanornie decades were the 1940s (red per capir,lir GNP grew 36 prcent 1, when. the economy was nxn a a. command (socialist) wartime economy, and the 1960s (real per capita GNP grew 30 prcent), when we had all that growth in w i d welfase pr~grarns.~ Real per capita grwth since the advent of t intervention has ken. more than twice as high as it was when governmen&did not intemene or have saeial wtfase programs. The British are often held up as a horribte example af what will happn to us if we do not mend our ways and revem the trend ent. But whatever is wrong with the Br;itish emnomy, it has little to do with the size of government. British wawth fell bhind that of the lelxding industrial countries in. the since. Sow nineteenth century and has remained beh in 1945. On growth did not adve with the Laibur gov the contrary, British growth since 1945 has actually been bt&r than hfore. mere is no doubt that the British economy is in sad sfxap, but as the West Germanys of the world demonstrate, its problems are not a simple function of government size. As both our experience and foreign exgerience demonstrate, there is no conflict htween m i a I expenditures or government intemention and economic success. *Xndmd, the lack of invesment planning, worker participation, and swiaf spending may be a cause of our p a r pedarmance, As we, and others, have shown, social refoms can be productive, as well as just, if done in the right way, Xf done in the wrong way, they can, of course, be h& disas&ous md unijusl. mere may also be some meit in ""lkratiag free enterprise" if it its done in the right way, mere are cerlainly unnwessaw mks a ~ d regulations . that are now strangling our economy. The tfick is not rules versus no rutes, but finding the right ales. The American problem is not returning to some golden age of mnomic gowth (there was no such golden age) but in raomiz-

An Economy That No Longer Performs

9

ing that we have an economic structure that has never in its enke histog gedorrned as well as Japan and West G e m a y have perfomed since World War If, We are now tfie ones who must copy and adapt the policies and innovations that have been successful elsewhere. To retreat into our mythical past is to gumantee that our days of economic glory are over,

But our problems are not limited to slow growth, m r o u a a u t our society tlxere are painful, persistent problems that are not being solved by our system af plitJeal wanomy. Enexgy, inflation, unemployment, environmental decay, ever-spreading waves of regulations, s h q income gaps fieween, minori~esmd majo~Gezs-&e list is almost endless, Because of our inability to solve Ebes-e prablems, the Imenr is often heard &at the U.S. economy and plitied system have lost their abifity to get thrings done. Meanin@ul cornpromises cannot be made, and the plitics of confrontation are u p n us like the plague, Programs fiat muXd imprave: the general welfare camot be started because strong minorities veto them. No one has the ability to impo;se solutions, and no solutions command universal assent, The problem is real, but it has not been proprly diagnosed, Oxke cannot lose an ability that one never had. What is perceived as a lost abifity to act is in fact ( 1 ) a shift from international cold war proMerns to domestic problems, and (2) an inability to hp= large economic losses explicitly. As domestic problems rise in imprtance relative to internationat problems, action kcornes increasingly diffcufr, International confrontations can be, and to some extent are, poflrayed as situations where everyone is fairly sharing sacrifices to hold the foreign enemy in check. Since eveq member of smiet)c is facing a. commcm threat, an overwhelming consensus md bipartisan. approach can be achieved.

mmestic problems are much more c o ~ @ n ~ ain u sthe m m that whm wlicies are adopted to solve d o m a problems, ~~ &ere me Americm w h e m and Americm lmrs. %me hqornes go up m a result of the salution; but o&ers go down, Individuds do not s a d fiw equally. Some gah; wme foscr;, A progrm to raise the wcupational psition of women and minorities automatically lawes the wcup;ttioa*dl; position of white men, Eveq black or female appointed to Resident Carter" sGainet is one less white mde who c m be appohtd, People often ask why President Kennedy was so essay able to get the Man on the Moon project undernay, whzle Presidena Nixon and Ford found it hpossible ta get their Project fndepndence undernay. mere is a crery simple mswer. Metaphoricdly, some American has to have his or her hauw mm down to achieve enerw hdepndence, but no American lives htween the e h a d the moon. Evevone is in fawar of enerw indeperxciene h gerteral, but &ere are vigorous objwtors to every paticulw path to en;erm indepndence. In contrast, once a Gonsensus had b n reached on going ta the mmn, the particular pa& could, be left to the technicians, fn domestic pr&lems, the means are usually as contentiow as the ends thernfelves. As W shall see in later chapters, there are solutions for each of our problem areas. We do not face a world of unsolvabte probtljtese dutions Xems, But while there are soIutions in each c*, h m a common characteristic. Each requires that mme large group -sometimes a minority and sometimes the majority-be willing to tolerate a large reduction in their real standad of: living, When the economic pluses-and minuses itre a;ddecf up, the plus8 usually exceed the minuses, but there are large economic losses. These have to be allocated to someone, and no group urmtdj to be the group that must suffer economic losses for the general g&, Recently I. was asttea to address a Harvard alumni reunion on the problem of accelerating economic grow&. I sugested th;ir we were all in lFavclr of more investment, but &at the heart of the problem was deciding whose income should fat1 to make room for more invesment. Who would they take income away from if they were given the tatsk of raising our investment in pfmt and equipment &om f Q to 15 prcent of the GNP? One hand was quickly raised,

An Economy That No Longer Performs and the suggestion was made to eliminate weifme paymen&, Mat surprisingly, the person was susesting that someone else's income be lowred, but I: pointed out that welfare .eonstitu&s onEy 1.2 percent of the GNP.@Where were they going to get the remaining funds-3.8 percent of GNP? Whose income were they willing to cut after they had eliminated government programs for the p r ? Not a hand went up.

A Zero-Sum m i s is the heart oi our fundamental problem, Qwn economic prabferns are solvable. For most of our problems &ere are wveral sdu€ions, But a l these solutions have the c h a r a c t e ~ s ~that c sameone must suRer Jarp econamic Imses, No one wmts to valunteer for this role, and we have a pliticd process that is incapable af forcing armyone ta shoulder this burden. Everyone wants wmeane else to suffer the ngessary economic lasses, and its a conquenm none of the possible solutions can be adopted. Basically we have created the world deserikd in RaEKFZ Ar&ey8s The Terrirorial Imperative, To beat an animal of the same s p i e s on his home turf, the invader must be: twiee as strong as the defender, But no majority is twice as strong as the minority opposing it, merefore we each veto the other's iintiiiatives, but none of us has the ability to create successful initiatives oumelves. Our political and economic structure simply isn't able to cope with an economy that has a substantial zero-sum element. A zerosum game is any g m e where the losses exactly equal the wimitlp, All sporting events are zero-sum gmes. For every winner there is a . the wiming loser, and winners can only exist if losers e ~ s t What gmbler wins, the losing gmbfer must lose. When there are l a r p losss to be allocated, any economic dmision has a large zero-sum element, The economic gahs may exced the economic losses, but the losses are so large as to negate a very substantial fraction of the gains. What is more b p r t m t , the gaim and losses me not afloeated to the same individuals or poups. On

average, society may be htter off, but this average hides a 1mge numkr of pople who are much better off and large numkrs of people who are muck worse off. If you me mong tfiost: who are worse off, the fact thaf someone else's income has risen by more than your in~ornehas fallen is of little comfort, To protect our own income, we wifI fight to stop economic change from oecuning or fight to prevent society from impsing the public policies that hurt us. From our prspctive they are not good public policies even if they do resuit in a lwger GNP, We want a solution to the problem, say the problem of energy, that does not reduce our income, but all solutions reduce someone's income, If the government chooses some poticy option that dms not lower our incame, it will have made a supporter out of us, but it will have made an opponent out of someone else, since sameone else: will now have to shoulder the burden of large income redueGons. The problem. with zero-sum games is that the essence of problem solving is loss allocation. But this is precisely what our political pracess is least capable of doing. When there are economic gains to be alfocated, our plitical prwess cm allocarc;:them, When &ere are large economic losses to b4: allocated, our ptiticat process is paralyzed, And with gofitical paralysis comes economic pmalysis. The importanw of economic losers has also been magnified by a change in the political structure, Xn the past, political and economic power was distributed in such a way that substantial eeonamie losses couXd be imposed on parts of the population if the establishment decided that it was in the general interest, Economic losses were allocated to particular powerless group rather than spread across the population, These groups are no longer willing to accept losses and are able to raise substantially the cos@far those who wish to impose losses upon them. There are a number of reasons for this change. Vietnm and the subsquexlrt, political scandals clearEy lessened the ppulation" sillingrxess to accept their nominal leader" jjudgnrenl that some project was in their general interest. With the civil rights, poverty, black power, and women's liberation movements, many of the groups that have in the: past absarhd econorni~lasses have become miiitant, n e y are no longer willing to accept losses without ai

An Economy That No Longer Performs

K3

political fight, The success of their militancy and civil disokdience sets an exampk that spreads to other groups representing the environment, neighborhoods, an®ions. All minority groups have gone through tt learning prclicess. They have discover4 that it is relatively easy with our legal system and a little militancy ta delay anything for a very Xong period of time. To be able to delay a program is often to be able to kill it. Legal and abinistrative costs rise, but the delays and uncertainties are even more important, When the cos& of delays and uncertainties are added into their calculations, b t h government and private industry often find that it pays to cancel projects that would othewise be profitabte. Costs are simpfy higher than bnefits. fn one major environmental group, delays are such a major part of their s t r a k a that they have a name for it-analysis paralysis, Laws are ta be passed so that every project must meet a host of complicated time-consuming requirements, 'The idea, is not to l e m more about the costs and benefits of projects, but to kill them. I f such requirements were to be useful in deciding whether a praject should be undertaken, environmental-impaet statemenls, for exmpfe, would have to be inexpnsive, simple, and quick to complete. m e n a firm mist undertake the studies to help deternine urheher they should or should not start a projwt. Instead, the studies are to be expnsive and complex to serve as a financial detement to undertaking any project, to substantially lengthen the time necessaq to complete any project, and to ensure that they can be challenged in court (another lengthy prwess). As a consequence, the developer will start the process only if he has already decided on other grounds to go ahead with the project. The result is an. adversaq situation where the developer cannot get his project undernay-and where the environmentalists also cannot get existing plants (such as Reserve Mining) to clean up their current pollution, Where it helps them, both sides have learned the fine art af delay. Consider the interstate highway system, Wkatever one believes about the merits of completing the remaining intracity portion c& the system, it is clear that it gives the countfy m interttiq transportation network that would be s m l y missed had it not b e n built, Even thasa: who argue against it do so an the grounds that If it

had not h e n buiih wme Better (nanautcr) syswm woutd have b x r devised, Yet m@ o b w e m would a s = &at h e h&mta& hi@d h way system muld not have k e n built if it had been the mid4 978s rather than in the mid- 1950s. Exa;ctly the s m e factors that would prevent the ~ t i a t i o nof m htemate highway syskrn would also prevent the iniGation af a y afemative & a m p m ~ o nsystem, A few yeam -a, when a hi&sped rail sysern wac~being considered far the Baton-Wmhingm eoedar, a garner governor of Cannwdeut amounted that he would veto my relsationi of the Bosmxl-t+New York line an the gounris that it would be af prhe hnefit ta thwe at either end of the fine, but would tear up Caxlnwti~~lt homes. "Ibe p01~pso p p i n g an intercity rail nefwork would be slightly ditTerent &om the g o u p opgssing m htercirty highway network, but they would be no less eBective in stopping the project, Any banspeation system demands that land be taken and homm be tom down. At one time, this wzw possible; at the moment, it is im m e Bdkmimtion of nations is a worldwide the United States has not escaped. Regions and laealities we less md less willing to r cos& that will prhadly help p p 1 e in eauntq, Consider the development of the ather p m of the coalfields of Wyoming md Montana. mere is no question that mmt of the haeats wiil mcme to those living h wbaai me= in the rest of the muntq while m a t af the cmts wiilt be i m p s d on i t h a livin$ in that region, As a rrcsult, the laeal population objects. coal .mining might be g& for the United States, but it will be bad for 1mal cam'tituen&. merefom &ey will irn mmy &lays md unceHainties as le. Iwalion of nuclear pwer The s m e problem b issible plants. matever one bttlieves a b u t the benefits oE nucfear it is clear that l e n g ~ ydelays in approving sites sewe no a&= than m a s&ateH for kilfing the prajecfs, If the pr have: 'to suger the s a e risb unde~&enanyay, th wia delays. What is md pay the hiaer c wantd is a quick yes ar no answer; but this is just what we find ibfe to do. The question of nuclem pwer sites also raises the B&&mtion isue. Whatevm the probabilities of acci&n&, the const3qtuenms of such failures are much less if. the plmts se-

An Economy That No Longer Performs

25

located in remote areas. But thqse who live in remote areas do not want the plants, since they sueer d l the gatetltiail hmads and do not need the project, Everyone wants pwer, but no one wants a pwer plant next to his own home. mmestic problems also tend to Xlave a much longer time horizon. In modem times, even long wars are won or lost in relatively short p r i d s of time, fn contrmt, a projmt such as energy independence would take decades to achieve. The patience md foresight necessary for long-range plans is generally not an American viflue, Consequently, rep~sentativesswking reelection eveq two, kur, or six years want to supprt pragrms that will bring them votes, mey do not want to stick their necks out for a goad cause that may conflict with their carers, Even. more fundamentally, domestic problem oftext involve long priods where c a b accrue, with the hnefie follawing much latex. mink about enerw indepxtdence. Far a loag time, sacdfices must be made to construct the nemssasy xni~esand plants. Benefilcs emerge anfy near the end ale the prwsr;. The: p1itieiatn who must incur the costs (rais the n-ssafy revenue md incur the anger of those who are hurt as the projects are cansmcted) is unlikely tto be mound to cdfect the credits wheat enerm independence has b e n achieved,

Given the problem of lass allocation, it is not sawrising that govent stands in the middle of an adversary relationshi;p. Each group wants government to use its power ta protect it and to farce others to do what is in the general interest, Enera prducers want prices .to go up and the real income of energy comumers to go down. Energy consmers want prices to go down and a reduction in the irxcome of producers, Each understands that the government could stop &em from having to srrRer such losss, Each of us demands what collectively is hpssible. But as the demands for protection grow, the basic assumptions of the demwratic prmss are undemind.

To be workable, a democracy assmes that public decisions me made in a frmework where there is a substazltial majority of coneerned but dhinterested cithens who will pxevent policies from being shaped by thaw with direct economic zielf-interests. h c i sions in the interests of the genegal welfare are sup duced by t h m concerned but disinterest& citi arbitrate and judge the disputes of tkre intertrsted parties, As &QVerment grows,"however, the aurnbr of such citizens shrinks. Almast everyoae now has a direct wonomic stake in *at government dms in an area such as energ. me Watergate and asociated c o v r a t e brikry scandals revealed the illegal side of this problem, but the real problem is not so much illegal acts as it is the incentive to use legal ones. Wi& evewane's eeanomic self-interest at stake, we df form pdectfy proper lobbying groups to bend decisions in our favor. But with the disinterested citizen in a minority, haw me decisiom to refiwt the general welfare? Who is to wbitrate? Our natural inclination is to rely on the adversmy prwess, whe-re diAeereat self-interested groups present their ease, But somewhere there has to be a disinterested judge with -the power to decide or tip ai political decision in the right way. The general welfare is not always on the side: of those who can mobilize the most econamic and plitieat pwer in their own &half. If we really w r e to enforce the rule that no one could vote on an issue if his or her income would go up or d o m as a rault af the action, we would end up with few or no voters on most issues. The problem is to establish a madicum af s disinterested decision-making capaciq in a political prmess where eveqone has a direct self-interest.

The Need for Distribution Judgments ental prwess &at g m to peat lengths to avoid hving to ovedy lawer mmmne's hmme. Such dwhiom are dways king made: og caum, but they are made hplicitly, under the g u k af mcamplishing other obje@tivrss,Cowrvativm me now

An Economy That No Longer Performs

27

arguing for a restructuring of m e s and expnditures that would m&e the distribution of income mare unequal, but they do not defend this goal overtly. Inequality is shply a regrettable n-8sity on the way to hi@er growth. Fortunately or udo~unatelywe have reached a p i n t where it is no longer pssibXe to solve our economic problems and still make such implicit distributional decisions. T'he problems are stark enough a d the options clear enough that evefyone both knows and cares about the distribuaanal consequenwg that will fallow. DereguXating the price of energy might be the eBcient thing to do, but we have great trouble dloing sa, Everyone whose income will, go down knows it, objects, and stands ready to fight the proposal. Since goverment must alter the distribution of income if it is to solve our economic problems, we have ta have a government that is capable of making equity decisions, Whose income ought to go up and whose income ought to go down? To cis this, however, we need to know what is equitable. What is a fair or just distribution of economic resources? What is a fair or just ptoeedure for dktributing income? Unless we: can specify what is equitable, we cannot say whose income ought ta go down. Unless we can say who* income ought to go down, we cannot solve our eeonornic problems, The diBculties of spifyinf; economic equity nei&er obviate the need far equie decisions nor stop such decisions &om b h g made. - Every time a tax is levied or repealed, evePy t h e public expenditures are expanded or contracted, evev time regulations are ex&nded or amishe&, an equity decision has trr be made. Since economic gains are relatively easy to allocate, the basic problem comes down to one af allocating economic losses. Whase income "~ught"to go down? HistoricaltIy we have used economic growth to avoid h a ~ n gto make this judgment, If we just have mare growth, we can have more good jobs for everyone, and we won't have to worry about taking jobs away from whites and givix them to blacks, If we just have more: eeonomic growth, we won" have to worry about government collecting taxes in the Nofieast and spending t h m in the Southwest. More is abviowly better than less, and economic has been seen as the social lubricant that can keep different groups working togeher.

to regad ecoh & c m liberafs and consewatl\tes h& nomic ~ o w t has unambiguously g o d . mrough the magic of economic gaw& md hdividuaf %If-inkregt, eveeone would have more, If everyone had a hi@er ineone, then society would nol have to address the divisive issue of equity or what constitutes a just distribution of economic resources, Individuals would be happy with their new, hi@er incomes regmdless of their relative status. We now know that almost all the implicit assumptions in this social consensus we false, When we are talking a b u t incomes above the range of psychological necessities, individual prceptions of the adkquacy of their economic performance depnd almost solely on relative as opposed to abmfute position, m e poor in the United States might be rich in India, but they actually five in the United States and fwX p r . The middle class may have fresh fruits and vegetables that the richest kings could not d o r d in the Middle Ages, but they fed deprived relative to the uppr-middle class, who can afford thin@ they cannot aEord. "l'%@prapflion of my ppulation &at repart themselves satisfied with their economic pdormance rises not at all as that p p u fation" average income rises.x0'Those happkst witljl their economic eircumstmees have above-average incomes, 'There is no minimum abmlute standard of living that will make paple content. Xndidual wants are not satiated as incomes rise,-md individtrds do not hcome more willing to transfer some of their resources to the poor as they grow richer. If their incow rises less rapidly than someone else's, ox- less rapidly than they expect, they may even feel poorer as their &comes rise. This immediately fmces a democracy into a no-win situation where, whatever it decides about the just distribution of resourw~, &ere will be a large numkr (perhap even a majority) of unhappy voters. Distributional issues are highly eantentiaus and precisdy the kind of issues that demomacies find it most di@cult to solve, It is not we versus them, but us versus us in a zero-sum game. In the past there was also a widespread optimistic klief that the distribution of maker incomes would autamaticafIy &come more equal with gowth. Minorities would automatically catch up with majorities, and the pmr would e l a ~the gap beween theansefvw and the rich, Exmpt for the physically handieappd, everyone

An Economy That No Longer Performs

49

would Ix: able to reach an amptaMe mi tun smdard of Bvhg if output were only high enough. And for tfiose few who wuId not earn their own wsly, the richer our society, the easier it w ~ d dbe to give them m adequate Incame. Mere again, we know now that this is not the c-, From 1948 to 1978 the distribution of earn in^ grew mare unquail. In: 1935) the average: year-round, full-time female warkm earn& jwt 61 prwn:t of what the equivalent male made. By 1977 she made just S7 percent as much.lEForty years of*rapideconomic growth, yet women were father bhind at the end than at the bgirtnixlg.

The Drioe for Eco M W is exacerbaed by m heremhg drive for ecano&c mwity, Economic murity is to m d e m man what a castle and a moat wem to medievd mm. One wadd have e x p t e d that the &she far economic security would fall as the dmger gf red samatian and expsure faded into the past. But this hasxr? happnd. Immd, the desire for economic scurity is probably the major ecortomie demmd c a d r o n ~ gthe pliticd mwketplace. Evefyone vvmb economic security, and government is seen as the p r h e vehicle for gwmteeing it. The drive for economic ~ e u r i t ydominates our actions and may end up dominating our ewnamy, Tke desire far economic security can: be seen in both how we earn our incomes and haw we spnd them. When pubLie opinion p l l s ask about desked job characteristics, economic scurity aXways takes top place-well above higher pay," "is preference for economic scurity shows UP in many ways. Old workers want seniority hiring and firing so that worries about layaffls can be canfined to sameone else-new workers. Restrictive work rules are designed to provide job =curifye As for consumers, "kt the buyer bware" is not an aphorism that attracts much support nowadays. Yet with bttereducated buyers who make fewer mistakes and have higher ineames, so &at

they can aEord mistakes more easily, we should be moving in the direction of letting individuals make more of their own decisions. But we wen", We are much less willing to let individuals make tbeir own mistakes. Anyone who has bought a house under a federally insured mortgqe knows that the regulations act as if the buyer were at first-class idiot. Consumer legislation usually assumes that consumers are incompetent. Xt is common to explain these regulations as having been forced upon society by some extremely powerful minofity that wants to torment the current economic system, m i s is a mistake. The problem is to understand why most of us want to be protected from our own mistakes, Everyone wants economic security and runs to the government for protection when he feels it slipping away. When OPEC raised the price sf oil in 1973-74 and food prices exploded, both were met with overwhelming demands for government regulations to mitigate the real income fosses, Energy became a regulated industg md export embargas were imposed on grain sales, Examples are endless: farmers, the elderly, the steel industry, electronics, &xtiles+veryane wants economic security, None of the grows are villains. They siwly want what each of us wants-economic securify, Some of the demand for security springs from the naare of hdustrial swieties, In agricultural societies, economic destruction was seen as, and mainly was, the result of imprsonal, uneontrollable fofes: if the wather is bad, incomes are gaitlg to fdl and no earthly force can alter the results. Economic dwtnnctian in industrial swieties is caused by identifiable human actions that can, t>e contralleb, If someone plans to build a coal-sluy pipeline &am the coalfields af Wyoming to the Midwest, the: irrcome of railroaders will fall, but they can m o b i l i ~to prevent the pipreline companies from getting the right of eminent domain necessary to buiId the pipfine. If incomes are threatened by Japanese steel or W sets, Japanese prducts can be identified and kept out. In axr industrial society, economic security.becomes a feasiMe objective. Mderrr industrial societies may also lead to a set of financial interrelationships (mortgages, consumer credit, pension rights, and so forth) in which small declines in personal income are more

An Economy That No Longer Performs

21:

threatening to an individual than they were in the past. Objectively, king hungry may be more grious than having your car repossessd, but subjectively the repossession may pose more of a threat to mocles of living. With income security during retirement depending u p n private pensions, job security while working be;comes directly tied to income security during one" old age, fndustrial sons and daughters are not expected to take care of industrial mathers and fathers in their old age. Instead they depend on pensiom that are attached to jobs. Skills are also threatened in a world where many skills are learned on the job and where job agenings are awarded based on seniority. To move from one employer to another invafunta;riXy is to ga to the bttorn of the skills ladder and start over. To lose one" jab is to take a, chance on destroying one" human capital and substantially reducing one" earnings, Eecmomic security also has a peeutiar dynamic. Every instance of providing econarni~security leads to demands for more economic security. If the qteel industry is protected from its own inefficiencies, why shouldn't everyone else be protected fmm their own ineRciencies? Even more hpartant, 1J.S. steel users will now have to buy steel at a higher price than their foreign eompetitarsThis makes them less comptitive and increases the probability that they will also have to ask for protectian. They must have protwtion to aRset the egects of the protection given to mmeone else. h protection grows, there is no naturaI stopping point. The more protection. we have, the mare we need, Protected indusMa almost never reach the point where they can throw off their protection and reenter the c~rrtptitivemarketplace, Instead they drag oaers down with them, The growth of large economic institutions also forces government to take many protective actions, At the heatt; crf eapitdism and competitive markeb lies the doctrine of failure, The inefieient me to be driven out of business by the eEcient. But gavemments cannot tolerate the failure of large economic actors. Neither the bckheed Corwration, nor New York City can be allowed to fcil, since.the disruptions to our integrakd economy would be t m large; to tolerate. Needed military gaods would not be delivered, and millions of bondholders would lose a substantial part of their

wealth. In both cases, the rescue was organized by a conserva&ve, fi-an~ket Republic= government. Any o&er have done the same. But if we rescue large economic actors, this creates a demand for rescuing the local gromu store or the small town fram its misbkeg, Unlm we do so, we hilve a double stmdard for the lkge md the small when it corn@ to failure, But to rescue is to con&ol. Xt is also to undercut the whale dwtrine of competitive capitalism. moscz: who fail won3 t punished economicaHy. If we wuld simply buy economic security, as one buys an insurance policy on ant=%life or houw, economic security wufd not be a difficult problem, But we cannot, Instead, we give people: eccm~micsecurity by guaranteeixlg them that their cument e m ings oppgunitks will not disappar, But this guarantee Imks us into cunent activities and makes it difficult to shift tta the new prducts and prwesss that are the heart of wnomic progress. The problem is to combine economic progress with economic security when to a great extent they are rnutudly incampatible. Evevane wmts b t h , but everyone cannot have b t h . Eonomic progress always tends to be thought of in terms of bdgfxt new prducts and prwsses, but we forget that every new pr&uct repXaees some old prduct and every new prwss replaces some old prmss. Economic construction is based on economic destruction. In the process of destroying old products and old proca=s, =me Americans will sufTFer large economic fosses even fhough other Americans wilt make even larger economic gains. Qnty very seldom is economic growth a grwess without l o ~ r s , Average red standards of living rise, but this gain ohcures many lmses, L o ~ r naturally s want, to eliminate their losses, but this can ody be done by stopping the economic pragress that threatens to cause their losses, As each of us, individually and in groups, searches for economic seeurity, we collectively reduce the rate of real gr stnd praduee an ossified society that is incapable af adjusting to new circumstances. One simplistic solution is to give up on either economic proffress or economic seeud.iry, There arc: advocates of both positions. Cmsmatives, f m what they believe are imprepable economic pmi-

An Economy That No Longer Performs rims, generally recommend that everyone else should give up on economic security and live in a rugged, dynamic, competitive, free enterprise monomy. Xn practim, those s m e people nrrt to the government for protectim if they see their own incomes threatened. None of the kinduaries that me now protect& would have been pr* tected if the managem of thoa industries had not wanted protectim, Others with equally advantageous phtions recommend giving up on economk growth under the cover af environmentd qudity or natural-resource exhaustion, T%e economy is to be frozen so that they can enjoy their current advmtageous psitions without fear of competition for the indefinite future. As they say in ~oloradb,s conservationist is a person who built his mountain cabin last ye=, while a devefaper is someone who wants to build his mountain cabin this year. fn practice, neither of these solutions is a solution. Toa mmy pople are not satisfied with what they have; they want more. Tbey are not about to turn the economy off and freeze themselves into a position where there is no hope nf economic advancement, Similarly, too many people want economic security. Each of us, when threatened, wan& security, And in a democracy, we will organize to get what we want, T'he obvious goal is to deliver eeonornic security without stopping economic progress. But how? The demand far economic security also heightens the tension between our ideology of individual decision making and the praetied necessity of collective decision making. No individual can guarantee hirnwlf economic wcuri.ty. Economic security is only possiMe if some other individual, or group of individuals, agrees to shwe income with you under some spcified set of circumstanws. By i& wry nature, wonamic secudty is a colXective action requiring collective decisions a d collective cmrci~n,n o s e who make televisidn sets can only b v e their income protected if the rest of us are farced to buy IP.S.-made TV sets, In an economy with only individual decisions, there is na individual economic security. Vet each of us is inconsistent, When collective coercion is used to raise our real standard of living, we are in favor of it, When it is used to limit our actions and raise someone else's income, we are against it, The same utility executive who preaches the viflues of individual enterprife objects when a neighbrhaod organizes to

Vet &ey ast: just pracstop thr: comtruction of hk pwer ticing what ale hm b e n preaching. The drive for ecoqomic wudty is daeult to awornmdate in our mix4 capitalistic economy. As we delivw emomic security, we mdacut the implicit wumptions of capitdism, demwracy, and individual initiative, hanomic failure wbn't hurt, k c a w failurres will be protsted by government. This b& reduces the rate of e~anornieprogress and removes the ratiande for having capitdism in the fint plaee, Xf government protmts and cantrols, it might jwt as well awn, With everyone bin@probctezld, there are no conwrnd, dieinterestd c i t i ~ n sto m&e the krnwratic prwss work, SpciaXintermt lobbies dominate, and we all klong to =me i p i a l intemt, T'he abilif-y to decide cotlaps into lengthy advemq w h m everyone is worn out and no one is the tong-ma winner. Cm& r k , new projwts cannot bt: unde~&en, and old prajern carnot be transfomed, Each of us pays verbal hamage on the tau& of July ta individual initiative, but we mn to the government whenewr we are threatend,

At the end of the 1970s our pliticd =onomy e m s pardymd, Tke economy is stagnant, with a hi& level of imfla~onand ukmpjoyment, Fundammtal problems, such as the enera ckis, exist but cannot be salved.. We have lost the ability to get things done. A successful man-on-the-mwn projeet could be launched in the 1960s, but in the 1970s energy independence is byond our reach. Lacking a'camnsus on who= income ou&t to go down, or even the recognition that this is at the f i e a of the problem, we are paraly~d.We dislike the eument situation, we to do some&in8 about auf problms, but we adure them h a w we have

An Economy Tbat No Longer Performs

45

not femed ta @ay m economic g m @ with a substmaal rngesrn ef~rnent. it vrea~hesa limit. Will But its in all boilers, when the s t e m the oprator devefw a g d wn&ol valve &at wlvm prabjenxs, or will the ,in h e , become so i lid blow8 off? 4% have we shply rewhd the pint whem future mnamic hhisto&m m say that our day h the -node sun has mm@ to ;an end2

Chapter 2

Energy

alw&at& &m in enere. High p ~ m s sbamges, , and supply (Xi& m p ~ o mare wriow. mey h a & n future paw& ia our standmd of living and are the pain &vling force behind an accelerating rate of Mation. mey dismpt md disturb our lives in countfem ways. At the same time, we have b e n unable to solve the problem. President Nkan couid a Project Indepndence, and succ d i n g presiden@ cou that the energy vablem was the ""morzlilequivdent b o s t a decade later we me fu&er from energy independenw &an we were at beg This has oecuned in spite of the fact that we are a counq rich in energy resowW. T'he lack of stetion does nat s p h g from a lack of mlutiam, but from the hct that each solution would caum a large, red incame dwline for some = p e n t of the population, Evevane is in, favctr of energy indr=peaBence.in the abstract, but each path to enera indepndenee is vigoroudy opposed by same sjignificmt vaup that would suBe.r large income declines if this pafiicular solution were choen, In. the procelis, alX solutions are vetoed md we remain paralyxd. The status qao is painful, but we cannot move.

Energy Origins of the Probbm The history of our current problems began in 1957 when President Eiwdower impsed an oil import quota to protect domestie oil producen .from cheap Middle Eastern oil. With the developmeit of Middle Eastern oil fields, prkes were threatening to fall md force mmy U.S. pr-ducers out of bwiness, Their &gh-em%wefls could nst mmpte with the lowcost wells of the Middle &st. But higher phces for producers means lower incomes fsr consumers, menever government policies raise someme" income, they must bwer someone elzin="s income, The irxzprt quotw imposed by the Eisenhower Administration were designed to raise the income of oil produmrs and were defend& on grounds af national ~curity.mey were preserving a domestic oil industry in case of war. Yet from a. nationd *c&@ p h t of view, they were completely eounte~roductive,If defenw were the real aim, government programs should have been encowaging the consumption of foreign oil during pawtime ta save domestie oil. for future wars, Our cument military vulnerability to oil eutaEs partially springs from this X 950s so-call& defease plicy, Xf it had not b e n in place, we would have irnprted more oil md now have larger resemes of domestie oif left. In the 1950s even keeping out foreign oil was not enouQr;h to give prducers the inmme they wmted. Without fuflber conwals, U.S. production would have substantially exceeded U.S. consump&on with the inevitable hiling prices and incomes for produmrs. Here ent regulations were used to stop consumer incomes kom rising. The Texas Railroad Commission simply limit& the amount of oil that could be pumped. This policy was defended on the grounds of long-mn, consrvation. I f the fields were pumpd more slowly, they would produce more oil. The feebleness of this wgument can be seen from the fact that the policy was quickly ilbandaned when. prices rose two dwades later. m u s we start with a long p r i d where government policies were actively used to raise prducer's incomes and lower consumer's incomes. At the moment, the oil industxy is in favor of price deregulation and a free market, but it is well to rememkr that thig i s

not their basic i b j o g i c d psition. m e all indusby, like evevane else, is ody in favor of &W mmkets when it is in their economic self-interest to be in favar of free mwketS. But as t h e pased, oil comumption grew faster &an ptential prdu~tion.mete; we could once prduce mueh m r e than we neded, we eventually reached a p i n t where we xlteecfed m o thm ~ we could prduce, By X978 almost 50 p r a n t of our oil was being hpoaed."ile: oil accounts for only 40 percent of oug tcttd enera consumption, b p r t e d oil supplies were our mwginal source of enerm nwmary far worrornie growth. As demmds far energy r w , these demands were being met wi& i m p m d oil. By 1973 U.S, consumption exceeded U,S, production, but the world still had prduetion capabilities. significantly larger thm consumption &man&. This was only true, however, if one ineluded that massive pool of cheap Middle Eastern oil, having it aside, wmld consumptictn significantly excwdd warld prduction. As a msult, any group ctontt.ofling Middle Eastern oil had a significant monopoly position, By raising or lowering Middle Eastern production, they could control world oil pfices, W e n econamic oppflukties' exisr to make massive m o u n b of money, it is sur@sing if wmeone does not take advantage of them, md in this erne there were no suwriss, OPEC was formed and t ~ p t e dthe pdw of ail in 1 9"1-74, If a free market in. energy had b e n allowed to exist, this woufd - have aneat a tripling in the price of bath domestic ail and other toms of energy, Buyers would have attempted to ski& tward cheaper forms of domestic energy when the price of imported oil went up, but the net result would drive up the price of domestic enera to warld levels. Even at. mueh higher prices, the United States was no longer self-sufficient.

The Frea Market Solktbn One solution to the energy prowern is simply to let the price of = e r a rise in =cordan= with that of imported oil, 'This wuld wlve the problem in the sense that there would be no gas l i m , no

Energy

29

shortages, and no Energy Department full of complex a d sometimes counterproductive regulations, Supply and demand pricing would work, but at the same time it would involve an enormous change in the distribution of income. From the perspective of Americans, higher oil pri~esrepresent a mixture of gains end losses. For the country as a whole, Americans lose since they had to pay an extra $30 billion (in 1978) for imported oil over and above what they would have had to pay if Since $30 billion represents about prices had stayed at 19" Ievel~,~ 1 .S percent of our GNP, average real incomes have to fall by a b u t that amount, But domestic energy producers also gain if domestie . energy prices are a t l o d to rise. Since about 80 prcent of our energy is domestically produced, this transfer between Americans from energy consumers to energy producers is much larger than the transfer to foreigners. Xn 1978 an additional $120 billion or 6 percent of the GNP would have been transferred from American consumers to American producefs if alX energy prices had k e n allowed to follow the price of imported oif,"On the average, Americans are not poorer hcause of this transter-it is from one American to another-but particular Americans wilt experience large income gains and other Americans wiXf experience large income losses. Given an expected increase in the price of imporred ail of about 1W percent during 1979, the 2979 transfers woufci be correspondingly larger, No one wilXingEy accepts such a reduction in. their income. The distribution of tosses depends upon who consumes energy (see table 2-1 ). Each. of us is a direct consumer of energy in the form of gasoline and home heating or emling, but each of us is also an indirect consumer of energy in the products we buy, Every prduct embdies energy in its production and distribution. As you can sec in table 2-1, the proportion of income going to energy consumption diRers dramatically 'tsetween the rich and thepoor and less dramatically across regions. While a 100 percent increase in the price of energy would reduce the real income of the average American by 9.9 wreent, it would have reduced the reaX income of the poorest decile of families by 34 percent and the richest decile by 5 percente4The real income eaects among the poor are almost seven times as large as they are among the rich,

TABLE 2-1 Direet Howehold E ~ e r g yComumption as a Percmtage of Before-Fa lneome keile * (fm~st Hame Enera to Richest) Comumption c%)

GawXine Indirwt Consumption(%) Consumption (9-6) Toa't (S)

First Second Third

Faurlh Fifth Sixth Seventh Eighth Nin& Tenth

TABLE 2-2 Direct fil~usehofdE~ergyConsumption by Region Hvme Energy Consumption Region

(% 1

Northeast Northantra8

4.5

South Wmt

3.3 3.9 2.3

Casoginc: Consumption (961

Indirect Cvnsumptian

3.3 3.7

2.5

4.0

2.5 2-5

3.7

Tatd

$96)

2.5

11.4 9.5 10.4 8.5

snulccs [for Tabb 2-1 and Tabis 2-21; E?stimated from data in 6J.S. Department af Icabor, G@nswnre~Expediture Survey $er&# 1973-74, and input-outpM tables of U.S: Dtpmrnent of

Labar.

Beween regions the real income decline in the Na~heast( 1X ,4 percent) is about 30 percent larger than that in the West (8.5 percent). (Et should of course be rememkred that these energy ws& include the cost of delivering and distfibuting energy. A lQlS percent increase in the price of crude energy does not lead to a 100 percent inereasc: in the price of delivered energy.) While it is relatively easy to calculate who= income wwXd go down m energy prices rise, it is much harder ta calculate who%

Energy income would go up. The income of thos who own eneru resourms would go up, but who are &ey? No one knows witk. my eeflainty, but it is p s i b l e to find an approximate answer, Sinee most of our energy resources are owned by corporatiaw, the ownership of energy is probably very similar to the ownership of corporate stock, Here we know that the top X0 prcent of all households our= over 90 prcent of all mrporate stockm5 If we assume the same situation is true with r e s p d ta enere resourws (the top 10 percent owns 90 prcent), most of the income transfers among Americans will go to the t o 10 ~ prcent of the population, W e n the plusets and minuws are add& up, h i r income wilt go up, and the income of the remaining 80 percent will go down, Sinee the income gains to the top 10 percent from owning energy resources would be a b u t five times as large as their income losses from having to pay higher energy prices, akee market for energy would have resulted in a sharp shiff: toward inequality in the distribution of income. Given that the free market solution leads to large income logss for a large fraction of the country, it is not suf~Tisiingin a democracy that government stepwd in to prevent these lmses &am occurring. The U.S, government could not stop the $30 billion transfer to folreigners, but it could and did stop much of the $120 billion transfer among Americans,

Spreading Waues of Regulation Domestic emrgy prims were frozn in 1973-74, but this policy created a set of circumstances that required a vast elaMration of eontrcrXs, First, imported oil is not consumed equally acrms the country, %me regions use mostly imprted oil; some regions use only domestic oil. Since i n n p o ~ dail prices cannot, be controlled, actions have ta be taken ta equalize aif prices if those regions that use imported 031 (the Northeast) are not ta suEer large heome lasses while others suffer not at all. To equalize prices a complicatd set of taxes and subsidies wm

hitiated, but the essence of the sys&m h shpfe, Suppose that 50 percent of our oil is imported and sells for $30 per barrel, and SO percent of our oil is domestically produced and held at a price of $10 per barrel, Cheap domestic oiI and expensive foreign oil are mixed together and sold at the average price: of the twa-in this cme $20 [ ( , S ) ($30) 1- ( ' 5 ) ($1023. A tax of $10 per barrel is Levied on domestie: oil prduction and the revenue ( $10 per barrel ) is used to subsidize oil importers. With these taxes and subsidies, both importers and domestic producers can profiably sell ail for $20 per barrel. This regulation means that everyone in the countq faces the same price for oil, but it in turn creates two new problems. Pradueers do not have an incentive to look for new enera resources, and consumers do not have an incentive to conserve. The production problem afises kcauw you can make m much or more profits imparting oil as you can prarfucing domestic ail with price equaligation. You might just as well save your domestic oil until some future date when prices are higher and controls have been lifted. To offset this effect same modification af the controls must be made to restore incentives for more domestic energy production. To encourage production the regulations diEerentiate among differentoil sources. Oil fram new oil fields can be soM at world p ~ w . Oil from new wells in old fields can be soid at a price higher than that from old wells in old fields, but lower than that from new wells in new fields, DiEerent prices are set for digerent secortdary recovery rnethads (pumping steam down ta force more oil up, md so forth). The result is a proliferation of prices with many types of oil and many opportunities to make oil look "newer" "than it actually is. Regulations become cumbersome and complex, and more profits were to be made by the skillful political manipulator than by the efieient oil producer. The conservation problem arises since our marginal source of oil costs $30 but oil is sold for m average price of $20. Consumers use the lower price to decide how much oil to buy, but in doing so they use a price: that is blow our real costs, De facta, we are subsidizing the consumption of impofled oil. To counterbalance this eEeet we now adopt a whole series of replatians designed to conserve fuel. Mileage standards and sped limits are set for cam,

Energy mmimum and minimum kmpratures are set for commercial buildings, and tax credits are given for insulation, Each regulation is complex, slnd all of them are Iess eficient than $30 oil in discouraging the use of energy. Pricirxg energy at world levels will eventually reduce eonsumption and increase prduction, but there is a major political prablem. m e enormous income transfer starts immediately, but the higher produetion and lower consumption only msur slowly and gradually. The costs are now while the knefits lie in the future, In the shbrt run, each of us is locked into a pattern of energy consumption, We own a certain car, live a certain. distance from work, and heat and cool a home with certain energy properties, As a result, a EGO percent increase in the price of energy only lowers consumption by 10 percent in the short run." As time passes, however, we adjust more and more of our energy patterns. The new car gets better gas mileage, commuting distances can be sbrteaed, and homes can be made more energy eficient. Countries where energy prices have always been high produce their economic goods and services with much less energy (oken half as much), We can. do the same, but it takes a; long time to get from here to there, Today"$efft;ct~ are aiwstys smafi, yet if we do not start on the path to less energy consuqption through higher prices, we will never arive at the desired regults., The s m e problem exists on the production side of the problem. XR the short run, higher prims are goixrg to give you very little extra energy. It takes tirne to build new prduction facilities, In the tong run, shifts toward other energy sources, such as coal, can be very significant, Attempts to avoid market- pricing also lead to ever-widening waves of regulations, Regulations can cope with the sirnation for a period of tirne (they have been in ptaee since 1973-74), but they cannot cope indefiniely. They are too cumbrsorne to adjust to the inevitabIe shocks, such as the Iranian revolution, that will occur, Shortages aad gas lines appear with their disruptions af both work and. pleasure. Prices rise &cause truckers are spending time lookirrg for Euef. The regulatory approach, however, suRers from a more fatal flaw than inconvenience. Government regulations can control prices and

to a lesser extent productidon, but in aur system a e y cannag wntro2 new inv@saen(x,MO one c m be far~edto hvwt. Eventuafly new investmen& are necessw, md ?bey will not be made unles they are m prafimble as investmen& macle in countries &at ddo not emtrol energy prices, This leads to increasingly avere shoaages, as the necessary new facilities are not built to accommohte rising demads and new prducts (unleaded gas). Eventually we are f m e d to decide whether we want free market pricing (with its lxge income lclsses and gains) or a nationalized energy industry where government makes the necessary new investments. The free masket option is opposed by those whose income would go dawn. The nationalization option is opposed by those who are ideologicalfy against government ownership, but it does not avoid the income-distribution. question either. Xf large government investmen& are to bc: made, the fun& to make these investments must be taken away from someone, Who? No one wants to lower their standard of living to make way for massitre public investments any more than they want to contribute to the income of private energy producers, Fortunately or unfortunately, government regulation is not a gooat halfway point ktween the free market and government ownership. In the long run either the free market or government ownership will dominate regulated private industry. The vice of moderation Is also seen in the suggestions that we deregulate the price of energy but attempt to mitiga& the income efEeets with energy stamps for the poor and slective tax cuts for the middle class. This compromise simply sharpens the distributional issues. Whose taxes should go up to pay for energy stamps and tax cuts for the middle class? Xf all of the revenue is taken away from oil producers (windfall profit taxes), we are back to where we started, and producers have no incentive to make the necessary investments. If we take just some of the extra revenue away from oil producers, then there is anly enough revenue to mitigate some of the income shocks, Among those who are going to suffer reit1 income losses, who should get protection when protection cannot be given to weqone? Taxes muld be raised to take some of the necessary Rvenue away from other groups, but what groups? mere certainly are no voIunteers.

Energy Cowurnem want a full oBat; prdumrs wmt no oR*t, Ba& may hold politic& veto powers and be able to prevent the other"s deiira hrom b h g legidated. The c w e n t system dms not work, but it is impossibteto shift to a diEerent system, Attempring tcl find solutions to the energy erhis without hposing large income losses is like wandering ever deepr into a spider's web. The farlher you go, the more entangled you-get. The problem becomes more severe and the solutions more distant. The esgnce of the dilemma can bt: feen in the price of gasoline. In every other industrialized countfy, gasoline is not only sold at the full cost of imported oil (about $X per gallon in 1928 ) but coqorations are forced ta pay an excise tax that raises the consumer'8 price into the $2 to $3 per gallon range. Why is it that evexyone else thinks that very high gas prices are an important part of their energy p o l i c y m e rest of the warld thinks that the economic burdens of paying for imparted oil and the militav problems of being dependent upon the vofatile Middle East demand strong policies to discourage driving. Our policies encourage driving. Is everyone d s e wrong? Or are we simply unable to do what we should be doing? In this case, rhe problem is not even the need ta lower the reail income of drivers, but merely to appear to be lowering the real incame of drivers. Any tax revenue collected with a gasoline tax could be rebated in tower income taxes, Drivers are the nurnerieal majority eveqwhere, bat other countries set out to pnalize driving, In contrast, our government is pizralyzd at the mere apparance cif foweringsomeone's income.

Energy Independence me same prodiem of economic losses can IXseen in the political stalemate over energy indepndence. M i t e m a y countries cannot become energy self-suffcient since they lack the necessary resources, the United States could easily achieve enerm independence from a

technical persgective, Our coal reserves alone are so enormous that they could fill all of our n d s for the foreseeable future. Many other forms of energy-nuclear, small-scale hydr~lectric, sotar, wind-could be harnessed to provide some of our energy needs. Teefinalogicalfy energy independence is well within our reach, Politically it may not t)(= within our reach at all, Every path to energy independenrze requires a sharp reduetion in the income of some group, and as a result every path to energy independence has its pfitical foes. Even if the= ffoes cannot muster the votes to cleanly defeat a particular path, they can raise costs and delay the prajats so long that the path loses its appeal. If the problem were simply one of high-priced energy due to natural scarcities, energy independence wtiutd not he a desirable goal ecanomically, EflEiciency would eat1 for selling those goads that we are most-capable of producing and buying those g o d s that we are least capable of producing. If energy fell into the import eategory, rather than the e x p r t categoq, there would be no causc for concern, The basic current problem in energy, however, is not scarcity but a cartel that controls the marginal source of energy, This means that high prices are compounded by uncertain suppties. Unexpected disruptions occur because of political events in other countries, and supplies may suddenly be cut off in an attempt to force the United States to alter its foreign policies. In this context energy independence becomes a sensible goal when it athewise would not be. It may even be sensible if it means using energy that casts more than imported oil, While there are many energy alternatives in the United States, there are ailso many fundamental stumbling Mocks, The first issue is the one of costs. The costs of all altcmative energy sources are highfy dependent upon the regulatory environment in which they are to be used. Coal is cheap in a world where no one cares about the environmental darnage occurring when it is mined or burned, but coal can be a very expnsive alternntiw energy source in an economy with strict poflution controls. This means that there is a direct confrontation between those who want cheap goods and the cheap energy necessary to produce them, and those who want a clean en~ironrnent,~ As we shall see in chapter 5, these are digerent individuals in different economic classes.

Energy Srnilarly, nucIear enwgy is cheap or expnsive deprrding upon the risks that one is willhg to take with exposure to r;rdiation, If one wants to reduce the risks close to zero, nuclew energy is very expensive; if one is willing to take substantial risks, nuclear et.lergy is cheap, individuals diger on the risks they are wilfing to take, but our willingness to tolerate nuclear accidents also has something to do with how close each of us Jives to a nuetear power plant, The regulatory environment is a major part of the costs of afternative energy sources, but the confiicts about what constitutes the "right" ~ g a t o r yenvironment are even more costly, Changes in the health, safety, or environmental standards when a plant is halfbuilt or fully-built, are much mare expensive than any set of stable requirements known before canstructian begins, But not having arrived at an agreed upon set of environmental standards, no one can promise a stable set of requirements, The result is great uncertainty with lengthy time delays as we fight over what environmental standards should be imposed. Xn addition ts the conflicts between those who want more conventional goads and services and those who want a clean, healthy environment, each alternative energy source has a set distributional conflict of its own. Consider our mast likely candidate far energy independence-Western coal, While coal is found in abundance in VVyoming and Montana, water is not. Yet coaf gasification requires water, 'This means that the coal rnust be brought to water or water to coal. What current user is willing to give up the necessary water in the arid West? Who is willing to stag earning their living and give up their water ta make energy for the needs of the country? No one. Suppose that the coal is brought east to the necessary water supplies. Millions of tons of coal gasified ar burned in electrical. generating plants mean millions of tons af residue or fly ash that rnust be dumped. Where? Whose land is going to be used as the necessary slag heaps? We could transport millions of tons of coal east and then transport millions of tons of fly ash west to dump in the pits where the coal was dug, but this makes coal more expensiw than ail, The same distributional ~roblems occur with other energy sources. Each has noncontroversiat applications and areas where it

is cheap (solar power to heat swimming pools or hot waer, vvind power to pump water for cattle in isolated locatiom), but each is expflsive and eon&oversial when expanded to fill the enomaus gap now filled with imported oil. To think of alternative energy sources is to think of vigorous welt-organimd opponents. In some cases the opponents may be a minority, but they are perfectly capable af causing lengthy pditicat and legal delays. m e most visible are those who oppse nuclear power f cheap or expnsive), butt X have yet to meet anyone who wants a coal-fired, electrical-generating plant next ta him, Environmentalists want coal mined and burned safely and cleanly without disturbing the topography at either end, It is not at all certain that this c m be done, but it cerrainly cannot be done cheaply. Local communities in Montana and Wyoming don%want their fife-stylles dismgted to provide power for someone else. "I'fiiesmall tests of madern, commercial, wind-powered generating pfants have incurred mreighborhmd ~omplaiatsabout the noise frorn whining proprellors, The only power sources that have not accumulated their own particular set of opponents are t h o s that are so far frorn commercisl application that no one yet fears their existence. In eriteh c a s the opponents fear a decline in their real standard of living. This fear is not an imaginafy fear., They are right. Xf you are someone who places a high value on a clean environment, then a dirty environment is a substantial decline in your real standard of living. If you enjoy small-town weslem living, large coal mines are going to mean a major reduction in ;your standard of living, mile: evevone wants energy, everyone wants it produced in a wzty that does not disrupt their standard of living, Californians wartt: their electrical p w e r generated in Utah. Yet this cannot be done for afl of us. If electrical p w e r exists, it is going to disrupt someone's real standard of living, On average the gains wiFl exceed the losses, but this average truth is of little reeompexlsc: to those that must suger the actual lasses. Each path also confronts the problem that energy indelpenden= is a time-consuming problm. No path or combination of paths could succeed in less than fifteen to wenty yems. m i s gives us a classic political probfem. "I%e benefits of energy indepndence oecur in the distant future, but costa, potitieal and economic, start.

Energy now. The plitieians who; must incur the costs and get rwim@d now won? t around to claim the credit when e n e r a independence; is achieved in the distant future. m y should they staa down a path that is for them all pain? Our future economic life may be better if we start now, but we will have to pay now far those prc?jetc@ that will onliy later lead to e n e r a independence. But there is also another problem in the area of enerm independl-ence. ' f i e price of impocted oil is high because of rr cartel, not because of natural scarcities. Since the priee is a man-made price, it keames very hift'icuft to make alternative energy invest. ments. Suppose that imported oil is selling for $30 per b ~ r e l Now imagine that you were able ta discover some process that would make synthetic oil for $25 per barrel. Colrldt you agord to go into praductioxl"!f the $30 price were set by Mother Nature, the answer is clear ""yes." A substantial profit could be earned over the full costs (including citpitaf colsts) of production. Given billions of barreXs consumed, billions of dollars are available to be made, X1 the $30 price is set by a cartel, however, going into production is not so clear-cu t. Massive investments would be necessary to make the synthetic oil; but what would happen once you started producing ail? The cartel woufd simply cut their price and you would be left with a large worthless production facility. You would have done the world a favor-forced the price of ail down, from $30 to $24.99 -but you woufd have lost your investment. Private investors usually do not do social favors that lead to capital lasses. Since OPEC production costs (something Iike 40 cents per barrel in Saudi Arabia) are far below selling prices, a private investor cannot compte with OPEC. Private investors do not want to risk producing synthetic siI, and the priee of imported oil stays at $30 per barrel. As a result, energy independence is not something that can BP: achieved by liberating free enterprise. Because private companies are competing with a government cartel, they simply won? t a k e the necessary investments. But this Ieaves us with a contentious choice, Investments in synthetic oil will only be made if they are made by a government corporation or with government subsidies to private corporations. Either technique requires taxing someone to raise the necessary revenue. Whose income gets cut? Ta go the publie route is to meet the objections of those that are oppose&

to giving public monq to rich private investors. Each side a r m s its political veto and we take neither mute. But the result is energy depndenee, with all of its instabilities and uncertainties. In the face of gas lines in the summer of l979 and politicat pressures to do wmething, Congress was drifting towad extensive subsidies for the prductbn of synthetic liquid fuels. It remains to be w n , however, whether we wifE be abfe to raise the massive amount of revenue that will be necessary for this task. Will we really be willing to raise taxes by many billions of dollars ta implement such a plan? Will we really be. willing to give up on the environmental standards that make synthetic Fuel very expensiwwill we really find communities where people are willing to live next to large, syhthetie fuel plants? Mayb. But it is much easier to talk a b u t building synthetic fuel plants and to pass legislation saying &at they ought to bc: built than it is to do it, To do it you have to be willing to lower the real incomes of many people and mmy communities. Na one wants to bc: those individuals or those communities. We are in a morass from which we cannot escape. The president proposes timid energy legislation that could not possibly solve the basic problems, but Congress cannot digest even this, The basic problem exists, prsists, and kclomes more painful. But na solutions are possible since they all result in a shift in the distribution of income, Not having a etear idea af what constitutes a desirable distribution of income, we are unwilling to accept or ratify any of these changes. W have no way to decide tvhen campnsation should be paid; or when individuals should be forced to suffer real income declines. We sink becaufie we will not swim.

Chapter 3

Inflation

ECONOMIC LIFE, unsolved problem have the unfortunate . chasatc&ristic that they reinfme each other. IE this cam, our habifit;y to solve the ,energy problem contribubs to making the inflation probfem much worse, since energy i s used in the prduction and distribution of almost eveqthixlg, Ridng energy prices cause md wrvices, Wage e m e r s attempt price increases in other to keep up with prices by demanding large wage increases, This Eeads to even greater inflation, menever government policies seem to be: moderating the rate of inflation, a new burst of energy inflation pushes the economy back onto the inflationary track, The impact of energy prices on inflation is enormous. With 10 percent of our consumption going toward the direet and indirect purchase of energy, a 100 prcent increase in the price of energy generates a 10 percent rate af inflation all by itself,' If we are to have a nsninffationary economy in the presence af energy price hikes of this magnitude, the remaining 90 percent of our purchases rnust fall in price by an averag of l l prcent, An l l percent decline in 90 percent of our consumptim just counterbafanees a 100 percent price increase in 10 prcent of our consumption. But an I I prccnt price decline in 90 percent qf our prductian means that everyone who is engaged in producing gads and services other than energy rnust suRer an 1I percent decline in his incme, "I'his presents government policy makers with an economic probEem and a pofitical probtem. Ecanornically what p o l i c i ~can be imp s e d to cause 80 percent of our price8 to decline by 11 germnt?

Politically how can you impose economie policies that are goiag to reduce the vast majority of the population's income by I I percent? Unless such pOIicia can be imposed, the economy is going to have a significant rate of inflatisn as Iong as energy pfices are rising, Inflation is the paradigm zero-sum game. menever a price goes up, two things happen. Whoever buys that particular commodity finds that his real income goes down. But sameone also gets that higher price, and his income gaes up. That someow may be the seller, the produmr (capita1 or laboi), or the owner of raw materials, but no income disappears. Far eveq loser there is a winner, Inflation can redistribute income, but it does not lower the total amount to be divided. Everyone cannot be worse off. Some individuals win; some individuals lose. 'This is not an economic hypo.thesis but algebraic necessity, Eveqone wants a government that s-s inflation, but one that does so by inflating his income and deflating the income of everyone else, To stop inflation in the pr&i@;ncc: of upward price shocks, such szs eneqy, governments must adopt paficies that lower someone's ineome. The problem is not finding economic policies that will lower incomes, but being able to irnposie them.

The h istory of our current in8ationafy predicament nicely ilfustrates the problems that emerge when government tries to avoid making distributional judgments. Like most severe probfems, the history bgins wi& two intertwining lrssential ixlgredien&-bad luck and bad judgment. Suppose that you are in the process of climbing tt mountain, are: mat roped together with your climbing gastners, and an avalanche comes down the mountain, If you had hen roped up (shown good judgment) you would have had a chance of surviving the avalanche. If you had not been roped up and there hitd k e n no avalanche (good luck), nothing would have happned and no penalty would have had to be paid for the bad judgment, fri an-

,

alyzing the causes of bow our econonxy goE to where it is, there are ample amaunts of both bad luck and bad judgment. When this

combination occurs, there is almnrost always a severe penalty to be paid, The penalty cannot be avoided. The problem should not br: compsunded by making the penalty larger than it has to be, but in this case, each attempt to avoid the necessary penalty made the problem worse. The sequence of wen&that led to high infiation began with a bad judgment that now hlongs to the long ~ o To. avoid making an unpopular war even more unpopular, President Johnson decided not to raise taxes when they should have b e n raised in 1965, 1966, and 1967, We were to have a war, but we were not going to pay for it overtly, Given a civilian economy that had just reached capacity oprations before the Vietnam War began, the war created classic excess-demand inflation, The mijitary, for example, needed mib Xiians of boots. Orders were placed, and this fofced up the pritiee of civilians's sshms as military boots c o m p t d for scarce leather and shoemaking capacity. Emptoyers started competing for workers, and wages rose. A11 across the economy prices started to rise as demands exceeded prduetion capacities. This war was no exception to the rule that all wars must be paid far, but the payments cane in the form of an implieit tax--inflation. Although the economic mistakes began in late 1965, it is bport;ant to note that inflation only gradually accelerated from 2.2 percent in X 965 to 4-5 prcent in 1968.' Prices and wage pressures were gradually spreading across the economy, but it took a long time for these pressures to build up, even though the economic mistakes in financing the Vietnam War were very large. The econi*. amy does not respond quickly to either infiationary or deflationafy pressures. President Nixsnk strategy for coping with the fruits of President Johnson's mistakes was to apply the classic economic medicine. Monetary and fiscal policies were tightened to induce a recession. According ta economic theory, idle men and equipment would stop prices and wages from rising. Once prices and wages had stopped rising, the direction of monetary and fiscal poficies would be re versed, ?nd the economy would return to full employment by Novernkr 1972 ( a magic date fmrn the point of view of the presi-

dent), The mild remssiczn mived on t h e in 1969 and 1970, but by the summer of 197 5 , the rate of M a ~ o nhad not yet bgun ta fall. Instead it continued to accelerate to an annual rate of 5.9 percent in the. first half of the yearasUnemployment s t d at 6 percent, There is every reason to believe that if President Nixon had continued his restrictive policies he could, in time, have stemmed the rate of inflation, But the inflationq momentum of the Vietnam War was so large h a t it wsls not going ta h quickly stemmed unless the president was willing to incur an even biser asld much fonger recession, But recessions hurt Xhose who are unemployed. meir incomes fall and they quite naturally vote against those who are forcing them to be the economy's infiation fighters white 0them enjoy the fruits of their eEort. Xn the sr&ermatfi of even a mild recession, the public opinion polls shawed that President Nixm would lose to his presumed kmwratic challenger, gnator Muskie, Not wishing to run for reu election with high unemployment (whieh many blamed for his 1960 defeat) m d inflation, the president dramatically changed his economic plicies in August It871. His only choice was to do so or court defeat, price and wage canDespite repateif promises never to im trots, they were impoxd to stop inflation while monetaq and fiscal plicies swung strongly toward stimulating the eeanomy to lower the rate of unemployment, This double-barnell& approach was part of an exlremeiy suceessfuf reelection cmpaignt but it merely p s t poned the basic problem. When controls were lifted in 1973, the inflationthat had been suppressed by the controls in 197 1 and t 972 ~ a g p a r e dand was inintensified by the excess demand inflation produced by overstimulating the economy in It 972, We had been paying an economic price far President Johnsan's decisian to misfinance the Vietarn War, and we were about to start paying the economic price for President Mixon;" reelection campaign, But even this level of infitation was to 'be eornpunded by more bad luck and more poor judgments, Because of bad weather, craps failed in Russia. To raise the income of famers and helip in its reelection efforts,the Nixan &ministration sold too much wheat to the Russians in the summer af 1972. m e n Russian sales w r e subtracted from American supplies, there simply wmn%enough wheat

to meet American demands, and prices rose h a r p y , Despite & e s shortages, the Agrkulture bpa-ent left =age conrrols in place. Eor 1973. After tvventy-five years of ttying to dispose of surplws, they simply could not bclieve that a gerlod of shqrtages had arrived. "When caupts;d witb the 1973 corn blight, supplies fell even Eaaher behind demands, Then the anchovies fail& to appear off the coast of k r u , forcing European cattle fmders ta shift f r m fish meal to American grains. The net result-a 66 percent rise in farm prices kom 197X to 1974.' Industrial inflation was now compounded with agricultural inflation, Because other industrial economies were also growing rapidly in 1972 2nd 1973, raw material shortages were compounded by panic and speculative buying that led to even greater price i n c r e s s than were warranted. The final blow was the OPEG price inereast: &d the Arab oil baycott in late 1973, Imported oil prices tripled with corresponding price pressures on oth&renergy sources. With energy prices an important part of the production and distiibution costs of almost everything, significant cost pressures started to work their way through the economy. Prices went up because the cuts of imports went up. The economy ntsvv had both excess dmand and cwtpush infiation, Given this sequence of events, the double-digit infiation of f 973 and 1974 is not surprising, Anything else would have h e n surprising, But the shock of double-digit inflation fed ta another squence of events. Something had to be done about inflation, But what? The decisions of Presidents Johnson and Nixon could not be undone, Good weather and crops could not be legislated. United States eeonomic policies emId not reverse OPEC$ tripling of oil prices, Not knowing what else to do, and k i n g in political disanray with Watergate, the Nixon administration applied a; very large dose of the classic medicine-tight monetary and fiscal policies. Theqoticks worked, in that real GNP stoppd growing by tht: fourth q u a ~ e rof l973 and gradually fell throltghout the first three quarters of 1974. Every quafler the GNP was getting smaller, larger and larger amounts of idle men and equipment were k i n g created, but the rate of inflation did not respnd* Sinw inRation did not respond, monetary policies were tightened further until they created the famous credit crunch cif late 1974, Under the

hpact of ~ & money, t deman& fell rapdly, Hame eoltlfm~tionfen from 2.1, milli-on units in 1973 to rate of 1 ~ than 8 90Q,600milXiofi u ~ i t in, s fate 1974, A as creakd wifhiin a recession. While the real G ~ had P fallen 2.5 percent from the fourth qum* ter of 1973 to the thkd quarter of 1974, it now s t a e d to plunge mpidfy-fdihg another 3.2 prmnt in the feud q u m r of L874 and the first quafter of 1975,@'Jhe end result was 9 percent unemployment. Instead of just inflation, we now had idation and unemployment. The probfem was now to recover from the sharpst recesshn, since the Great &pression (but in an environment of xnising prices rather than falling pdces) , Partly keause of the severity of the rmession and paely kcause the adverw @Bee@ of any shwk ewntudly wear off, the rate of inflation fell to.5.S percent by mid-1975; but there it stuck despite massive amounts of idle capacity (30 percent in mid-1975) and idle Xabr (9 prcent in mid-1975). Aher holding in the 5.5 to 6 prcent raise far three years, infiatiorr started to accebrate in 1978. This accelerating is interesting &cause it illustrates the basic problem facing our government. ~iffe&ntgroups-farmers, the .etderly, the steel industry, low-wage workem-were hnnanding that government do something to give them more wonomic security. In respnse to these demands, government reintrduced zl system of agricultural price supporb, r a i d swial swurity t a e s lo pay more benefits to the elderly, adopted reference pricing to protect the American steel industry from the lapanese, and sharply increased the minimum wage to help law-wage workers. The net result, (e table 3-1 ) of these and other,similar actions, was to substantially raiw the rate of inflation. Other fsteitors were at work-a rise in meat prices, the falling dollar-but our government eau%&more than half of ail the extra inflation that wc~medfront X977 to 1978. It did not cause this inflation because it was stupid, but because it was trying to raise the incomes of particular groups in our swiety. But to do so, government must raise prices, cause inflation, and reduce the incomes of other groups, With these and other groups making more demands, with rapi41y rising oil prices, and with much of the 1978 inflation already built into the economy, the 1979 and 1980 geospcts are for further

The Underlying Enfiatian Rate Per Annum: 197G77 Actual Change in Cansunter Prices: 1978 Increase in Inflation Rate Acaterating EEects: 1978 F 4 Priws Policy Measurns 0.3 Livestwk 0.4 The b l l a r Minimum Wage Wial %cadty and Other Palieiw Homa *nemhip h m a n d and Prate~tion

5.3% 7.7 2.4

0.7 0.4 0.1 0.3 0.6

0.3

S~IJXCE: Rake tpugh and Robin Skgel, '*Why Inttatloa Became Warm, Bsra Resowws Review (Jan. IY?9), p. I.16.

atealeration in infiation. Same of this additional pressun: come8 from su&ide our economic system, but much of it is generat& by demands far economic security within our eeonomi~system,

Before l o o b g at the different cures for idation and who would be hurt if they were to be applied, let us look at the consequences of hfiatbn itslf, m o s e income has go% up; who% income has gage down? M a t has happened to average incomes? In addition to &Uing us who has wan and lost, an. analysis of the dist~buGanof income during a period: of infiation also tells us something &out the economy, The normal economic mechanisms for dampning i d a tion depexld upon tags and shifts in the distribution af income. individuals find themselves with lower incomes and must; cut their purehaws. kmands fall, idle capacity emerges, and inflation XraXI. Sharp shifrts in the distribution af income kad to a quick b m p n ing of idation; small shifts lead to a slow dampening. If reia~vein-

comes do not ehmge, this is it ma@r indication of an m n a m y where infiation is not going to stop of its own accord. Demands do not fall, prices do not fall, and haation continues as everyone raises his wages or pdces at a b u t the same rate. Since idation in its virulent f o m broke out in 1973, let% llook at the performance of the economy pre- and post- 1972. Starting from a 4 percent rate in 1972, infiation accelerated to 9.7 percent in 1974, fell back to 5.2 percent in 1976, and then reaccelerated to 8.5 prcent in the first quarter of 1979.@Unemployment reached a cyclical low of S prcent in 1973, rme to 8.5 prcent in 1975, and then fell to 5.7 percent in the first quarter of 1979. These gloomy statistics have been widely disseminated, as if they prove that the real standard of living has fallen, Xn fact, nothing of the kind has happened, From 1972 to 1978, real per capita disposable hcomes rose 16 percent.? After accounting for inflation, taxes, and population growth, real incomes have gone up, not down, The average American is better not worse off. Nor is his real standard of living growing at a much sfomr rate than biefore. ]if you compare the real income gains in the six years since the onset of stagflation with the six years prior to stagfiation, there is s u ~ r i s ingly little difference, In the go-go economic b m from 1966 to 1972, reaf per capita disposable incomes r o s 17 percent, The real standard of living was rising dightfy faster prior to 19"7 than after 1972, but the di-fference is very small. Based on &eir own impxessions, almost no one could tell the difference ktween a 16 ~ r m x l t and a 17 prcent rise in living standards over a six-yea p r i d af time. Why then are we in the mtid#le of a period of national eeonamic masochism where it is widely believed that the American standad of Jiving Is colfagsing? One possibility is that the distiibution of income is becoming unequal so rapidly, under the impact of infiation, that most Americans face a falling standard of living even though the total economic pie is growing larger, Averages are simply misleading, As we shall shortly see, this simply isn%the ease, Distributional shifts are few and far between, and those that have occumd are very small. The averages are not misleading. Most Arnerieans have expienced a real income gain of 15 percent from X 972 to 1978.

Why then do most Americans seem to be saying that they have been hurt by inflation? Part of the answer is due to money illusion. This is a disease that never aaicts a rational homo eemomicus but burdens almost every real human. being, While reaE incomes were rising X 6 wrcent, money incomes were rising 74 percent. Suppose a money man were to deliver $7& to your doorstep in the morning. You put m your bathrobe to go down to pick up the money along with the morning paper but find that when you get to your doorstep only $ f 6 is there. Are you happy or mad? You are $ X6 better off than you were, but you have seen the $74 and can inlagine what life would be like with it, You may even be able to convince yourself that your real standard of living has gone down. And in some psyehoIogical sense you may be worse off, Money illusion is eompunded by our puritanism, Everything we have we have earned. We have never been lucky, Whatever we have is due to our personal merit, As a consequenm, when we see oar money incomes rising we attribute it to our merit, neglecting to remember that inflation raises someone's income whenever prices rise, When we find that same of our rnoney income gain is taken away, in the form of inBation, we we it as some alien hostile farce taking away from us purchasing power that is rightEufXy ours, Each of us gives infiation credit for taking income away from us, but almost none of us gives inflation credit for raising our money incomes abave what they otherwise wouId be, A world with a '74 percent gain in real incomes every six years woufd Ere a much less frtistrating world than one with a X 6 percent gain, but it aXso is an unattainabfe, imaginary world. Xf inflation had been halted, we would not have had $74 to spend, The rnoney man would have only helivered $16, But this does not stop everyone from thinking that he is one of the losers. Government should do something to protect his income position. Inflation also turns personal problems into what appear (o be: social problems. At any point in time in an economy as complex as ours, there are a wide variety of economic changes taking place. Many people are suffering real. income loljses and many people are making real income gains. In an economy without inflation, those: who suffer reductions in their real income also sager a reduction in the rnoney incomes that they eam in the marketplace. They may

blame this toss on bad luck, bad judgments on t k i r part, or some ather circumstance or economic factor, but they cannot blame the whole system, since the system is not allocating income reductions to everyone, Xn a period of inflation, the same changes are occurring. Shifts in the basic supply and demand conditions of the economy cause the real incomes of different individuals to rise and fall. But inflation causes most people" money incomes to rise. Real incomes will still fall for some, since the rate of inflation exceeds the rate of increase in money incomes; but now each individuai can think that if only inflation had not occurred, he would have had a rising real standard of living, After all, his money income has risen. As a result, what is, in fact, a personal problem is seen as a social problem. Many college professors blame inflation for their falling relative incomes, while the real cause lies in demography and surplus Ph.l[S.'s. Some misleading statistics also contribute to the illusion. \IVe are all familiar with the idea that the real take-home hctary w q e has gone dawn. Headlines regularly proclaim it to be so, m a t the headtines do not tell us, however, is that. less than 20 prcent of the American work force is a factory worker, and that the averages are down not because of inflation but because of the rise of part-time e rising female participation rates and part-time workers. ~ e c a u s of work, average hours of work are going down, and this leads to Iower average earnings even if hourly earnings are going up. From f 972 tto 1978 our real GNP grew toy $228 billion ( 1972 prices) .@ Xf a Iarger economic pie exists, as it daes, then someone is getting that larger economic pie. With $228 billion more to go around, someone has to have a much higher standard of living, Unless there have h e n shifts in the distribution of income, most of us are participating in that larger economic pie, Table 3-2 shows the distribution of money income for households from 1972 to 197'7 (the last year for which dates are available) .@ Given the size of the measurement errors with this kind of data, there has k e n essentially no change in the distribution of money income between rich and poor, The top 40 percent of the population had 69.5 percent of total income in, N972 and 69,6 percent in 1977, The bottom 40 percent of the population had 13.7 percent in f 972 and 13.8 percent in 1977.m i l e the changes are

not large enou* to M statistically significant, there may have k e n a very small shift in: income toward the battom 20 prcent aid the faurth quintile (sixtieth to eightieth prcentites) , TABLE 3-2 Distribution of Money Income Among Nbuseholdls (96 'o)

Fir& Sec~nd Third Fauflh Fifth

4.X 10.5

4.3 103

17.2

16.9 24.7 43.8

24.5 43.7

souare: U.S. Buredu of the Census, Current Papuluiion Reports, Cu~sumer Incorrrr 1977, Series P 4 , no, 117 (Dec. 1978). p. 19.

While the distribution of money income has not been altered by inBation, the charge is often made that the distribution of real income firas been altered since the cost of Iivintg has gone up fm&r for low-income groups which spend more of their income on &OS goods and services (food, fuel, and so forth) that have gone up the most in price. When cost-of-living indexes are calculated for each of the five quintilers, this charge is not substantiated. From 1972 to 1977 the implicit price deflator for personal consumption expenditures rose by 39 pement, No quintite, however, has experienced iz. rise in cost of living that is more than five percentage points above or below this average, Converting the maney distribution of ineome to a real distribution of income does not change the canclusion that there has k e n essentially no change in the distribution of income between the rich and the p o r . With bath money incomes and the cost of living k i n g essentiaIIy constant across the distribution of income, simple algebra leads to the conclusion that all income groups have exprienced a 15 percent rise in their real standard of fiving. Another argument that is often heard revolves around the progressivity of the federal income tax, In a p r i d of inflation, i d -

vidual taxpayers move up the progressive rat&structure since taxes are levied on money income, This leads to a higher level of taxes on real income. While the argument is certainly correct if everything else remains the same, everything else dms not remain the same, More individuals itenzke their deductions (which also rise with inflation) and Congress geridicaHy cuts taxes to ogset the impact of inflation, When one actually malyzes the data, the latter egects more than oEset the farmer effats, Federal personal incorne taxes were 10.9 percent af personal incorne in 1972, but they only averaged f 0.5 percent from 1972 through 19rne1@ Since the onset of infiation, the federal income tax burcfen has fallen, not risen, While total tax collections are not up, the distribution of tax collections could have shifted to inereasp the burdens on some income classes, Were again, there is no indication of any change. In the most recent data, each quintile of taxpayers is paying the same share of total, taxes that they paid in 1972. The same absence of any shift in the distribution of income is seen if one looks across att af the normaX saeioeconornic groups. From 1972 to 1977 the percentage af the population living below the ofici-af.poverty line (corrected for infiation) has declined from I 1.I) percent to 1 1.6 percent." Black household incomes have fisen from 58 to 59 percent in comparison to the incorne of whites. Data on Hispanic housholids arcs not available for 1972, but their relalive incorne has risen from 71 vrcent to 75 percent in comparison to whites" relative income from 1973 to 1977, Low-income groups have not gained In the 1970s as they did in the 19608, but they also have not been falling behind. High unemployment and slower real growth have stopped them from catching up with the mainstream of the economy, but these factors have not hrced them back to the levels of relative income that existed in the early 1960s, Since elderly incomes are much more skewed than the incomes of the rest of the populatim, the relative position, of elderly households depends upon whether you look at mean or median household incomes. Per capita mean household incomes for the eXderly felt3-IXinsignificantly from 94 percent to 93 percent of the entire population" from 19'72 to f 977." Per capita median hou&hold incomes rose sfightly from 72 percent to 75 prcent of the entire

population" over the s m e W e period. h i d Security payments are also heavily undemepofied in our o f i i a l income data, If one corrects for this underreparting, in 1972 and 1977 per capita mean elderly household incomes hold constant at $00percent of the rest of the entire popuIation". Per capita median household incomes rose from 80 to 85 percent of the entire population's. If anything, the elderly have improved their relative income position during the period of high inflation, The same cancXusilsns hold if one looks at other groups such its farmers and the young or at the spfit of income between individuals, governments, and corporations, What changes have occurred are all very small and would probably have occumed in any c=. T'his is not surprising in an economy where government raises income trantsfer payments to protect the real income of the poor and the eldterty, and where labor unions index their wages to keep pace with inflation (se-e blow), Everyone keeps up with inflation because everyone is part of the cause of infiation, The sharp sfiifb in the distribution of income that are often condemned in discussing inflation sinpfy do not exist when one lwks at the fact, This does not stop inflation from being a serious problem, but it does mean that many of the policies often suggested to stop inflation-a sharpl recession-can have more adverse distributional consquences than the disease itseIf. There is, howeyet, one exception to the dieturn that there has k e n little or no change in the distribution of economic resource8 in the 11170~~ T'he distribution of net; worth (wealth) has bcome more equaI because the stock market has fallen, Since the richer you are the larger carporate stock looms as a fraction of your portfolio, the richer you are the greater your losses are on corporate stock. And in real terms, the value of corporate stoek has fallen over 50 percent since f 968, But the decline started well before $be o n s t of rapid inflation and has been sIowr since rapid inflation b g a n in 1973. Analysis of declining real stock prices by two MXT economist.s indicates that t k y are probably related to mistakes in how the financial community evaluates stocks during a period of inflation rather than ta the effects of inflation on income tXbws.lg Investors forget to mrreet for the fact that the real value of coqorate debt declines

diifing a p d d of inflation. And they discount earnings, with interest rates that include tke irnpaet of inflation without a corresponding increw in future expeeted emings. If you look at the distribution of the GNP, it is clear that the pried of inflation that we have had since 1972 has made surpria ingly Etile bigerence. This tells us two things about the; sonomy. Fimt, the impact of high unemployment has b e n extensively eushi o n 4 by government &ansfer payments. Second, idation m m s to have had. little, if my, impact an the distribution of income. This methat all wages and prices are rising by about the same amount, Inflation has helpd and hurt each icrf us, mere have b e n xxo drmatie shifrts in the distribution of economic resources since the onset of inflation. None of this analysis should be taken to mean that infiation cm be ignored as a source of real economic pain. W i l e groups have , pnhoubtedly have b n hurt, To say that not k n h u ~inttividuals the system can cope with inflation is not to say &at inflalrion is desirable. We might have perfamed even b a r if infiation had not existed. At the same time, the lack of dramatic distributional in living standads for shifts and the existence of a good red most Americans should tell us samething about chmsing among the digerent cures for inflation. Sinee all of the potential euRs inh a cure ~ whose: ~ costs volve substantial costs, it is imprtant to c m less than thaw of the diseaw itelf. The consistency in the distribution uf income also indicates that the economy is not going to quickly d m p n infiation if it is just left alontt, Real demands will not fall md stop prices from rishg since real incomes me not falfixle;forany significant goup.

The Structure of a Mo lnflatioa is endemic in a madiern economy for a very shple reason. Menever upward prriee shwks wcut, inflation wilt oewr unless other prices and incomes frill. But in a modern industrial econ-

1bgan

SS:

is a m y , pices a d wag= in other seetors do not easily fall, substmtial amount of downwwd p ~ m fi@&ty. ms is due to b h the smcture of the private ecanmy and the a c ~ a mof Fafling prims mean falling incomes, each of us orgmizc:~publicly a d privately to ensure that we are not the ones who will experience faUing prices and incomes. But if eaGh of us is successlul, inflation will be the inevitable result. For a numb-er of ==am, it takes great shoeks to reduce industrial wages and prim%.Government is one of them, If the Japanese are threatening to force down the p ~ e e of s steel, textiles, and electronic goods, our prdueers run to the government for protection to prevent their prices md incomes from falling. Sctors that expfienee fliuctuzlting free market prices (agriculture) demand and get government interventions that stop prices from falling. Minimum wage rates and prevailing rates on government eomtruction contracts place floors under the wages for workers. Large companies and unions play a rote, Both have the power to stop their prices or wages from falling. Union Xezi$ers do nat have to worq about the votes of the unemployed. The employed want higher wages, Ofigopofistic fims are aware that they have mare profits to lose from cutting prices than from cutting output, And as long as the demanded cutbacks in produetion me xxldest and of, short duratiion, they can infamdly cwrdinate such cutbacks with their industriaf comptitors. But c a v r a t e and union power is not abmlute. Prices and wages do not respond to mderate amaunts of excess capacity, but they would fall if demmds fell enough. To re-create the 'Great Depression would be to once again we falling prices, In our economy wages are even kss flexible downward than industriaI prices. Unions pXay a role in this, but with only 20 prmnt of the l a h r f m e unionbed, unions cannot be blamed far wages that do not fall in the remaining 80 percent of the economy. The basic problem is that stable wages are u ~ f uin l a modern industfid economy, It is irrational far private employers to take advantage of unemployment and lower the wages of their existing work force: unless the downward shift in demand is so large that they are faced to do so to avoid bankmptcy. Standard free market economics is based u p f w r basic as-

swpGom a b u t the chwactefistics of the l a b r maket: ( 1) SkiXXs m exogenously aquise;b a d then sold h a corngetidve atrction nzwket; (2) The prdudivity of ea& indiddud worker is h a w n and fixd; (3) Each indiaual urarlter" hhapphess with his wages depeods solely upon hk own wages. workers never look to see what me getting; (4) TobI output is simply the summation of individud produetivities, ff the economy" actual oprations were b m d an &eg four h p & = $ , wage inflation and unemplopent could not exist. Menever unemployment mo &clhe in demand or a faster &an e x p c t d rise in the Eabr forcewages would fall until the extra workers were reabsorkd into employment or until they had decided that wages were no longer high enough to merit saeifici-ng &eir leisure, But wages do not respond tr, mderate amounts of uxxemployment, and unemployme~lris exIrerneIy pmktent. Upon examination, the bwic assumptions about the nature of the f a b r market went less than adequate. mey ignore Xong-run employeremployee inkrests in a good mutual relationship. 1. They ignore the fact that much of OM human capital is aequired on the job raaher than in formalt education. 'Ibis can be wen in tbe malysis of the deteminants of earnings or in the surveys of where working skills are acquired." l e labor make%is not primarily a market for allocating skills but a market for allocating training slots. VVarkem are only trained when job openings exist and an inbepndent supply curve does not exist, But without indepndent supply and demand curves, wages must be: detemined in some fmhion other than by a market coneetion, 2. Imtead of being fixed and known, individual prduetiG9 is variable md difficult to know, Each worker has a mmimum productivity, but depending on motivation, Itte can provide any lproduetivity betwmn that n a a h u m , and zero, Employen find it diffiGult md expensive ta %now how much productivity each of their employees is providing, And even if they do know, it is dtificult anct expensive to change wage rates or fire an employw, As a result, every industrial opration requires a surbstsntiizl component olf voluntary cwpration. If employees c h m s to wi&hoId that voluntary cmpration (work to rule), any i n d u s ~ a ~ l p r a t i o nin the countq could be brought to its knees. Evidence fof the potential

vmiability h prduetivity can seen in the discipline of industrial pychdog, business interests in motiva~an,and through intre spection. 3. Instead of having independent preferenws, rllczst workers have interdependent preferences where their satisfaetion depads on their income relative to that of"their neighhr's. Evidence for this em be seen in the miologieal literature on relative deprivation and s o nomic sumeys of what causes wnomic sa;tisfaction,l"Se= SUP veys udversafly find that paple's satisfaedon or dissatisfaction with the economic circumstances is depndent on their relative income and not on their abwlute income, 4, Aft industrial operations are subject to a substantial compoDent of team a?j well as individual prductivity, Evidene for this can be s-een,in the sharp learning curves of new industrial plants. As workers learn ta work with each other, msts of produetion fall dramatically. They develop teamwork and team productivity that is over and above their individual skills and individual productivity. But under these circumstances, where does eccmomic analysis lead? It leads to the two factors that are widely obwrved in the labsr market: f l ) Money wages exhibit downward rigidity; they da not fall when surplus labor exists; ( 2 ) Relative wages are dgid and change only in the long run, Because skills are acquired on the job, in an inform& praess of one worker Waining another, every industrial operation needs workers willing to tx: trainers. But in a truly competitive world, no one wants to be an informal trainer. Every worker realizes that every additional worker trained will result in lower wages and a greater probability of being fired in any economic downturn. It is rational in a cornperithe world for each Individual to seek a rnonopoXy on Eoeal knowledge (how to run machine X) and then refuse to share his or her knowledge with anyone else. This preserves wage and job opportunities. To promote training and make workers willing to be trainers of other workers, employers essentially offer two guarantees, First, they promise not to lower wages if surpfus warkets become available. Second, they promise to hire and fire based on seniority. This means that each trainer" trainees will be fired before he is, &sentidly the employer agrms not to be a short-run cost minimizer in the interestf af hng-run training md esciency. Elut

this leads to money wages that do not fall when unemployment emerges. Rigid relative wages spring fram interdepndent preferenms, but these preferences are enforced on the employer through the employee" ability to vary his awn prductivity and disrupt team prsductivity, Because of interdepndent preferences, workers perceive some wage digerentiilb as fair and other wage differentials as unfair. But they need some threat to farce employers to pay fair, relative wilges, Xn the textbook economy, there would bE: no way to enhree the interdependent preferences even if they existed, But in the real world, employees can cut their own prductivity or disrupt team prductivity if wage differentials are perceived as unfair. Employers find it diacult and expensive to deternine who is providing less productivity, Even knowing who is at fault d w s not lead to an ,emy solution, Firing is expensive and disrupts the team. As a result, employers find it more profitable to pay the wage differentiais that employees view as fair than to shift to the wage differentials called for by changes in short-run su~lpfiesand demands in the l a b r market, Total productivity paying "fair" "differentials is higha than totat productivity paying supply and demand digerentials since workers can atter the level of prodtuctivity depending on their satisfaction or diss~tisfactionwith pay scales, The net result is a structure of rigid relative wages that do not fall when unemployment emerges. This pattern exists in any industrial. apratian, but it has been hi&ly visible on the nation's sporting pages over the past few years, One suprstar gets a large wage increase, and this lea& other superstars to break their existing carttracts for higher wages. With suprstar wages rising, lesse-r players demand and get large wage increases. Each threatens to use his p w e r to disrupt the team and lower his own productivity if his demands are not met. Wages rise and owners pass the birrdens onto consumers in the form of higher ticket prices, While the wage structure and bargaining of sporting teams is mare visible than mast, it is by no means unique. m a t goes on there goes on in a milder form throughout our complex interrelated economy, Wages are set in a social process that is far removed from simple supply and demand curves in :r moderi~industrial economy, From

Infiat.ion

59

the employer's perspective this process is ineflfieient in that he cannot adjust wages to individuai prctductivities and short-run c;han@s in circumstances, but it is eficient since his production team is not disrupted by dissatisfied workers, and since training aceurs at less cost than it would otherwise, The gains from rigid wages are greater than the gains from flexible wages, With downward rigidity in money wages and fixed relative wages, labor markets cannot clear via wage reductions and shifts in relative wages. They clear based on worker qualifications (level of education and so forth), but this leaves the economy with unemployment and infiation, Workers who are willing to work at current wages cannot find work. Since wages do not fall, prices do not fajl. Instead of reducing prices in times af excess capacity, firms cut pro- duetion. 'This proefuces more uaernployment and exacerbates inflation. When oil prices rise, other prices do not fall. Xf anything, other prices and wages rise in an effort to catch up, With rigid wages, the demand lEor economic security becomes more eomprekensibfe;. In a world of wage flexibility everyone has economic security in that one can always find a job by k i n g willing to work for slightly less. In a world of downward wage rigidity w k e ~skills are acquired on the job, economic life is much more uncertain, You may end up unemployed, and you do not eontrot the skiLIs you will learn. Ta a great extent they will depend upon what learning opportunities are allocated to you in the job market. But there is another major factor that leads to increasing inflation, Xt is the phenomenon of indexing. Since 1974 and the scare of double-digit inflation, labor, business, and government have sought to protect themselves from the uncertainties of future inflation by adding cost-of-living indexes to all of their future commitments. Cost-of-living escalators are increasingly being built into government wages and programs. V e ~ yfew business contracts are currently signed without the protect-ion of inflation escalators. Cost-of-living clauses have become almost universal in new labor union contracts since 1974. Nonunion workers da not have legal cost-of-living clauses, but companies that provide cost-of-living protection to their unionized workers almost always give the same protection to their nonunion employees, Similarly, nonunion empfloyers de fact0 index wages to keep their best empfoyees from

moving to empfoyers who do index and to keep unions out, Adding cost-of-living escalators to private cantracts is a pdectly rational r e s p n e to inflation an the pm of b t h business md l a b , but it fundamentally alters the nature of the economy and the effectiveness of monetary and fiscal policies. The classic objection to ""legal""incfexing is that it reduces the effectiveness of. monetary and fiscal goiicies, The reasons are ewy to understa~d.Xf inflation is 6 percent this yem, ail wag= and prices will go up 6 percent next year due ta escalator clauses; but this bads to a 6 gercent rate of inflation next year and hence to 6 percent increases in wages and prias in the third year. m i l e only parts of the economy (same govement programs and wages) have b n legally indexed, there is no difference between gowmment indexing and private indexing when it comes to tkeir impact m mtlcrmconomic policies, The policies still prduce unemploymeat, but they lose their capacity to reduce inflation, They can only rduce the rate of inflation if they are tight enough to prduce a, basic wage settlement (excluding the cost-of-living clauses) Xess than the ra& of grow& of prductivity (about 2 percent). Given barsic settlements cumently far in excesLs of that level, unemgloynxe~twould have to be much higher to generate the appropriate settiemen&. Indexing is onr; of the main remans why the idation rate stuck at 5.5 prcent per year in mid-19"l find did not fall fu&er, despite large amounts of idle capacity. Not knowing what was going to happen in the future, economic actom did the rational thing. mey inserted an insurance efmsc: (a cost-of-living e ~ a l a t o r )in their izgreements about wages and industrial prices, But in the prwess, they changed the characteristics of the economy, Whatever the degree of price and wage responsiveness to itdie cslpaeity ht'sre indexing, it wm less after indexing, But there is an added problem. Any upward price shocks will h built into the index and carrid fowstrd into the future, Xf further oil price increases lead the rate of inflation to rise from 8 percent to X2 percent, then indexing will carq the 12 prcent inflation forward into the future since wages and prices will now rise by 12 prcent per year rather than by 8 percent per year, With prices and wages inflexible, downward, and indexing, the monetary authorities lose mmt of their pwer to stop infiation.

I d a tion

61

To stop infiation in the face of upward price shocks someone's prices and wages must go down, but tight money no longer leads to this result. The monetary authorities are confronted with the choice between letting the money supply grow and confirming the rate of inflation or stopping the money supply from growing and prcxfucing unemployment to go along with the inflaticm. But they do not have the power to stop inflation-to make other prices and wages go down without producing a major recession or depression. This structure of our economy emanates from a simple human desire. Although falling wages and prices might be g d for the economy, they are not good for the individuals or graups whose income falls along with these fafling wages and prices, Each of us organizes to avoid k i n g subject to falling prices, But: if we all sueceed, we have an economy where in8ation is endemic. To stop inflation someone's income must go down.

Given a heavily indexed economy where prices and wages do not fail subject to occasional upward price shocks, what are the options? mere are essentially five, but each of them has severe drawbacks,, n o s e that could potentially cure the problem have the basic characteristic that they would substantially lower the real income of some significant group in our society. Since no overt choices have to be made, the easiest option is ta simply tolerate the current inflation, And until we fezrrn how to choose some option overtly, this is exactly what we wit1 do, Countries like Brazil and Japan have demonstrated that it is possible to grow rapidly with high rates of inflation, What small, adverse distributional effects do exist could be made even smafier by indexing those parts of the econorny that are not indexed. Unenrploymcnt is high, but i't is concentrated among the young, If we are patient, many believe demography wiXl sharply reduce the n u n k r of young people and the unemployment problem may cure itself, Against this one can argue that we have to be concern& about

s to isolated bdividualts even if gaups &n9t lose, and &at the eumerzt system dismp@f0ng-m ewnomie plannhg, m i l e the number of young people will decline, thase who are now young wiU contintie to exist, and hi@ unemployment may plague them throughout their working lives, As they grow dder the conEquences of unemployment abviously h o m e more severe, "IBe most telling objection to this option, however, is the simple fact that tolerating idation is unten;zble pofiticdly. Americans want samething done. n o s e with falling real incomw think &at their problems are due to inflation. mase with rising real incomes think that their incomes are falling or that they would rise even fmter without inflation. Being voters they want their elected representatives to do something, Doing nothing may not make real czeonomic insecurity war%, but it seems-to make economic hsecufity war=. Sooner or later the denrand to do something will express itseli. What we do may not cure the problem, but we will do something. The first real cure would be to tighten fixal and/ar mon.etau poficies to the point that they created a recession or depression large enough to crack indexing, stop inaationaq expctations, and force wages and pfices to fall. While we muld argue about exactly how high unemployment would have to be far these egects to wcur, no ane doubts that there is some level of umnn@oyment that would stag infiation. West Germany and Swieerland are often held up as counties that followed this route and succeeded in stopping inflation. They did so, but each country had two advantages that we do not have. Because the fixed exchange rate system of the post-World War TX priod had led to their currencies being undervalued, the cumencies were appreciating in value in the aftermath of the doubledigit inflation sf 1974, With rising cuneaey values, the price of impom was fatling and served to moderate inflationary shocks. As W have =em, the Swiss ended up with cheaper oil after 197.4 since the value of the Swiss franc went up faster than the dollar prim of oil. Appreciating currencies are nice to have in an inflationaq period, but one countq" appreciation. is another cauntvk depreciation. n o s e with depreciating currencies find that import prices go up even faster. More importantly, VIVest Germany and Switzerland each run.

an economy with a large number of foreign workers. When tight m a n e t q policies lead to fslfiq employment, the unemployed can be expurted to the countrres from which they came. And this is exaetly what was done in West a r m a n y and Switzerland, In 1978 industrial employment was 12 percent below 1973 levels in West did not lead Gemany and 10 percent l w e r in Swit~erland.~~This to massive unemployment since e a ~ hcountry sent fareign workers home. Scaled up to an economy the size of ours, the Swiss rownded up 10 million workers and sent them home, Which f Q million American workers do we round up and send home? There is no doubt that inflation was temporarily cured, but the price was enormous in terms of unemplayment. Given our rising labor force and unemployed workers who cannot be sent home, similar policies in the Unikd States would have prduced an unemployment rate approaching 30 percent, I have no doubt that prices would fall, But we would abo be in the midst of another Great Depression with all its enarmous economic fosses and intense political pressures. Nor does the "'big bang" solution ensure you against future inflation, With the rise in oil prices in the spring of 1979, U.S. inflation rates rose by three percentage points, but inRation rose by almost five percentage pints in West Gern~any,'~ Each inflationary shwk needs ever-tightening monetary and fiscal policies. At some point even West Germany runs out of foreign workers to send home, At this paint -tough choices need to be: made. Bisemploying West Germans is a different matter from s a d ing foreign workers home. A severe recession and high unemployment will cure inflation, but the costs are very unevenly carried by those groups that actually suffer f't-om unemplayment. This structure can be seen in. the actual structure of unemployment for 1978. Officially unemployment ranged l see table 3-3) from 8.4 preen$ for teenage black females to 2.6 gercent for white males aged fifty-five to sixty-five; but if one corrects for the number of black teenagers who have droppd out of the system (are not at &sol, at work, or tooking for m*), black teenage rates rise to 52.7 percent and approsleh 90 percent in some central city are;=. Almost SO percent af those officially unemployed are from sixteen to twenty-four years of a@.

T B L E 3-43 Structure of

Females

#&-l9

Males White Males

Black Mares 1619 20-24 25-54 55-44 65 & up

5.2% 4.5

2%24 23-34 55-64 65 8? up

Black Ffemales

7.2%

14.4 8.4 4.9

3.0 3.7 13. l

10.9 34.4 20.0

6.6

Hispaniw

4.4

f 6-19 Malabs 20.t-

7.1

Females 2&

9.l 20.5 6.3 9.8

At the bginnin8 of 1979 many analysts were mguing that the economy was at fuli employment despite a 6 percent rate. Even the 1939 Economic Rtzporf of the President expremd s m e sympathy with the position that W were approaching full employment far primeage (meaty-five to,fifty-five) whik males, Wile one em quibble as to whether a 3 percent rate for prime-sllge vlrhite males is reetfly full employment for &is group (&eix unemployment rate reaeked 1.2 percent in 1969), there is no denying a very uneven. smcture cif unemptapent, Women, adult btacb, Hispanics, elderly whites, and young whites range btween tihe extremes of black teenagers and prim-* wftite males. And as the nation& rate rises this dispersion becomes even larger, %metimes unemployment is simply dismiswd on the grounds that it consists of millions of individuals unemployed for very shah p r i d s of time that are of no consequence to any of the individuals involved. This simply dms not square with the facts. Over 50 percent of the total nurnkr of weeks of unemplayment is b r n e by individuals who are unemplayed more &an, twenty-mven weeks. Almost 50 wrcent of all spells of unemployment md up not in em-

ployment but in urithdrawd from the labor force* A discouraged worker who has aetiwely quit seeking work is not a markof eeonomie success, If Xabor were sold in a competitive environment wi* Bexible wages, such a struetzlre of unempfoyment could not exist. L a b r shortages would cause the relative wages af prime-age white males to rise and tabor surpluses would eau* the re1at"jve wages of o@er groups to fall, EmpXoyers would resgand to these changes in wages by hiring fewer prirne-age white males and more of the rest of the labor for=. Unemployment g a p would shrink. In fact, the uneven structure hats not k e n disappearing but has k e n growing worse during the 1970s. If a recession is to be used to stop inflation, we draft inflation fighters in a very uneven pattern, In proportion to their size in the labor forr-ce,sixteen to ttventy-four-year-& are three times as likely to be drafted as adults; Females are 38 prcent more likely to be drafted than males; blacks am twice as likely t.o be drafted as whites; and Hispanics are 75 percent more likely to be drafkd than whites," &e group that is drafted least is prime-age white males, but this is precisly the group where unemployment is most effective in caeing wages to falf. Qfien the argument is made that women and children should be more than proportionally drafted intd the war on inflation because there arc: fewer harsh eccmornic consequences when they sufFer unemployment since they have families to fall back u p n . X have yet to hear this argument made by women or young workers; it ignores a very large number of women and young warkers who are family heads or come from low-income families. Xt also ignores tlre long-mn consequences of having a generation of young peaple who have either dropped out of the economy or have not gained the wark expriences that Xead to skills in later life, m a t do we da when today" unemployed hnrenty-year-old becomes the next generation9% unempioyed forty-year-old? A major recession would stop inflation, but it would exacerbate many of our fundamental problems, Eeonanie security and economic growth wauld both have to be "Eoregone. Beelining incomes would be a reality. Individual vi~ueswould no tonget be overwhelmed by the social disease of inffation, but they would now b

overwhelmed by the; s ~ i dim= d ef tion of income would shift s h q f y toward &quality m the economi, erilily strong forced the economically weak out of the economy. The second real option is to impse fomal wage and price controls-a collective defense against inflation. m a t the can&01s have to do is clear. Actually doing it is the problem, Xmagine an indexed economy with, an 8 percent rate of infiation. If everyone a g ~ e dto raise his or her wage or price try only 5 pereentr, instead of the specified 8 percent, no one would be worse off and the inflation rate would be reduced to 5 percent, How to aecomptish this, however, is not clear, Every individuaf economic actar has an incentive to raise his wage ar price by the full 8 percent, since he will have increased his real income by 3 preent if the rest of the &or14 goes down to a 5 percent gain, Conversely, if he eooprates with the incomes poEicy and goes down to a 5 gercent gain while everyQne else stays at 8 percent, he will have made a 3-percent income loss. Thus there is no such thing as a voluntaq incomes pglicy. The incentives not to emperate are simply too large. The problem is similar to that found at a football game. Suppos ;m exciting play takes place, To get a better view individual spctators stand up; but if everyone stands up no one gets a better view and now everyone is uncomfortable since they have to stand rather than sit. But the first one to stand up gets a better view until eveqone else stands up. Only collective action can keep everyone seated; individual decisions will lead to everyone standing, But what about the process of sitting down? The first Vrsm to sit down, gets the worst view, and the; fast person to sit down gets the k s t view. Evegone wants to be last and everyone stands. The sane is true W[& inflation, The first person to raise his prices and the last prson to stop raising his pricm are the winners in the inflation game. Everyone wants to try to be that individual who will win and everyone wants t;o avoid bking that individual who will Iase. Farmers at one and the same time can b screaming &out inflation yet demand agricultural price supprts to raise farm prices, Everyone wants inflation in his own prices and wages and deflation in everyane eke's prices and wages, But there are problems beyond those of noncooperation. m e n ever the controls are imposed, there will be some groups that are

head of a&er group, Ae even pbwdown of idation will bave those that started the inflationary prwess pmmently dead, mere will be other areas where basic supplies and demands call for rksing prices. Exemptions from the controls will be needed and will be used. But every exemption leads i h o ~who are not exempt to wonder why they should be the economy" inflationary fighters, If some of the inflation is due to the price of imported oil, contrcsfs must lower the incomes of some Americans to pay h e i g n energy praduwrs, Whose incomes should controls lower? No one wants It to be their income; Controls are opposed beaus@:groups klieve that they will lose- if controls are imposed. The business community is fond of attacb ing general price and wage controls on the grounds that it is "'up American," b t they are the first group to ask for controls when it can help them raise their prices. They simp?y fear that general controls will be u s d to squeeze their incomes and not sommne elwk incomes. The currently fashionable fom of incomes policy discussion revolves mound "".t-basd incomes policy," Employers woufd bt: given a series of tax incentives or penalties, depnding on whether they did or did not five up to some enunciatd standard of noninflatianary +havior. A tax-based incomes policy is, however, just equivaient to a set of wage and price controls with a predetermined set of financiaf genalties for vioXators, Catching the violators and enforcing the rules is no less dificuft or expensive, The system is more flexible (if you want to violate the rules you can pay your wrralty and violate the rules), but it is every bit as complex and expensive to administer, Detailed norms must be written and then enforced, In the Korean War, eighteen thousand price and wage inspectors were necessary to make the system work. mere; have been advances in computational techniques, but the economy is now much Iarger than it was then. Any serious system would require ;z large number of employees. There is no such, thing as wage md price controls without a large bu~aucracyto administer them. While cwfrols can ?xmade to work, any compulsory incomes policy is more dilffcult in a democratic peacetime economy. Even with eighteen thousand price inspectors during the Korean War, the system needed widespread voluntary cooperation. Without some

exkmd &eat, it is difxicult to envision the rxeceme degree@af vofi u n t q cmpration. prosrann is &a twhically more difficult, In waaime it is relatively easy to see how p ~ c e sshould be adjustd. They should be djusted to maximhe militw prduction md rninjxxrize eivilim p r d u c ~ o n But . in, peacetime the goals me not that simple. Which of all of the millions af eivilim cammdities should be expanded in suppliw, and which should be eon&xtedWage and price controls in wartime are also accompanied by labr, investment, and production controls, These controls make it easier to enforce wage and price controls &cause thos who evade one set of controls will probably bR: caught in another set of contrals. lEn peacetime wage and price controls are adopted without invesment, produetion, or l a b r csntrob. The real objection to controls is nst that they are cumkrsome and inconvenient (they are) or that tfiey won" work (they will), but that they must reduce someone's real income if they are to s u e ctwd in stopping infiation, It isn%pssibXe to predict who this will be without knowing the exact details of any system of controls, but &ere is na doubt &at someone will be hurt. Some groups are vigorous opponents of controls b e a u s they klieve that they will be the ones to suffer reduced incomes. Thox: groups that think they would gain under controls want controls. In the third potentid cure, goveramerrt attempts ta balmce upward price shwks with dawnwud prim shmks, If the priw of energy riws, the government lmks around the Kanonxy to see where it has leverage to reduce prices, If inflation is already un&rwa-y, government attemplts to jolt the e-eonomy with a series of negative price shwks that will hcome embedded in the seuchre of indexing and spiral downward to a pmanently lowered rate 9f inflation, 'The deregulation c;l.f the airlines industry (and the resultant reduction in alir fares) is one such pragrm. If deregulation can l&er air transpoaation costs, this lowers the nremured rate of iaRation. With a lower inflation rate and indexing, all wages and prices will go up less &an they othervvie would have, md the future rate of inflation is less than it athemise would have k n . bregu1atian coufd force p ~ a sdown in mcking md mmy &er in-

dustries, Insteitdt of raising social security t a e s (a tax which shows up in the cost-&-living index) and cutting income taxes (a tax that does not show up in the cost of living), all tax cuts could be b u s e d on those taxes that reduce the cost of living, and all tax increases could be focused an those taxes that do not show up in the cost of living. The postal service could be made subject to private competition and forced to cut prices. mere are a host of government programs &signed to raife prices that could be abandoned, Such programs now exist in agricuhure, the maritime industry, the steel industry, textiles, and many others. Abandoning any ar all of these programs would substantially reduce the rate of inflation, EEorts can alss be m d e to restructure bottleneck industries where inflationaxy pressures are endemic, such as health care. Wealth insurance systems can be structured to encourage cost savings and discourage overusage and administered ptice increases. Given the current upward momentum in inflation and the expected future upward shocks from energy prices, government polities woufd have to create massive d~~oncvarri prr'ce shocks. Massive downward price shacks is simply an economist" sway of saying that nlany economic groups are going to be forced to accept sharp declines in their real incomes, Wenever government forces prices dawn, it forces sameone's income: to go dawn. While the economics of the third anti-inflatioaaq strategy are clear, the politics are not. Each of these anti-inflationary actions has a vigorous set of opponents. TrucXEers do not want trucking deregulated, Upper-income groups would rather have income tax reduetians than sales tax reductions. State and lwal governments want their grints-in-aid without strings, Each of the industries pratwted by government policies to raise prices wants these policies kept in place. No one wants to wluntex" as a prim fighter in the war on inflation. W i f e everyone is in favor of reducing the rate of inflation m long as this is accomplished by lowering someone else's income, everyone is also against any anti-inflationay policy that lowers his or her income. Unfortunately an effective anti-inflationary policy has to loser sameone" income blow what it othervviw woufd be;, This is not a matter of economic analysis but simply an algebraic truism,

Whose income is going to go down given that the income of energy producers is going ta go up? As a result, negative price shwks represent a real threat to the economic security of many individuals and firms. m e y may stop infiation and they may be good for economic growth, but they rep~ prias resent a real threat to the economic security of t h o whose and incomes are going to be negatively shocked. Lacking a consensus of whom to hurt in the fight on infiation, the Gafler administration has pursued an anti-infiationary strategy which is a mclderate amalgam of all three of the basic strategies. The prime ingredient in the Garter strategy is monetar)l and fiscal policies designed to create a substantial, but still moderate, amount of idle capacity, Whenever the idle capacity threatens to disappaur, policies are tightened to slow the economy and re-ere&&idle eatpaeity. Supposedly this idle capacity wiH gradually sfsw the inflatition rate, We are told that it took a long time to build the current inflationary pressures, and that therefore we must expect it to take ir long time to eliminate thos infiationaq pressures. The prime strategy of idle capacity is to be augmented with voluntary wage and price controts that are supposed to reduce the rate of inflation sfightly faster than would have happened if we relied soEely on idle capacity. Hence the price controls are set ta cut one half of 1 percent off the rate of price increase of the previous year, and the wage controls are set ta Xower the rate of wage increase: slightly k t o w that of the previous year, At least a verbal attachment to the third strategy is afso shown. We are reminded that airline deregulation went into egect under the Carter administration (the process k g a n much earlier) and we were told that further deregulation (tfains and trucks) would be proposed, Here again. the strategy is to use mderate ®ulation to shave the rate of inflation slightly faster than it might otherwise fall. Patience may be a virtue, but it i s a virtue: which the Ame~can public probably does not pasg;ess when it comes to inflation, But even more imgoflantfy, a gradual phase-dam is not possible in a heavily indexed economy with the mix of the three strategies chosn by the Carter administfiation, For the stratea to warfr,you must beEieve: that moderate amounts of idle capaciv will gradudly

dmpen prim inereass, md that perhaps this process can be slightly accelerated with voluntary wage-price con&ols m d mayb a little bit of deregulation, In a heavify indexed economy moderate amounts of idle eapacify will not reduce the rate of inflation. Whatever last ye=% or fmt quarter's sate of inflation, it is c a ~ e fdo r w ~ dinto this year or this quarter by escalator clauses in wage contracts and in industrid contracts m o n g fims, In an indexed world only three things can bring dawn the rate of inflation. If there are exogenous downward price shocks (due to a rising dollar or il, falfing oil price) the rate of infiation will gradually subside. If the basic wage =Element (feaving out the cost-of-living escalator) is less than, the rate of growth of productivity, then unit fabor costs will fall and the rate of inflation will gradually subside. Presumably the workability of moderate excess capacity rests on the idea that it can hold the basic wage settlement below the rate of growth of productivity. But with the strength of our labar movement rate of growth of praiuctivity around 1 prcent per year and inflation near 10 percent, it takes rit lot more than moderate unempfoyment to bring this result about. The third solution is simply to have a recession or depression so large that the private cost-of-living escafator clauses are k ~ w k & out of the economy, bcalator clauses stilf exist, but firms quit honoring them just as Westinghouse quit honoring Its uranium contrac&. But this isn? t moderate policy, In a heavily indexed economy moderate policies either won't work or they will work so slowly that they are perceived as not working, Moderate po'fieies also depend upon the idea that the slochastic shocks which hit the system do not serve to oBst the small p i t i v e eRect of idle capacity. With rapidly rising ail prices, this is unlikly to h true. Even if the shocks are equaf and apposite in value so that in fofo we have an economy with RO net good or bad tuck, this does nat mean that the impact of shocks is neutral, Because of the oligopolistic nature of our corporations and unions, our economy responds much more to upward priee shocks than it dcxs to downward price shocks. Upward priee shocks get passed through quickly while downward price shaeks get p a s ~ dthrough slowly and tend to be absorbctd in rising profit margins. But the exogenous price shocks will also not have a zero-average

value. When negative price shocks occur there will be pressures to stop &ese shaeks from occuning &rough protation or price supports. If agricultural priws were to fall in international markets, we would simply institute more agricultural price supports. If the price of steel threatens to falf, we institute steel reference pricing. Xf the price of textiles theatens to decline, we &crease protection far the textile industry, We wilt always be adapting more public policies that raise prices than reduce prices, just as we did in 1W8, Were were the countervailing policies that sho~ldhave lowe~edthe cost-of-jiving index? They do not oecur since they would have required someone's income to be lowered by a noticeable amount. But there is another reason why moderation won% work. To create an economy with substantial amounts of idle capacity over a subtantial p r i d of time, it is nemssary to be willing to tolerate a rising uxlemployment rate and slow growth. Consider the problem af capital investment, With a substantid mount of idfe capacity it does not make sem to invest in new facilities. But gradually, over time, slow growth plus depreciation eliminates whakver idle capacity exists. At this paint the authorities either have to give up on their goal of idle capacity or fueher tighten monetary and fiscal policies t-o prduce some more idle capacity. Xf they do the fatter, they are once again depressing the rate of growth of the capital stack. If they accept the -Former, their antiinflationary palicy has withered away-at least as far as the antiinflationary impact of idle capital is concerned, On the labor side, a rising unemployment rate is necessary for two reasons, First, as the rate of growth of the capital stock is depressed so is the demand for labor, In the very tong run, relative wages might fatl ta encourage the use of more Iabor-intensive techniques, but in the short run there are simply fewer jobs in the system. But there is also a dynamic within the labor market. Operating in a Iabor queue, employers always seek to get the Best possible employees. In a period of high unemployment, employers try to replam less prefemed workers with more prefemed workers in the prmss of labor force turnover. The unemployment rates for the preferred workers fall and the unemployment rates for the Less preferred workers rise even thou@ the totag level of unemployment has nat changed. Over time this means that unemployment "becomes more

and more corneaitrated man&the bast p e f e n d , and &at f&e memployment of the preferred gaups graduafJy drops ta what migbt be catled full employment for that group. But when the unemployment -rate of the msst prefemed goup =aches full empfayarent, tbe pliey m&ers once a g h have &e s m e chdce that they had in the capital =ea. mey c m h d e r tie^ policieg to re-create unemployment among the preferred group ot they can see their antiidationary policy wither away, But fhe peridic tightening of policies and the resultmt rising unemployment rate are a never-ending proass. It c-antiauafly h a to fiFe done* This gradual rise in what is implicitly assumed to be; full employment can be s e n in the Eeo~xormicReport of the Pre~dent,In the Kennedy administration, 4 prcent unernplayment w w set as an "interim" unemplopent target because they did not w m t to defend even this level of unemploymetlt, By the end of the Johmn administration, full employment was ereqixlg up ta 4.5 percent, Bp the end of the Ford administration, the economic report was defending S percent a% full employment, In the 2979 economic reporr of President Carter, 6 percent is the impXicit fult-emplayment target. Given current policies, fuEl employment will Ir>c: even. higher in the mid-1980s. To same extent the problem is similar to our hmbing p1icy of North Vietnam. We attempted to nibble tSlem to death by gitduay inereasing the intensi5 af the bombing, but we only succeeded in making then more immune to bmbitlg as we went along, In the end we droppd an enomous tonnage with little egect. The same tonnage dropped all at anee at the beginning mi&t have had a veq diaerent eRect- The same with unemplayment, Ta say that a dramatic sudden rise to some idvel, let's say 15 percent, would stop inflation is not to say that a agradual escalsttion to I5 prcent over a numkr of yeam will stop inflation.

Miracle Cure8 That Don"$Work The other cumnt solution is the idea that we can stqp the problem if only we would bdance the gave ent budget. Whib there are m a y theore~cdreasons why this won't work, it isn%teleeessq to go into the= reasons to see the failure of the policy. Govermmt budgets have came into balance in I978 and 1979 inflation rates are accelerating, ff balanced gave would stap inffatiaa, it should haw stoppd. At one time it was apprapriate to look at the federal go to see what government was doing to the economy, Lligerent fevefs of government were self-financing, and state and locd goverments always ran bafaneed budgets. With the grovvth of grants-in-aid, it is no longer possible to make a clear distinction beitween diffeferxt Xewls of government. In the first three quarters of 1979, the federal government gave state and Ewal governments $79 billion or 24 percent of what they sprit," During this t h e the federal government had a deficit of $9 billion while state and tacal governments had a surplus of $24 billion. Overall, government was nrnning a surplus of $15 billion. The federal government could have cut its grants-in-aid by $2.1 billlion, reduced the state and Iwaf surplus to zero, and given itseEf a surplus of $ X 5 biltion, WolxId that have made any diBFerence to the economy? Presumably not since it is simply a matter of accounting where the gwrnment snvlus appears. The only thing that affects the economy is the balance between what governments edlect in taxes and what governments spend. White we could tun a government surplus sa Imge that we wouid produce the big bang recession and cure infiatian, here is little reason to believe that a balanced government budget would care the pmblem. That solution k in effect, but &e pmbtem is nat being curd,

Our Fe

ntal Dilemm

Intractable problems are usually not intractable becaas &ere are; no soluaans, but b e a u s them ate no soXuaons wi&out severe side egwts. Such is the case here, B c h pot%ntiaXsolution to the inflation prablem lawem soraeone'g iacme by a 1wge amount; each increases wmeanek sonomic imecurity, It is only when we demand a solution with no cosh that there are no so8utiarxs.

Chapter 4

ow Economic Growth

in accelerating economic powth has gone in md out af fmhian, Along with the: missile gap, it was one of the key campaiign issum in 1960. The Rwsim grm& rate exewdd &at of the Unit4 States, and N&ita Dushchev was threatening to bury us etanamical1y and mflitdy, Fmed with sho&aga of key m&&& and iz shaq decline in Ame~ca'sprducti economi~grow& has ance again b o r n e m The heaa of the issue is prductivivdu ability to eomume uXtima&ly depn& qmn our ab2ity ta p r d u a . ff we p r d u w mare per hour, each of us cm haw more purchmbg p w e r to buy the things we want. If prductivity does not money inernes c m rise, but it is nat purchasing pwez, Wten the issue is re1Femed to as srtpply-glde economics. Haw ean we in~remethe supply of g d s available for private consumption, c o v r a t e investment, and government expndiwzes? To find, an answer we must find a way to aceelera& the g r o d af prducgvity. To stop inflation recmt adnnbistratians have chosen to tighten manetw and fiseat ptieies to grduce idle capacit;y, Matever fhe merits of idle capacity in the fight against idation, if: mac& a 8tS p ~ c ein slower prMuctiivity growth. With idle capital, keen~ v e s invest dhinish, There is Xittle need for new, more produc~vefaitities, Knowing that they do not ne& to expmd, fims o&en cut back on xesmch and developmeat far new p r d u d a n

Slow Economic Growth.

77

processes, With high unemployment workers fear that technical progress will wst then their jobs and that alternative work will be hard to find. Consequently they push for more restrictive work rules to stop technical progress. '?'Re end result is a stagnant economy with a productivity slowdown on top of a basic productivity growth rate that atready puts us at the bottom of the industrial league-with about one-third the productivity growth of Japan." Unless this decline can be: reversed, and unless productivity can be accelerated to the levels being achieved by West Germany and Japan, it is only a question of time until we slip into relative backwardness. Few ma~tjorcountries have been brought down by foreign enemies; mmy have disappeared because of their internal fajtures, How are we to etirninate our failures and make our economy more dynamic than it ever has b e n ? Rere again the problem is not in finding policies that muld significantly accelerate economic growth (there are many), but in adopting policies that would inevitably cause significant income reductions for someone. To increase investment someone's shme of the national produet must decline. mose't Even more diacutt is the process of disinvestment. We tead to think of economic go* in terms of investment and new products, but disinvestment is a necessslfy precondition, To have the tabor and capital to move into new areas we must be able to witIzdraw l a b r and capital from old, X~w-pr&ucfivifyareas, But every disinvestment represents a threat to sonreond. Disinvestment is what our economy does worst. Instead of doptof disinvestment, we w t ing puMic policies to s p e d up the p-8s to slow it down with protection and subsidies for the ineaciextt. If our steel industry cannot compete, we pratwt it, If our television industry fags khind, we negotiate "orderly" marketing amangements .to keep out fareign-made sets. If textites are a law-productivity industry that should be Imated abrotid, we adopt stiff tariRs to preserve a focal industry. Our shipbuilding industry is an industry comptetety dependent upan subsidies, A11 of these actions we designed to provide economic security for someone, yet each of them imprisons us in a low productivity area, If we cannot learn to disinvest, we cannot e o v t e in the madern growth race,

The prmss of economic growth cm 'be compaed to a complicated road-building opration, The first step is to scout the landscape; a d survey the terrain to ser: where you want to go and find the best p a i b l e routes f s f reaching desirable objectives. This is the role of scientific re;~earch.GeneraXSy scientific rewmch prwwds far ahead of the rest of the road-building opration, We knew theoretiedly that an atomic b m b could be built four decades Ibefore we actually did it. At the moment, we know that fusion energy is theoretically possible (we ean explode a hydrogen bmb], but wveral decades will have elaped before we harness fusbn reactions to generate eefctricity. Well bhind the frontiers of: scientific research lies the domain of engheering reseach. The direction to go md the baie p&eiples of how to get there are known, but a practicd road must be designed. When engineering reseucfi has k e n completd, prducts and prwesses move from the domain of the t_Xreoreticallyp s i b l e into the domain of those prmesses that have been maftered and can actually be done, Using rockets for space travel wm an idea w h m origin is 1mt in the mists of. histoq, but it passed the frontier of engineering knowledge when we were able to put a man an the moon and get him back. Wile scientific explorations and engineering designs are bo& imprtant, neither affects economie growth directly. The l a n h a p may be known, the road can, be built, but the road won't be built unless the economic benefib from hatvhg the road are greater thm the costs of building it. Space travel is clearly feasible, but ;it cos& so much that there is no economic demand far regular space travel to the moon. New knowledge only becomes relevant to our economy vviren costs have b e n reduced to the point that the infomation can produce g o d s and services, which we want, at a: price we can agord to pay. Further scientific and enginmring refearch and development is necessw bfore a mad will actually be built. Banornic feasibility must he achieved. It is at this p i n t that new knowledge stam ta

Slow Economic Grow&

79

impact productivity, We build the road and start to use the new processes that prduce better or cheaper prducts than we prevlously had. Our standard of living rises. But an economy is not composed solely of new products and processes. It takes time and resources to skift to the new, sa &at any economy is a mixture of new, high-pmductivity activities and old, law-productivity iietivities. Some plan& produce the newest products with the newest technalogies while other plants prduce old products with old techniques, The average level of productivity depends upon the relative weights in this mixture. Our economy encompasses a wide range of productivities, I&tween broad industrial categories (see below) we had a ~ o d u c tivity gag of atmost five to one in 1977. Tjrpically within each industry there is a range af prductivities on the order of four to ane, The result is a. very wide distribution of productivities; but thme comes a point when any produet or process is so obsolete that it is no longer used. Mew prduets and prmesses drive old prducts and prmesses out of the economy. The dd roads are tom up and abandoned. m i s means that there are three factors that control the growth of productivity, First, how rapidly is the fmntier of economic feasibility leading to higher-productivity activities. Second, how rapidIy is the economy discarding low-prduetivity activities, And third, what is the distribution of activities ktween these extremes, Are most of our economic activities concentratecl toward the high-productivity end of the swctrurn or toward the low-productivity end of the sgectrum? The frontiers of scientific and engineering knowledge are only relevant in that they are a distant road-building operation whose speed limits the long-run s p e d of movement toward higher-productive techniques and processes. Already we are in a position to see same of the restsons why productivity has grown faster in countries such as Japan and West Germany. Xf a country is rebuilding fmm wartime devastation it will rebuild with new plants. Even if its best practice plants are no better than those in other countries, a larger proportion of the plants will actualfy be iacated near the = k s t practice frontier, This will give them fater productivity growth, even if they have no advantage in terns of their b s t practice plants,

Often people talk of this phenomenon as if it wen better to lo3e to win a war md a war iznd have your country blam up escap destmctian, Thb is shply silly. To rwaver, the West Germans and the Japanme must devote a large &action of their GNP to invesment, The result is a much lower standmd of living during the recovery perid. PrQduetivity grows rapidly but onfy at the sacrifice of red standmd-s of living, If it were an advantage to have your country blown up, the winners could do likewise, They cauid junk their old plants (bomb tbem if you like) and build new plants. They don't tcaeause to do so is to reduce their standmd af living. Consumption would have to fall both &cause prductioais dawn and because investment would have to ciw. Rebuilding countries do, however, have an advantage, O&en countries find it di@cult to get out of IOW-prductivivinduswes iuxd products even when economic analysis waufd edl for it, Individuals lose their jobs and fims go bmbrupt. Workers and fims lobby for government protection, subsidies, andlregulations. If they are successful, the economy is lwked into low-productivity operations much longer than economic circumstanms would wmant, In the devastations of a poswar pried, there L nothing to protect or subsidhe, and no one could afford to do so even if there were. The economic losses that have b e n sugered can bc: blamed on someone else's army. The net result is that obsolete industries are not rebuilt. Disinvestment in low-productivity industrim sccurs at a mueh faster rate than, it usually does,

While there are many voices calling far more investment, the prwess of disinvestment is even more impo~ant.Eliminating a lawprductivity plant raises productivity just as much as owning a high-prductiviv plant. But doing so takes fewer resources, Large investments are nat necessary, To cbse a low-productivityplant also makes it possible to move the workers and capital that have b e n

tied up in this activity into new, high-productivity wtivitks. With more men and investment funds, new activities can grow more rapidly. Paradoxically the essence of investment is disinvestment, While W may have prsblems with research and develryznent and with investment, our main failure lies in the area of disinvestment. We simply are not very g d at accomplishing it, This is one of the. places where the mixed economy has not worked, Capi~lismis, after all, a doctrine of failure, The ineaeient (the maja~ty)me to be: driven out of business by the eRcient (Ithe minority), and in the process prductivity rises, Yet we are extremdy reluctant ta practice this part of our ecctnornic religion, This reluctance has a real moral basis at the level of the individual (a failing individud is a starving individual), but it kras no mora:! basis when it comes to firms, Yet if anything, we have more programs to protect imtirutions (all of course justified in the name of pro&cting individuals) than we do individuals, Low-prductivity e m s are often located in industries where the demand is stagnant or falling. 'This is partly due to the fact that new pXmts do not need to be built to meet new demands, but it is also due to a human problem. Dying industries simply cannot be managed as efieientlly as growing industries, Growing industries amact bright aggressive managers who want to advance rapidly with their companies. In dying industries promotions are few and far btwwo, Smart young managers know that they should be avoided. m o wants a job where the basic problem is t-o decide who to fire each day and where new, exciting investments are not happningxn a dying industry everyone is out to protect what they have: rather &an to build samething k t k r , They h o w that my gains in efieiency will simply resuIe in more XayoEs, The result is a set of attitudes and actions on the part of both managers and workers that make it virtually impossible to have rapid productivity growth in an industfy where output is not growing or fafling, The phenomenon can be seen all across America from railreads to schools, Eaeiency falls as output drops, In the Boston area, where schoaX enrollments are now rapidly failing, X know of no school system anywhere that has manaf4ed to redus personnel nearly a"sfas as enirollmnents have fallen. 'The basic problem in disinvestmeat is the desire each of us has

to avoid the economic pains that are endemic whenever disinvatmenf mcms, %meone is wow off bcause af those disinvmments, and tbey have every incentive to appal for gove or slow down the prwess of disinvestment, Regulations are adopted to stop railroads from abandoning noneconomic lines. Subsidies are used to keep an ineecient shipbuilding indusm in business. Instead of shrinking with declining enrollments, sehmls discover s p i a l education and the nwd for more teachers, W i l e it is easy to say that such things should not aceur, each of us would be demamtdixrg the s m e protection if we were in the dected industdes or communities,

Ofkn the productivity problem is portrayed as if it were a simple problem of t m little investment, ff we jmt cut c m u m p ~ o nand invest& a larger fraction of-our GNP,our prduetivity would be higher, One of thte problems wi& this analysis is that more investment would now Brz: weurring if it were profitable to do so. Xn most of the post-World War II pgriod our economy has had the problem of wanting to save more than it wanted to invest, The resuit has been a *rigs of reassions where demand (wnsumptian plus irrvesthent) wm belaw what the economy could produce, ff anyone had wanted to invest more, there was no shortage of savings or prodtuction facilities, yet the investment did not oecur. T a e s are often blamed, but our business taxes are no higher thm thorn abroad, For some reaon we just da not seem to have as m a y profitable investments. Part of the explanation for this lack of investment c m be: lFeen in the cantext of what economists call learning curveg. The team&g curve phenomenon first came into fwus in the production of Liberty ships and airplanes during World War If. Aft-er the plants w r e buiIt and in opration, the number of mm-hours of work nemssat)l to build a ship or grplane fell rapidly W more and more

we= built, The capiW -@wen bid t not ~hmgc: apprwhbjy, but prductivity r m &=&tically. e phenomenon hss been widely observed in civilian pr* duction. Fallwing the intsoductio11 of a new prduct or tbe g m up of a new @ a t , l a b costs typically drop shwly for a few ye= and then more dowly, even &ou& the labor for: is workhg with the same capital equipment, Investmen& ultimatelyeprove to be profitable or unprofiabk &pnding u p the s t m p n sf ~ the leaning curve and &e pace of productiviry advanmment after the plmf figs been built, B e d on engineefing data, it is not easy to p ~ d i c t production costs since production casts we not comtmt avez h e . Multina~onalfims b d that they can build the s m e plant in digferent countries or different regiom and yet have veq diaerent pre ductivity results. The learning cuwe is relatd to the prmess af inform&, on--tfiejob acquisition of skills and team prductivity? 15 the p r m a of prducgon urorkrs learn and improve their individual job sMls and learn to work together as a team, New workers are infedor of time, to thox that have 'been working on the job for some p~od even tfxough their fomal education and skills may be identical, As a product is being built, new and better ways of building it are found with exprienee, Each innovation in the prductisn process may h small, but the cumulative eEect of mmy small impravemen& is o h r t large. The net result is a s h q rise in prduetivity as a plant gms down its feming curve. h b o r cos& of prduetion at the b%tomof the leming eume are often a mere &action of those at the top. But the prmess is not automatic. It ctepnds upon high quiility mmagef the work force is uhappy, it rnent and a cooperative work force. X c m sti& the learning pracess. If mmagers are ineomptent, oppaaunities for new labr-saving prwedurw are mimd. h early adoption of ~ g i dvvork rules can &mze the plmt into its initial productivity level and prevent it from prsceeding down the leaning curve, (mis is an importat factor in Britain where rigid work rules an: usually negotiated lbefore a plant goes into production.) The problem is to descend as far as possible and as quickty as pmsible down the learning cume. The firm that does so will have &@ lwest cofts of prduction and the mwt prafi&,

This creates an h & r & p n d e m b w m n capit4 and l a b r sat is in the shpX@cry to kvesment, H the J a p o gene=& a s e w X e ewe hehem, ill may be a g d hvesment h Japan and a p m iaivesment in the United SQtes, Ib raise investment it is neceBary to hprove the characbds~csof the Xabor mmket. New skills and hiaer e a r ~ depend ~ g upon new hvestJnents, but new hvestmeak atso depend upan a cmpratGve work force. Simply raising the income of capitalists, with tax cuts that must be paid for with tax increws for workers, is unlikely to achieve either more investmept or a higher growth of productivity. In generating .more profitable iavesment opporttuni~es,skill acquisition and a Goerperat& wofk f m e are as important as more hnds to buy new equipment. B a t ing a class war is hardly the way to proceed. Imagine what &who blieve that all work e g o ~i~ & ~ ~ d e nupon t , I m p income digerenees would predict a b u t an economy where large fims give Jifietime jobs, where relative wages are almost completely depndent Mpn senio~tyrather &an gersanal skills and merit, and where income diaerentials am 50 percent smaller than in tbe Unieeb States, the Japanese: have the wlorfss highest rate of prductivity VOW&. Why? The mswer is found in the incentives this system provides for 80ing down the Iembg came, With lifetime employment and seaiaritj, wages, twhnicaf- progress is not threatening, Whatever if iawnred, it is nat goi-ng to threaten eith9r employment or wages. Wirfr the typical worker geEing about 50 prcent Of his or her wag= in mice year& bnums that depend u p n profie, a steep Ie-inl~ curve is of dinct concern 'ta each worker. Every worker has an inwntivo: to maxirnim prductivity by welcoming technicd chmge, kmhg new slriltls, and coatdbutbg to i a d u s ~ dternwork: in a way that make-s U.S. employers envious, Often this phenomenon is dismissed as a cultural one impossible to duplicate in the United States, but it probably has more to do with the wonornic inantiye system than it has to do ~& culture. Faced with the same incentives, U.S. workers would resptld in the same way, In any cat*, W to find some system that ackieves the s m e gaulQ,

Re&

Declines in Productioity

While we need to do much more than simply reverse our recent slowdawn in productivity, the slowdown is interesting since it sheds some light on what might be done to accelerate productivity, But more importmdy, it vividly illustrates the comp1exit.y of the probfern and the irrelevance of simple one-factor solutions such as more bvestment, There is no doubt &at the rate of introduction of new products and new prwesses has fallen. Productivity in the pdvate b u s h a economy was growing at 3.2 percent per year from 1948 to 1965, at 2.3 percent per year from I965 t s 1975,and at I. 1 perexlt &am 1972 to 1978,3 A wide variety of v i b l e causes has been suaested for the lack of perfmance. Researcb and development expenditures are lower naw than they were in the Isms. It is often said that invesment has fallen, We invest a smaller fraction of our CW in pfant md equipment than most of our iadustridizd neighbors, Government health, safety, and environmental regulatio~s may have ma& p w t h more diBcuIt, The age-=X mix of the l a b r farce h n shifting t w w d inexprienced (law-prductiviw?) workerswomen and the young, Stop-go economic paticies and inflaticrtr have made investors reluctant to invest, Uncertainty has n"sen, Workers are alienated and l e s eooprative in producing prduc~vitygains. With high unemployment and more fears a b u t job scud@, work rules have hcome more restrictive. The list of pmsibilities is dmmt endlea, Two of the commonly suggested ews(1:s shpfy do nat fit the facts, IRe~achand development expndituses are dam from 3 prcent of the C M at the hginnixlg of the 1970s to sli@tly more than 2 prcent at the end of the t 970s, but prsductivity staaed to fall in 11965 well before the downturn in R W e x p n d i t u r ~ . ~ 1x1addidon, m we have seen there is a long-time tag bemeen R&D and p r d u c t j ~ q A . Iack of R m in the 197& may causr: prductiviry problems in. the 19808, but it does not explain productivity

problem in the 1970s much less than in the 19W~.Our hdu8~sX neigEbm have also eomistently hvmM lea in cause it is up, not dam. When our prductiviry was growhg most rapidly ( 1948-65 ),plant and equipment investment averagd 9.5 preent of the GNP, Prduetivity growth Ml after 1965, but invwaent r w to 10.2 prmnt of the GNP &am 1966 to 1972. hoductivity growth took another fali after 1972, but investment stay4 up at 10.1 percent of the GPdS from 1973 -U& 1978, &spite the sharpest pmt-World War I1 rewssion.Verhaps we shadd inwst mm@,but &clinin&investment is not the source of our problems. of productivity growth, it is dear that If you analyze the large pr&uetivit)l gains are =xiat& with any surge ta full ernploymenr, G~verselyprductiwity grow& falls as the economy moves away from the full utilization of men and machines, This oecm b a u e we have a large proweion of overhead Xstbor and plants designed to opritte most efficienlly at capacity. Nmagers, arch depaaments, salesmen, maintenance workers, and the like either cannot be or are not cut back, proportionally Hchen output falls, The result is a drop in productivifrysince more man-hours are now nemssary to prduee a unit of output, Convenely when output rises toward capacity, we do not have to expand the overhead labor fur=. Output gm8 up, but overhead mm-hours do not go up, and the result is a rapid gdn in prdueljviv. A b u t 30 preent af our productivity slowdown cm be attributed to idle capacity, fn our eEofif-tsto fight inflation, we have delikrately chosen to hdd the demand for goods and services b l o w what the economy could produce. Whatever benefits this may creatd in terms af less inflation, one of the costs is a slower rate uf prductivity gowth. m i s part of the producti~~iq problem will only be cured when we solve the inflation problem or decide to fight inflation with some other technique. A b u t 40 percent of the decline can be traced ta a shifrt in the mix of g d s and services being dmanded and prdueed. If there are substantial digerenws in prducrivity Ezetween industries, as there are, the mix of output demanded by consumers, business, and government can have a substantial egect un the rate of growth of

prductivity. If riemands are sfiiftjng towwd high-prductivity industria, the economy" prductivity will grow rapidly, If &mm& are shifting toward tow-prductivity industries, the e~onamykpraductivity will grow sXowIy, In tha United States there are large diflEerences in prductivity between industries. In 1977 a man-hour of work gr&u& $4.92 ( t 972 S) warth of output in services and $23.59 worth of ouQut in finan=. This is a range of almost five to oneeBDespite what is often klieved, manufacturing productivity ($8.44 per hour in nondurables and $8.42 in durables) is not much a b v e that of the economy as a whole ($8.09). High prductivity industries are finance, wholesale trade, utilities, communications, and mining. Law productivity industries include services, retail trade, construction, and agriculture. With such wide differences in productivity, the mix of goods and services demanded can have a large egect on probuctivity. Far a substantial period of ,time after World War II, the mix effect was enhancing prOdu~tivity.We were leaving low-prsductivity industries, mainf y agriculture, and entering high-productivity areas. But this process ended around 1972, m e mix of goods and services demanded started to decelerate the rate of growtb prductivity rather than accelerate it, The sharp movements out of agriculture ended, and services (another low-prductivity industry) started to grow mueh more rapidly, From 1948 to I972 qriculture, an industry who% productivity was 60 percent blow the national average in 1948, reduced its demand for l a b r by S00 million man-hours per year. Every worker leaving agriculture and entering the urban eeanony meant a sixarp rise in productivity, and there were millions of such workers. Butt b"y 2972 this prmess had esentially end&, Producti~tywas still rising rapidly in agriculture, but agriculture had &come so smalX that It no longer was releasing millions of workers, After 1972 annuat reductions were down to SO million man-hours per year. Large amounts of fabbr w r e no longer k i n g released fram a lowproductivity industry. Quite the reverse was now occurring, Another low-prductivity industry, services, started to grow much more rapidly, UlhiXe less than 30 percent of the additional man-hours added &I the economy

frm 1965 tx, 1972 had been in hours added to the p ~ v a t eewxlomy a&r 1872 were in semims. Since srvice prductivity is 40 p r m n t below the nitional averase, every worker moving into services reprC:sa=ai&da sharp cut in average productivity, m a t had been m s h a p shift toward higher; productivlity tybecame a sharp shift toward lower prductivity. Mmost half of those extra services workers went into health care. Xf WC: want health care that is what vve want, but one of the inevitable cansequences is a lower growth af prductivity. The essence of the problem can be seen in the three hundred thousand security guards added to our emnomy since 1972, Sin= securit;y guards protect old g o d s and do not prduee new gocsds they add nothhg to output, but they increase man-hours of work, The same number of pas=ngers are flying fmm Boston to Angeles, but now it takes more hours of work to g$ them there since their luggage must be checked. The net result is a decline in prductivity even though our fen@of well-king may be up. The remainiq 30 prcexlt of the decline c m be traced to particular prbblems in three industries-mining, construction, and utilities. Mining and constmetion have even experienced negative productivity growth. Output per man-hour is less now than it was a d ~ a d ago. e Utility prductivity growth Is down s h q t y . T%e decline in productivity growth in electrical, gas, and smitary utilities is the easiest to explain. This is a dear case where productivity growth is highly dependent upon the growth of output, Additional output is produced in new efficient plants, and a very large haetion of the l a b r force is overhead labor needed to maintain the distribution systems. W e n more energy is consumed, output goes up very rapidXy relative to employment, Conver~lywhen output stabilizes or goes down, productivity stabilizes or goes clown. With the much higher prices of enerD, output growth has slowed and some years even fa'l'len,with a sharp fat1 in productivity growth from over 6 percent per year to I percent per year, The obviaus cure, is a return to rapidly growing consumption, but this is not likely given what is expected to happen to energy prices, Mining prdwtivity has fallen 23 percent since 197 1, 'This is F e one place where it is possible to lay part of the blame at the door of new health, safety, and environmental regulations i t n p ~ dby gov-

erment, But much of the problem is due to geology. k s s oil is king prduce& from many more wells, and this shows up as a. decline in productivity, This is not to say that the regulations me either u n w k or mwananted. Greater health, safety, and environmental protection simply i m p e large costs in mir?ing, Xf we want safe mines and a clean, environment, we are going to have a slower growth of productivity in mining, at least far awhile, than if we do not w a t those things, Construction is another indwtry with negative prduetivitydown 19 ptzrcent since 1968. Here the proMem is partly a measurement proMenn and partly a real problem. How do you measure output in an industry that does not pradpce a standardized prduct? The standard twhnique is to use inputs (the voiurne of constmction materials) to measure output, and this may underestimate real output if progress is king made in using materials more efieientfy. We may also be demanding more variety in our constructionfewer large housing projects, fewer massive road projects-than ia the past. And as a result, the construction industv dms not get to take advantage of its learnixlg cume or economies of scale* As the decIinte in prductivity is e x m i n d more closely, simplicity disappears. Even when the c a u a are clear, the solution is not, We have elected to fight inflation with idle capacity, and this explains 30 percent of our productivity decline, If agriculture were still disgorging massive amounts of Iabor, our productivity would be higher, but that phase of our industrial life is now over. Productivity would be higher if we did not want so many services, but the demand for services is only a probIem ifwe were in some sens buying more services than we really want, One can argrxe, for example, that medicaf insurance leads us to buy more health care than we would buy if insurance were not available and every bill had to be paid in cash, But who wants to go without health insurance? Our reaX standard of fiving would grow marcl: rapidly if we happened to want g o d s made in high-prductivity industries, but W don't, Ta buy a high-productiwity good that*you do not want is not to raise your reail standad of living, although it would ace celerate the growth of productivity, Prduetivity growth. would be higher if energy prices were fall-

ing and consumption was rising, if it were easy to make mines safe and environmentaily sound, and if we all wanted to live in identicieil-l homes, work in identical factories, and shop in identical stores. But none of these things is possible, Simply raising investment might lower productivity growth since it wouXd allocate more resources to an industfy with below-average prductivity-mnstruction. Just as the causes of our prductivity slowdown we complex and varied, so will be the cures. ff you renrernhr that productivity has been growing at a b u t 3 perant per year far as long as we have been measuring prductivitpl growth (well back into the nineteen& century), and that our neighbars have achieved growth rates double or triple this in the last few decades, it is vefy unlikely that there will t3K? a simple cure, Current prduetivity growth rates are deeply embedded in the stmctum of our economy, and ntajar changes will 'tze necessary before we see major improvements.

Productioity and lntefiuuiod CompetBion While advance in productivity in any seetar contributes to our overa11 standard of living, our international comptitiveness is primarily dependent upon what happens to prsductivity in two indusliesagriculture and manufacturing. In this we diger from mast other industrial powers in that over 20 percent of our expo- are agficultural commodities. While we Iag in manufacturing, in ag~cufture we continue to lead the prductivity race with more than a Q preent annual gain. In agriculture the problem is not prductivity but opening fareign. mafhts to our prducers, Agriculture is the industry that evefyone, including ourselves, protects the mast, For all practical puwses, the United States is a residual supplier to the rest of the warld. Eheh country buys onty what it cannot produce itself, Operating behind high price suppofls, Common Market farmers produee whatever they can. If crops are bad, the Common Market is a massive a@cultural imparter. If crops are normal, tfte Common Market is a

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large importer, If craps are very good, the Common Market subs i d i ~ exports, s Other countries do the same, This leaves us subject to large demand shocks and sudden price changes, but it also deprives us of one of our major export markets, As a consequence, we become more depndent upon our relatively weak seetormanufacturing, To survive in today" international competition we must push far freer trade in agricultural products, It is our area of greatest comparative advantage, But it is also an area that illustrates our basic problem. WhiXe we have a large comparative advantage in the praduction of most agricultural commodities, we are not in a position to push for free trade since we protect weak agricultural are@ (sugar, cheese, and prwessed meats) as much, or more, than the rest of the world protects their farmers. We need free trade in agricultural commodities if our economy is to compete, but we cannot demand it because we do not practice it. Overall, farmers would make large income gains, but particular farmers in some regions of the United states would lose. Here again, we cannot play an econon~icgame with a substantial zero-sum element. To keep pace econornicaXIy we are going to have to give up our own protection in some areas and demand access for our prducts in other areas, We no longer can aRord to accept a world where our agricultural commodities are excluded, Basically this is going to mean getring tough with our allies. West Germany and the rest of the Common Market have got to stop preaching free trade in manufacturers while pract icing protection in agriculture, Xf Japan wants to export cars it has to be witling to import food, Vzry limited progress was made in the recent Tokyo round of trade negotiations, but it was so limited as to not even constitute the first step in a very long march, Future trade negotiations must make progress on agricultural commadities. If necessary, we should being limiting others's manufacturing access to our markets if they do not give us agricultural access to their markets, In manufacturing there is no evidence of a slowdown in praductivity once a correction is made for idle capacity, but this is the area where our productivity growth rates are the poorest relative to the rest of the world. Often these problems are blamed on American multinational corporations, As is true in most cases, the war-

rires are greatest when the problems have past their peak. Xn the past, United States multinationals undoubtedly moved production abroad faster than would have happened if they could not have awned those foreign facilities, But this activity is clearly on the decline. Multinationals need low wages, stable governments, and educated fa&r forces to establish facilities that can compete with those in the United States. In Europe low wages are already gone, And they are rapidly disapipearing in those parts of Asia (Korea, Taiwan, Hong Kong, Singapore) that have stable governments and an educated fabor force. There are, of course, many countries with IOW wages that will be attractive far taw-prsductivity industries, but these are precisely the activities where we should Ize disinvesting, If anything, foreign multinationats should contribute to manufacturing productivity in the future, Since wages are lower here, they are now starting to enter the United States. In the past we bad little to gain, but now a company like Miehelin brings us knowledge about prducing radial tires that we do not seem to posxss. When foreign multinationals enter the United States they s p e d up the transmission of industrial knowfedge from high-prductivity areas abroad to law-productivity arem in the. United States,

Accelerating Producti~ity Outside of agricuIture, our basic problem is accelerating the growth of gr&ttctivity, Our research and developnlent expenditures may be

too small (the right proportion of GNP to devote to R&D is one of those imponderahtes), but the real prt3btem is a substantlaX bias toward developing new products rather t hsn new processes for producing old products, This bias exists for two reasons. First, new products are atways more glamorous than new processes for producing old products. Scientists and engineers wotild rather have government R&D moncy go into new prr>ducts, Sscond and nlore importantly, we have great difficulty in publicly funding

process R&D in an economy where prduction is almost always in the private sector, When government funds are u ~ tod finanm the development of new products in universities, no one can predict the chief economic beneficiary if success is achieved, Government afllicials cannot be aecust=d of delliberateXy raising the income o$ some particular firm. Itn process R&D, however, the potential gainer is clearly identifiable--the firms that now make the product in question, In the ease of defense or space we are wilting to provide public R&Dfunds for process improvements since government is the ultimate buyer of the prducts that will be more eff-iciently produced,-But when it comes to civilian production, we are reluctant to provide public funds for process R&D, since the question ariss as to why the taxpayer shouitd have to contribute to make some stockholder richer, To engage in process R&D, tax money must be taken from one private individual and given to another private individual. But this is what we cannot do. Yet, as we have seen, the heart of the prductivity problem lies in quickly advancing down the learning curve. Prmess R&D expenditures are needed to generate a steep learning curve, but the learning curve lies in. the private seetor. One could argue that the private sectar should finance its own fearning curves, but there are good reasons why R&D is financed by government both here and abroad. R&D expenditures are financed by government far the simple reason that no private firm can hope to appropriate alt of the k n e fits that might occur. A new product may be develowd, but it ma;)r not be of use to the firm financing the work, The firm does not have the expfiise or c=orrxplemerrtasyproducts necessary to take advantage of the breakthrough. If the product is developed with public funds, the research lies In the pablic domain, and the firms that can use the product can gain access to the knowledge necessary to exploit it. Governmen& pay for R&Dsince what may be a good investment for the whole society may be so risky for any one fim that it wif l not undertake the expenditure. The same inability to appropriate a11 of the benefits exists with process R&D, Suppose a new product has been developd-the solar cells that directly transform sunlight into electricity for our existing space satellites. Given current volumes and production

techniques, they are too expnsive for earthly ebctrieity generation, YOUare a manufacturer thinking a b u t civilian prductian. You k n w that large prwm R&Dexpnditures md large initial investments would be necessary to go into prduction. Xf the learning cume is very steep your investment wilt be profitable, but a shaiIow fearniag curve could exist which would n~akeyour investment unprofitable, ff you were certain that you and only you could reap the bnefib of success, you might take the risk, but yo; know that this is very unlikely. ff you succeed and the learning curve is very steep, you may get your product to market first, but other firms now know that success is possible, They can start production knowing that a steep learning curve exists, Eventually they will find the path you found and gain some of the benefits you were counting on. In essnce the problem is sirniXar af that of a book on chess end games, If you are told that the game can be won in four moves, it is almost aEways possible to find the four moves, but in a real game not knowing that victory is within your grasp you d s not look hard enough and never find the four moves. m e first persan down the learning cume paves the way for the fotlowerrs. He demonstrates that success is passible, But not king able to get all of the h n e fits, no one may be willing to be first. Antf ewn. if Iionleone is willing to be first, we have an ineacient process where different firms must essent-ially reinvent the wheel-the desired prwess, To s p e d up productivity vvs: must find an acceptable technique for involving government in process R&D. There are probabty three essential ingredients, First, we atl have to accept the fact that any government program is going to help someone, The fact that the winners can be identified ahead of time does not make a program wrong. As llong as we have a private profit system of enterprise, any public efforts to raise productivity will make more profits for someone, Second, there is nothing wrong with profits and making someone rich if we have a fair system of taxation, Tax reform, and having what is perceived as a fair tax system, is an important ingredient in stimulating productivity since it allows us potitically to shift R&D to areas where it can have a large ptoductiviv payoff. mird, process innovations paid for with government funds should be available to everyone in an indwtry, Other firms should be able

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to study how it was done at the first firnz sct that they can get the same procfuctivity gains without having.to make duplicating R&D expenditures. This is essentialty what we now do in agricultural R&D where new processes are tried out on experimental farms and then offered to all faimers, In this case the experimental farms are owned by governrlzcnr, but this is not pssibfe in most industrial oprations where production units may be very large, But however we do it, we must restr~cturethe economy so that we can engage in more process R&D and gain more of the potential knefitl; of steep tearning curves, New prducts are important, but at any point in time most of the economy is composed of old products, Making these products more efieiently is the heart of the productivity problem. While foreign analogies should be treated with caution, it is instructive to think about Japan" success with process innovations. They have not been a leader in new praducts, but they have been n lcadcr in better processes for producing old products. X'his springs fwnr the absence of a sharp dividing line ktween public and private. and a wilfiqgness to engage in process R&D, But ta do this the Japanese must take revenue away from some Japanese and give it to ather Japanese. W are reluctant to do this when it comes to private corporations because we do not trust them to give the benefits back to us, and because we cannot justify a transfer of resources from one American to anotherq7 Accelerating disinvestment is the second ingredient in speding productivity growth, Ending subsidies, protection, and hvorable regulations will help, but we are not going to be able to do so untiX we find a way to provide economic security for individuais without providing economic security for failing institutions (see chapter 8). At the same time we also need to go beyond a free market policy that promotes disinvestment and encourages reinvestment in highproductivity areas. We do not need central economic pIanning in the s n s e of an qency that tries to make afl economic decisions, but we do need the national equivalent of a corporate investment committee to redirect investment flows from our'%sunsetW'industries to our '"sunrise" "industries, Such committees play an impflant role in the investment decisions of large aorporations, and they could play m

equally imprtant role in national investment and disinvestment decisions. With our current system of internal finance, growth in high-productivity areas is often limited by the funds that can be internally generated, This often lowers their growth and our national growth &low what it should be, Similarly with internal financing, "sunset'* industries often have access to plentiful funds far new investment. They can reinvest their internal savings, but their steady cash Rows alscrIet them borrow in the capital markets, Qften these investments should not occur: A national investment committee could help make sure they did not oeeur. For most of our industrial competitors the central bank plays an impartant role in allocating investment funds, In addition to worrying about the money supply and the rate of interest, it attempts to direct funds toward areas of major national interest, The system is probably mast heavily develop& in Japan but exists to wme extent 415 Italy, France, and West Germany, In the past our Recanstruction Finance Corporation played a similar role. Xt could and did provide major funding for large prqects in new areas, A national investment bank could be regarded as a competitor with private banks or it could work through private banks as it does in Japan, It certainly represents more government in the mixeg economy, but the time has come to recognize that if we are going to compete with some of our more successful industrial neighbors, we are going to have to change the way we have h e n doing things in the past. Simply retreating into the past and calling far the end of government involvement won't solve the problems, We have to do mueh better than we have ever done pre- or post-New Deal if we are to compte in the productivity race of the 1 980s. While there is much to be gained by taking our foot off the current economie brakes on economic change, we must afss learn to put Qur foot on the economic accelerator. If others have learned how to more quickly reorientate their economy ta new growth. areas, so must we. We do not have to reinvent the wheel, we rnereIy have to adopt and adapt what others have learned to our culture and institutions, While a decline in investment did not cause our current productivity problems, an increase.in investment is probably one of the in-

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gredients in a cure. Those who are doing better than we invest a substnntiaily larger fraction of their GNP, But to invest mare, we have to do two things, We have to create incentives to increase investment, and we have to accumulate the necessary funds for this investment. The simplest part of the problem is increasing the incentives to invest, The easiest solutions would be to abolish the corporate income tax and integrate corporate and personal) taxation, With full integration, there would be no corporate income tax but each individual shareholder would be liable to pay personal taxes on all income (retained or paid out) earned on his or her behalf, At the end of the year, sharcholdcrs would get the equivalent of a W-2 form telling them how much income to add to their other sources of income and how much income tax had been withheld on their behaif. Since corporate after-tax rates of return would appraxirnatejy double, corporate managers would have a strong incentive to increase investments, At the same time, we would increase both the equity and progressivity of the personal ineome tax. Each shareholder, rich or poor, would now pay taxes at a rate commensurate with his own income position rather than at some common rate. Taxes would go down for some; up for others. The corporate income tax should be abolished regardless of whether you are a conservative or a Ifberaj, Based on our principles of taxation, the corporate income tax is both unfair and inefficient, Xn a country with a progressive persona[ income tax, every taxpayer with the same income should pay the same tax (horizontal equity), and the effective tax rate should rise in accordance with whatever degree of prngressivity has been established by the political prmess. (vertical equity). The corporate income tax violates both of these canons of equity. Consider the earnings that are retained in the corporation on behalf of the individual stockhotder, Low-income shareholders with personal-tax rates below the corporate rate of 46 percent are being taxed too much on their share of corporate income. To the low-income shareholder the corporate income tax is unjustly high. Conversely, high-income shareholders with personal-tax rates above 46 percent are being taxed too little an their share af corporate i~tcome,To the high-incame sharehatcler

the carprate income tax is a tax shelter or tax Iwphote. As a conEqrrence, vertical equity is being violated, Horizontal equity is aIsa being violated; since two individuals with exactly the same inerne will pay different taxes, depending upon the extent to which their income comes from corporate sources. It is important to notice, however, that to eliminate the horizontal and vertical inequity sf the corprate income tax, the tax must be eliminated an bath dividends and retained earnings. Simply efiminating the corporate income tax on dividends increases the tax shelter aspects of the tax without achieving equity. While carporations are legal entities that write checks to government, they do not pay taxes. They simply coltect nloney fronl someone-their shareholders, their customers, or their enlployees-and transfer it to government, There is no such thing as taxing carprations as opposed to individuals. This immediately raises the issue of who ultimately pays the corporate income tax. The incidence of the corporate income tax is an area of economics with a large Iiterature arid fittie or no agreement. Depnding upon the exact assumptions u s d , the definition of incidence, and the time periods under consideration, it coutd be a tax on shareholders, a sales tax on f ieve that it is a consurners, or a tax on employees. (Personally, X b tax an shareholders in the short run and a sales tax in the long run, But my advocacy of: its elimination dms not hang on that ktief,) While there may be a certain, pexrrerse political virtue in coflecting a tax where no one is sure whether he pays it, simple economic efficiency and equity would seem to call for the elimination of taxes where incidence is uncertain, Qnfy if "we do so can we establish a tax system that is fair and has 'the economic eonsequenas we intend, Since interest payments are deductible business expenses while dividends are not, the corporate income tax also biases the structure af capital toward debt capital and away from equity capital. Debt capital becomes cheaper than equity capital, not because that is true in the market, but because the tax laws make it ss, Frarn the point of view of the eaicient allocation of eapitaf and an eficient capital structure, there is no reason why government should be intervening to bias busintsss choices In the direction of debt capital and away from equity capital, From the point of view of having a healthy, vital capitalistic economy, government shwld, if any-

thing, be; doing the opposite. Eliminating the corprtte incame tax would eliminate this bias in capital structure and hence improve the eeciency of the capital market, But the capital market would also be improved in another way. Since the maximum personal tax rate (70percent) on property income is substantially above the corporate income tax rate (46 percent), and most corporate shares are held by high-income individuals, there is a strong incentive for firms to retain earnings, reinvest them, and provide benefits to their high-income shareholders in the form of a larger capital stock and higher stock prices. As Isng as the stack is held, no personal income tax will be paid, and when it is sold, only the lower capital gains tax need be paid. While there is nothing wrong with retained earnings, it once again should be up to the market rather than thc tax laws to determine how much income shoilld be retained rather than paid out to the shareholders, Eliminating the corporate income tax would remove the tax ineentive to retain earnings, As a result, both the supply and demand for filnds in the capital market would increase, once again leading to greater efficiency, T o the extent that the corporate income tax is in fact a sales tax co1Iecred from the buyers of corporate prducts, a number of benefits would accrue from its elimination. The prices of corporate products would gradually fall with favorabIe effects on the rate of inflation. Because of lower prices, our competitiveness in international markets would also increase, and this would be especialty true vis-h-vis cc3untries that can rebate their value-added taxes on exports, The net result would be more gaods sold and mon: Americans employed. I f ail of these advantages exist, why do we have the corporate incotne tax, and why is it still defencledmany people, including the man on the street, think that it is a way to tax the rich. As I have shown, this is simply a mistaken perception. To the extent that the corporate income tax is a sales tax or a tax on employees, it is not a tax on the rich. Even if it is ultimately paid by the shareholder, it is not a very good tax on the rich, To tax the moderately rich we must tax the paar at very high rates and provide a tax shelter to the very rich. If we want to tax the rich, the personal income tax is the right way ta do it.

Some fiberafs oppose the elimination of the corporate income tax on the grounds that low-income stockholders would not have enough cash income to pay the taxes owed on the earnings retained on their behalf. This-is not a problem since corporations cauld be required to withhold taxes for shareholders just as they now do for, emplsyees. Every year shareholders would receive the equivalent of a W-2 form that woutd tist their corporate earnings and the taxes that had been withheld on their behalf. Those overwithheld would receive a refund, and those underwithfield would have to pay the additional taxes owed just as they now do on their wage and salary earnings, Some business managers support the corporate income tax on the grounds that it encourages retained earnings, and it gives them mare funds not subject to the competitive bidding of other managers in the capital market, To same extent this perception is undoubtedly true but 1 suspct that shareholders would still be willing to tolerate same substantint amount of retained earnings in a system where the tax system was neutral with respect to whether earnings were or urere not paid out, Those who manage government often oppose the taxation of carparate income as personal income on the pragmatic grounds that less reenue would be collected and thus some other tax would have to be raised. Depending an exactly which estimate of the distribution of stock ownership by income class is used, Treasury losses range from $4 ta $10 billion or from 2 to 5 percent of thc revenue now collected from personal and corporate income taxes. To put this amount in perspective, simple elimination of the corporate income tax on dividends would cost the Treasury $1 3 billion. The revenrte shortfall arises not so much because individual shareholders tvoufd pay less than they now do (some woutd pay more, some would pay less, and the balance depends upon the distribution of stock ownership by income class), but kecausc a substantint amr~t~nt of stock is owned by institutions (charities, pension funds, and so Forth 1 that do not pay personal income taxes, In thc- long run much of this shortfall would be recouped, and that tsihich is not recouped wortld yicld substantial benefits. To the cxtcnr that pension funds have higher incomes, they are cithcr going t~ reduce contributions (leading to higher tax&!@ incomes) or

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increase the pensions paid (leading to higher taxable incomes). If nonprofit charities have higher incomes, the public will, to some extent, give less to charities (leading to higher taxable incomes). To the extent that the higher earnings of charities are not oRset by tower annual giving, they will be doing more good works. And this is, after all, why we made them tax exempt in the first place. If we really want to tax them, we can easily pass a taw doing so in any case. At the moment we are simply being inconsistent and taxing their corporate, but not other, sources of income. When you review the arguments, there isn't any case for the retention of the corporate income tax, It is both unfair and ineficient, It ought to be eliminated. And all corporate incomes-retained or paid out ;~lsdividends-ought to be tmed at personal income tax rates appropriate ta the shareholders who own them, In doing so we will increase the hirness of the tax system, improve the allocation of investment ftmds, and create a powerful incentive far more investment, Increasing the incentives to invest is relatively simple, but raising the necessary funds for investment is difficult-not economically but politically, We are canfronted with the question that I posed to the Harvard alunrni reunion. If we were to raise investment from 10 percent of the GNP to the l S percent level of West Germany or to the 20 percent Ievel of Japan, who woufd be willing to give up 9 or 10 pcltrcent of the GNP? Conservatives say that we should generate the extra savings by lowering taxes on savers and raising taxes on consumers. ElasicalIy this means shifting the tax burden from rich to poor since savings propensities are naturafly much higher for the rich than for the poor, There is no doubt that the extra savings could be raised in. such a manner if ihe shift in the distribution of income were sharp enough. Suppose that households with incomes below $16,000 per year (the bottom 60 percent of the population in 1977) saved nothing, and that households with incomes above $38,000 (the top S percent of the population) saved 50 percent of their extra income.@To raise savings by S percent of GNP you would have to transfer $188 billion from the bottom 60 percent of the population to the top 5 percent of the population. This would lower the real standard of living of the bottom 60 percent of the population by 25 percent,

The iaconte of the top 5 percent would 14% by 46 preen!. (In fact the transfers would probably have to be larger than tkis since the bottom 68 w r ~ e n t , d om e saving and the top S prcent may not have a SO percent marginal savings rate.) To aecompfish the necessary objective-more savings-a majority of the population would have to endure a sharp reduction in their current consumptian, Nat surprisingly they are reluctmt to do so. Vet more savings are necessary if more invesments are to be made. The direct way to solve the problem in an equitable manner if simply to run a surplus in the government budget of the appropriate magnitude. Taxes are raised by the necessary amount, and each'of our incomes is reduced in accordance with a tax system. If we have an equitable tax system we have an equitable spreading of the burdens. But this directly poses the question of what is an equitable tax system and an equitable distribution of after-tax income. More investment, speedier disinvestment, more prmess R&Dthey all pose the fundamental zero-sum distributional question. %meone" income will have to go down and these losses are going to be substantial. For those that lose, the existence of even larger social gains we imelevant, 'They are anXy interested in preventing their losses.

Chapter 5

PART of the reaan why we don't seem able to compete in the growth r a e is that WC: are not sure that we; want ta campete"'small. is bautifal." In one corBer of the Nitieal wens we have: those who want to restructure the economy to stirnulate growth; in the other corner W have thax that want to restructure the eeanomy to limit gowfh. From the latter p e r s m ~ v ezero ecanomic growth (ZEG), if only it coutd be srehieved, would result in the ""gd'boeiety, Natural resources would be exhausted less rapidly, pollution woufd be less intense, and evevane wadd be happier in a society where we wereay tall struating to have more. x resolved sin= the two Technically the qumel could easily F groups are not really in oppsition, ZEG advmates want high p m duetivity growth with Xow output growth. With higher prductivity, fewer inputs f especially nonrenewable inputs) are needed per unit of output. Mew procesgs make it possible to cut the amount of pollution asswiated with any level of output, Snnilarly wha want more growth are really interested in praduetivity. Xf our ]productivity is high, we can compte regardless of haw many and services we choose to consume, If Americans just wmted more leisure and did not want more g d s and services, higher p m ductivity could lead to alt af thew hnefits wi&mt iacreasing o w production of goods and wrvices, In practice there is a real quarrel. There is no evidence that most Americans would want to use, higher productivity to have more

leisure md would not use their potentidly higher income to buy more goods and wrvices, As has previously k n shown, there is an intimate connection btween output growth md prductivity growth. ff output is not growing there is little need to build new plants or develop new processes. Countries where oullput is growing rvidly will automatically have higher rate$ of productivity growth. While environmentalism is not commonly seen as an income distribution probiem, it is closely linked with changes in the distribution of income. If you look at the countries that are interested in environmentalism, or at the individuals who support environmentalism within each country, one is struck by the extent to which environmentdkm is an interest of the upper middle class, Poor countries and poor individuals simply aren? interested, ff gau reflect upon this phenomenon, it is not surprising, As our incomes rise, each of us shifts our focus of demand for more goods and services, Initialry, we are only interested in physiological survival, F d constituta our main demand, As we grow even wealthier, our demands shift toward roomier housing and higher quality food. At still higher income levels, demands rise for services. To get service we start to eat out h restaurants more and at hame less. To avoid the drudgery of houshold work we mechanize household aprations, and wives go off to find more interesting work outside of the household. Suppose nowSthata family has reached an economy level! where they can afford good food, fine housing, vacations, consumer durables, and all of those goods and services that represent the American dream. What is there left that can mar their economic happiness? Up to this p i n t each of them can individually buy a rising real standard of living, But now they run into environmental poltlution. If the air is dirty or noisy, the water polluted, and the land despoiled, there is a roadblock in their way to a higher real standard oE living. They cannot achieve a higher real standard af living unless something can be done about environmental conditions, Environmentalism is a demand far more goods and services (clean air, water, and sa forth) that does not diger from other cansumption demands except that it can only be: achieved colt-

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lectiveiy, Xn any geographic region, we either all breathe clean air or none of us breathes cfean air. From this perspective, environmentalism is a natural product of a rising real standard of living* We have simply reach& the point where, for many Americans, the next item on their acquisitive agenda is a cleaner environment. If they can achieve it, it will make all of the other goods and services (boats, summer homes, and so forth) more enjoyable. Environmentalism is not ethical values pitted against economic values. It is thoroughly economic. Xt is simply a case where a particular segment of the income distribution wants some econcsmic goads and services ( a clean environment) that cannot be achieved without coflective action. merefore, they have to prsuade the rest of society that it is important to have a clean environment and impose rules and regulations that farce athers to produce a clean environment. If you own a fine house and your neighbor dumps his garbage over the fence, you would call the police. If your neighbor burns his garbage (throws it up in the air) and it Aoats into your yard, current laws may not let you call the police, but you would want s u ~ h laws, Xf you had the money to visit places of spectatuIar natural beauty, you would want pXaees to visit. Yau wmt limits on developmen t. EnvironmentaIiaim is the product of a distribution of income that has reached the point where many individuals find that a "cleans' environment is important to their real standard of living. Just as it is not surprising that it, is most in demand by the upper middle classes, so it is not surprising that it tends to be resisted by both the rich and the bottom half of the income distribution. Lower-income groups sirnpfy have not yet reached income levels where a cleaner environment is high on, their list of demands, and it o f en threatens their income-earning opportunities, Very high-income groups can, to a great extent, buy their way out of the environmental problem, and they see environmentalism primarily as frustrating their egorts to earn even higher incomes, A major part of the problem in the environmental area is that we are not used to thinking of a cfean environment as a normal eco-

nom ic commodity. Environrnental conditions have been excluded from our traditional measures of economic output for two reasons, Since they cannot be sold in private markets, it is diacult to determine exactly what they are worth. And, in the past, they may, have had a zero price. If the water is clean, no one would be willing to pay for clean water-they already have it free. 1But.neither of these reasons afters the fact that clean water is an economic good just as much m the private b a t that sails upon it. Given the relative supplies and demands for a clean environment, environmental goods now have a positive price, They are a part of economic growth, They have not yet been included in our measures of GNP, except on an experimenQ1 basis, but this refiects measurement problem in calculating the GNP and not the economic merit of including them. While it is possible to expand the meaning of the ward "environmental" to the point where it includes everything (income, housixlg, and so forth), environmentalism ceases to have any meaning, ft simply becomes another word for social problems. As result, it makes sensc: to Xirnit environmentalism to four major concerns: the plXution of air, land, and water; the exhaustion of nonrenewable natural remurces; wilderness and swcie preservaeon; and the health and safely factors in ixldust~alprduction. There %re three questiions that need to be addressed to each of these concerns. ( 1) What are the interrelationships between economic growth and the quality of the enviroment? (2) Should publie policies swk tio l b i t economic grow& to improve environmentd conditions"? (3 ) If public policies are used to limit economic growth, what will happen to the distribution of income? It is in the latter area that our bisic zero-sum problem emerges, Since a clean environment is evaluated differently by different income classes, the comparison of costs and bnefits will also diger markedy, Digereat groups can look at exactly the same cos& and exactly the same improvements in the quality of the environment and diAFer on whether the costs exceed the bnefits. Since we have: to share a common environment with a common set of costs, environment expenditures inevitably end up raisi~llgthe real income of income classes who have ;z clean environment next an their acquisitive agenda, and they lower the real income of those who have to

a

help pay for a clean environment but do not piace a high value on it.

Boll:~tioplrand Econonzic Growth The basic problem is not "Emits to grwth." As we have alreirdy seen, grow& is limited. From 1947 to I978 output was growing at 3.6 percent per ye=# real per capita disposable personal income was growing at 2.3 percent per year, and praductivity was growing at 2.6 perant per year.' Limits exist kcaustl: af the nature of the universe in which we live (eRort is required to produce goods and services") the nature of individud decisions (how hard do we want to work, how many children do we want to have), and s a i d institutions (taxes, regulations). Quite low limits now exist. The only question is whether we want to rake deliberate actions to lower the limits even fuaher. Pollution controls are often. opposed on the gmunds that they lower economic: growth and will reduce our real standard of living. This simply isn" true, Pollution controls only lower our stan-d of living if the costs of the controls are greater than the benefits of a clean environment, An efficient set of controls would raise the re& growth rate. Using our present measures of eeoaomic output, while the costs of cleaning it up do appear, the benefits of a ctean environment do not appear. But this is a problem produced by inadequate statistics and not a basic characteristic of pollution controls. Xt is not surprising, however, that there is an argument as ta whether these controls raise or lower our reaf standard of living. lf the benefits have a high value to one group-the u p p r middle class-and have a much lower knefit to other sacimconomie groups (yet everyone has to share: in the costs), different groups will see the desirability of the programs differently, m e output a t the program isn%equally valuable to evefyoxle, In principle, the problem is the same as that involved in nsttiond defense, Ever)rone has to pay, yet ewr)"one dms not put an equd

value on having another one thousand missiles. For some taxpayms, national d e f e n ~expenditures are our b s t buy, and for others they are our worst buy. It all depends upon your preferences for more missiles, Similarly the benefits of pollution controls depend upon the vdue you place on a clean environment, There is a way, however, that each of us should think &out the problem of how mu& "clean environmenr" to buy, Imagine that someone could sell you m invisibte, completely camfortable facemask that would guarmtee you clean air, How mueh would you be willing to pay for such a device? Whatever you would be willing to pay is what economists calf the shadow price of clean air, If we ad&& up the amounts fhat each af us would be willing fo pay for such a mask, we would have society" shadow price for elean air. Such a facemak cannot be purchased, but any pollution control program-that can, give us clean air for less than this price is a program that is raising our real standard of living. What we get in terns of bnelits is greater than what we must sacrifice in terms af eosts.

The gedanken ell-geriment also tells us how environmental cssts should be allocated, Revenue should be raised based on the amount that each of us would be willing to pay for our clean-air facemask, Those who place a high value on a clean environment would pay a great deal; those who place a low value on a dean environment would pay less. While we cannot actually perform our gedsmkea experiment, we should keep it in mind as we think of how the costs of environmental expenditures should be financed, While there is no shadow price that is beyond controversy, the basic problem in our national debate a b u t pollution conwols is that neither side is really willing to sit down and place a value on a clean environment and then do the necessav calculations to see whether it can h had for less than this price. Until we do this, no one can say whether pollution controls accelerate or dealerate real economic growth, But it is important to remember that in principle, there is no conflict between pollution controls and economic growth, Even output, as it is conventionally measured, may not slow down, n i s depnds upon whether we finance our pollution contrals by reducing other foms of consumption or by reducing other forms dr investment. ~twe cut investment to make room for pollu-

tion expenditures, conventional output will grow less rapidly since the capital stock will grow more stowly, If we cut other consumption exgenditulles to niake room for polfution expenditures, there is no reason to believe that even the growth of conventional output will fall. Pollution control devices are counted as part of our economic output, and we will simply have more such pollution devices and fewer other goods. Our total consumption will not be dawn. But what about the rewrse problem? Pollution controls may not adversely affect economic growth, but does economic growth ads versely ageet pflution? The obvious answer is ""yes," Reduetions in the level of economic activity below what they would otherwise be woufd clearly reduce the Ievel of pollution &low what it otherwise would be. The real question is whether ZEC is a first-best solution or an nri"-kstsolution. Slowing the entire economy to stop pollution is roughly equivalent to using an atomic bomb to swat a fly, Pollution would go down, but at enormous cos&, since nonpolluting activities would be slowed along with polluting ones, Advwates of ZEG often try to squirm out of this problem by saying that they really aren't for ZEG everywhere-just in polluting activities. But what are polluting activities? ft is not at all clear, Educational institutions do not Iaak dirty, but they are large consumers of construction materials, Hospitals are prodigious users of polluting goods of all kinds, Direct pollution may be easy to identify, but indirect pollution is not. Each one of us is responsible for our part of the pollution caused by electrical power generation, Even if we knew who was a polluter (we don") and had selective controls to limit their expenditures (which we don"), what would we b o W o u l d we place limits an their growth? If we did, firms woufd have no incentive to learn haw to produce what they are now producing with less pollution. We would have locked society into its current pattern of po1Iution. The preferred economic solution is a system of efluent charges where taxes are used to raise the price of polluting goads and services to a IcveI consistent with the shadow price we place on a clean environment. Xf a one-dollar pad of paper generates twenty cents worth of poltution, we pface a 20 percent tax on paper. This gives each of us an incentive to cut our consumption of polluting goods

(papr now casts $ lt 20 and not $ t .NI),provides funds for eleitaing up the environment or for more R&D on btter pglution co~trals(twenty cents per pad of p a p sdd), and allocates costs to lhcvse that use polluting g o d and srrices (the real standard of living is down $0.20per pad of paper g u r c b e d ) . Eauent charges are often resisted on the grounds that they let the rich buy the right to pollute. This charge is correct, incorrect, and irrelevmt all at the s m e t h e , It is camect in, the technical sense that anyone has the right to buy products that cause pdfution. But it is a right that will make them poorer, It is incorrect in that the price will be high enough to discourage purchases and provide funds for public egorts to clean up the environment. The environment will end trp cleaner. It is irrelevant kcause the extra amount that the rich will have to pay is larger than the value we place on a clean environment, If they choose to buy the right to pollute, they are transferring real income to the rest of us. But whatever technique is used to reduce pollution, it is important to understand that the consumer is going to pay. Ultimately, firms pass along the costs of all inputs to their consumers. If they must pay emuent charges, they will raise the price of their g d s to cover these charges or the costs of the facilities necessary to avoid these charges, If they are forced to stop polluting by rules and regulations, they wU1 do the same. The costs of compliance, whatever they are, will ultimately a p p a r in the price of the product, 'This is not bad but g&, Xf the procfuetion sf paper cauas pollution, we are only going to use less paper if paper is more expnsive. The problem of industriaf health and safety is identical to that of pollution; the only digereace is that workers rather than consumers or neighbors are subject. to damaige. As &fore, the basic problem is one of measurement. Greater heaEth and safety costs money, but we have not traditionally counted the benefits generated as output. No one doubts that this is difficult to do, but there also is no doubt that greater heaIth and safety are desired by each one of us when w e are personaIfy involved. As with pollution efiorls, an increase in health and safety will raise the price of those goods that are dangerous to produce. This will encourage us to use fewer dangerous goods and to shift to less dangerous alternatives. If done

properly, the net result should be an increase in real economic growth.

While there is no direct conflict between pollution and economic growth, nonrenewable resources would seem to present a digerent problem, neoreticdly, resource exhaustion could require a lager and larger fraction of our productive egart to prduce a given quaaturn of raw materials a?; we are force-d to retreat to lower-grade ores and less grductive energy Sourees, mether in fact mmenewable resources do or do not act as a brake on economi~growth depends upon a nunrbr of factors. God could undoubtedly tell us the number of tcfns af each nonrenewable resource available in the planet Earth, ft is a finite (but fage) numbr; but it is also m imelevant numbr. From the point of view of the economy, nonrenewable natural rewurees are actuality growing because of economic progress in finding new are Mies, extracting low-concentration ores, recycling usled materials, and developing renewabfe substit-utesf optic fibers far copger wires). Since with the exceptim of energy nothing disappears, we cannot physically use up any nonrenewable resources. 'They are always here. The totat tonnage neither rises nor falls with use, The only question is whether we can use it economica1Iy. Usable, nonrenewable resources supplies are expmding or contracting depnding u p n . what is happening to relative prices. If prices are falling, resources are becoming mare plentiful; if prices are rising, resources are becoming less plentiful. Excluding enera, the pn"ce of crude raw materials has fallen relative to finished gwds from t 947 to 1978, In terms of the hours of work necessary to buy them, they have become much cheaper, While raw material prices were rising =?,G-foldfrom 194"fo l 978, per capita dispabfe income was rising 5.7-fold,2 Measured in terms of work eEort, raw

material prices have been mare than cut in half. The same picture exis& over the past decade, Individual years can be found where: priees rise, but the Ion~termand short-tern trend is downwmd. Even if this were not true, there would be little to worq about, As nonrenewable resources become mare expensive, we would use less af them, find that we could now economically use sources that were previously too expnsive, and develop substitutes, Natural resources are not a box of chocolates &at we munch tbough and then are surprised that the box is empty. b n g before the usable supply of any natural resource is exhmsted, it will h so expensive &at we are using very little of it. Worries about natural-resource exhaustion are hard to ratianalize from the point of: view of economics. Depending upon miative supplies and demands, some natural. resources wilX be cheap (smd) while othen f diamonds) will be expensive, As demands for natural resources rise relative to supplies, prices go up. As prices go up the material will bc: used in fewer and fewer applications (copper). To some extent, other materials (aluminurn) will be substituted, and to some extent products will sim@ybcome more expensive and bss abundant (coppr pots) * To argue that there is a natural resource probiem, one must argue that for some remans the market is selling raw materials too cheaply ROW, r e l i t t i ~to future supplies and dernmds, But why should it do so? n o s e who buy and sefl raw materials can make, and have every interest in making, the same calculations made by hose who womy a b u t resource exhaustion, ff natural resoures are going to be much more expensive tomernow, one can make a great deal of maney by waiting until tomorrow to sell. Excluding energy for the moment, there %ems to be no reason to believe that raw materid prices will rise relative to other priees, They have not risen in. the past, are not rising in fhe present, md there are no current signs that they will rise in the future, And even if they were to rise, this is one problem that markeb are prfectly capable of handling, Slowly rising pfices in response to Eong-run shifts in supplies and demands should place no undue economic strain on the system. Relative price changes are aecunring all the time, and the fact that the gaod in question happens to be a non-

Environmental Problems

213

remwable natural resourm prewn& no peculim problems, If markets cannot handle such a problem, they cannot handle any&hg. While there is every reagon to believe that maket expectatians about the future are as good as anyone else's expectations about the future, this is not to say that the market is going to be ~ghrt.M a t if it is wrong, and raw material prices are higher in the future than is now expected? Asplong 'as supplies are not suddenly cut off, priees will simply start rising at a later date and rise slightly faster than if more accurate predictions had been mirde, But there will still be adequate time to adjust, since any ""naturraf""shortage of raw matelials is going to be visible t s everyone long before we have run out of any raw materials. But what. about energy? It has risen in relative price (2.5 times as fast as linished goods and almost 25 percent faster than per cagita incomes), and it is'lost in usage.$ While the direct cause of the price is a man-made cartel, rather than Mother Mature, there are those who argue -that the cart& has only speeded up what would have happened anyway. Wan% it retard our future growth prospects? In the case of energy, it is important to distinguish between the efFects an ( 1 ) a rise in price, (2) the speed with which prices rise, and f 3) the availability of supplies at the market price.' Wile economic ma&ets are good at adjusting to slow, persistent changes, in relative prices they are nat good at adjusting to sudden, large changes due ta man-made scarcities and political events. mere is no doubt that suck events are disruptive to economic growth. As seen in chapter 2, it is a man-made problem that demands man-made solutions, While it may not be the current case, it is worth thinking about what the impacts would be if energy prices were rising due to a natural scarcity, Here one has to ask himself whether there was anything to gain by limiting the consumption c7f nonrenewable energy sources below the level that would automatically occur with rising energy priees. Since we are going to have to shift to coal or renewable forms of energy (wind, solar, tidal, fusion) at sorne paint, is there anything to be gained by delaying as tong as possible the day when oil is too expensive t s be used far heating?

I we k i t grow& to ex&nd the p x i d of cheap ail enera, t h ~ input8 are requked), but kwer af tX1 &m it otherwise would have. Total consumption falfs either way, Limiting oil cansumpti~nto achieve this result is mXy rational if we tively know that leisure: is more valuable than consumption even tfxotlgh each one of MS would make the oppo'site dacisiont, if aflowed, But how could we came to such a decision in a democratic countsy? ft is true that future consumption @S will become more expensive (require more work egart to produce the necessary energy), but this is true whether we do or do not limit the use of oil below the level called for by its price, As long as you Xet energy prims reflect real current searcities, &ere is no case for limiting the; consumption of energy. mere simply area" any benefits, The basic problem still exists; swiety is running out of cheap oil, and the problem still has to be solved, The future reaf standard of living will fall, bbtt for any individual worried about this probtenr there is a so'iution, Save and invest tday's income to have a higher income tomorrow. Each of us, if we desire, can transfer consuwtion privileges from today to tornomow.

Wildernessor Species Preserwtion

Wilderness ar species preservation differs from the three previous concerns in that it has little: or nothing to do -with ecommie growth. me bmie problem is one of consumption, How much of our potential output sh~ufdwe &vote to protecting wilderncrsss or spcies? There is no technical economic answer to this question, It depends upon what constitutes your vision of a "'good'" society, To a great extent this will depend upon where you stand in the distribution of income, When we allocate some of our resources to wifdernesses, we are "buying a paHicular type of consumption g&, As long as we pay for it by reducing other farms of consumption, there is no reawn to

believe that it will agect real grow&. lF"stentia1wilderness meas may inelude M yet undiscovered raw materials, but this does not aaeet the-malysis. wponents of wilderness areas ofien act as if these resources were being thrown aw;lzy. This is simply silly. "E'he natural resources in wilderness areas do not disappear, Any future generation that decides that naturaI resources are more important than wilderness areas is free to change the law. We may never want to use them, but they are available to be used. Although environmentalists do not like to think of them as such, wilderness areas are to s m e extent natural resource insurance poXicies and a technique for saving resources for the future. There is no need for wilderness of species preservation to hinder economic growth, or for economic growth to prevent such preservation, QR all dimensions, preservation represents a gift to the future. If future generations want wilderness areas and species, it is such a gift, Xf future generations want space and raw materials, it is such a gift, We can give a gift, but like any giver W cannot determine how the gift will be used after we are dead,

Economic impli~icotionsof Zero Grototh What are the consequences of deliberately limiting economic growth? Since the interest in ZEG springs from a desire to avoid depletion of nonrenewable resources and to reduce poIIution, a =G economy is one where technical progress continues to occur. Gains can t>e made in. the efficiency with which natural remurees are extracted and used, New processes can be designed to reduce pollution, Industries rise and fall, but within a fixed total, The prablems with a compXeteIy static economy are so numerous and so obvious that they hardly need analysis. Fortunately or unfortunately, post-World War Xf American eeonomic history is full of perids of zero or negative economie growth -l 949, X 954, 1957-58, 1960-61, 1969-70 and 197&75,Vt this writing another seems eminent in 1979. Since history has pro-

vidd us with r e m t d expetirnenls in zero or negative growth, we need merely analyze these weessians to see: what would happen. Given an increase in prductiviQ of 2 prcent p r year, 2 percent fewer workers are nwded each yeeu: to praduce a constant level of output. In addition our labor form is growing by about 1 pereent per year due to population growth: and rising female participation rates. When these two egects are combined, zero economic growth led8 to inereass in unemployment of three percentage points p r year. After a while, unemployment would be: so high that workers wuld quit looking for work and participation rates would fail, leading to hidden unemployment rather than measured unemployment. But &ere is no w q mound the fact that ZEG implies rapidly rising unennplayment under our current institutional mangemen&, As has k e n seen in the chapter on infiation, this unemployment burden would be s h m d unequally. This sharing would &so become even mare un~qualas employers shifted to their most preferred workers in the normal proeess of turnover. Minorities, tfre young, the old, and women would carry the: burden of a ZEG sactiety. It is also possible to analyze what happens to the distribudon of income during a recession in order to see what would happn to the distribution of income if ZEC were imposed. The income gap between the twenty-five percentile of the population and the =vent?).fitre prcentife of the ppulation f the interquafiile range) for example, would rise by 0.2 percent per year for whites and 2.3 permnt per year for blacks with no growth.@With a higher burden of unemployment, black family incomes would, fall 6.5 percent per yew relative to thosc: of whites, Since the models that generate thew results ar@derived from short recessions, it would b a mistake to multiply by one hundred to see what life would be like one hundrd years from now, but these models do indicate the directions and magnitudes of the initial changes that would wcur if ZEC existed, Without a doubt, a, ZEG society would be a more unqual society than ours. Parity among groups would bcome more difficult to rrehieve, In a ZEG world there is no wily to employ mare women without making more men unemployed. With men are to be thrown out of workwith seniority patterns of hiring and firing, older workers

Exlviroltnnelltal Problems

3x7

would be protected in most cases, although those who are laid off would find it almost impossible to find reemployment. The young would find that the economy was not generating an expanding array of job opportunities and would have to wait for the old to retire or die. ff income were the only benefit Rowing from work, and earnings were merely a necessary bribe to get individuals to suffer the discomforts of work, the problems created by zero economic growth would be easily solved, Some system of transfer payments could be devised that would sustain the incomes of those who became unemployed and encourage those who do work to work less and share the work mare, But jobs are rnore than just a source of money income, mere are a. whole host of consumption benefits that flow from jobs that have little to do with money income, such as friends, status, feelings of accomplishment, fame, and power, Many jobs in our economy would be woxth fighting over even If they generated no income. To wham are these jobs ta be allocated? This question exists in every society, but in a society with zero ecctnornie growth it is more intense, Society cannot generate new economic avenues to status, fame, hrtune, and power through economic growth. For anyone to achieve any of these goals, someone else has to k displaced. Since we find it diffiicult to make a society work with a substantial zerosum elernent, it is dificultt to believe that we could make a society that was a pure zero-sum game work at all. While some see a no-growth society as a happier, less competitive society, this is hard1y an outcome that is foreordained. With few opportunities for advancement the economy might &come less cornptitive. But the reverse is probably rnore likely. Where at Ieast some of our energies were previously ugd to enlarge the economic pie, all of our energies can now be devoted to dividing -a pie that has stopped growing. We know from other zero-sum areas af life that they can be some or our most competitive activities. Sporting events and gambling are zero-sum activities, yet they are marked by intense cutthroat competitian. ""Kill, kill, kill" is is nnot unknown sporting cheer, A peaceful no-growth society could only be achieved if we could satiate wants. While it is logically pssible to imagine a culture

that could sustain satiated wants in the face of noticeably higher living standards in the rest of the world, there is no such culture now in existence, The demand for a rising real standard of living is virtually universal, The only exceptions are persons at the top of the economic totem pole. Often a fallacious "himpossibility" argument is advanced to imply that we have to limit economic growth, The argument usually starts with a question, Wow many tons of these or t h o s nonrenewable resources would be needed if everyone in the world now had the consumption standards enjoyed by those in the ~ n i i e dStates? The answer is designed to be a very large mind-boggling numbr which convinces you that something has to be done to limit American consumption and that others can never achieve our standard of living. m a t the question ignores is the fact that the rest of the world cannot have a U,S, standard of living until it has a U,S. standard of pr~ductivity,While consumption woutd go up by a large amount if this were true so woutd pr&uction, The world can only consume what it produces, When the rest of the world has our standard of living, they will be producing the extra resources neeessaty to have it. The relative prices of diEerent prscducts would undoubtedly change if this were true. We undoubtedly would be: forced to shift away from an ail economy faster and do more recycling of materials if the rest of the world were growing more rapidly; but economic advances in the rest of the world do not depend upon cuts in our consumption. While one can imagine changes in the structure of our economy that woufd prevent the rising inequalities that would exist in our current economy with ZEG, they are dia"icuIt to implement, The basic problem is rationing work when there are many more workers than jobs, Problems in work rationing are identical to those of any other rationing system. What is a fair distribution of work, and how can the rufes prducing this distribution be enforced? The U.S. work force is marked by a wide variance in the numkrs of hours worked by diBerent members of the labor force. Almost 6 percent of those employed work less than fifteen hours per week, At the other extreme, slightly over 7 percent of those employed work over sixty hours per week,' ff one were simply to limit the total number of b u n that anyone could work, only a small fraction of the work

farce wouM find themelves with tower earnings until the limit moved klow forty hours per week. This, however, would put the entire earnings burden of ZEG on those who now work the m a t . Absolute limits on work could also encourage a rapid increas in the number of secondary family workers, with. a consequent need to reduce the maximum hours of work even more than was originally indicated. Another option is to cut everyane" houlcs of work proprtionalty. This has the questidnable advantage of preserving the current distribution of earnings, but proportional cutbacks are impossible to administer except in short-run periods of time, Given a very rapid turnover in the labor farce, workers would quickly start exaggerating the n u n k r of hours of work they were seeking in order ta be assigned the number of hours of work that they actually wanted, The history of actual work patterns would rapidly fade out of existence. As a result, proportional cutbacks are not an administratively workable option over any extended period of time. As a consequence, an absolute across-the-board limit on hours of work would seem to be the oniy long-run option, To prevent the Induczed inerease in part-time workers, the limit. would have ta be set In terms of hours of work per lifetime rather than per week or per year, This wouXd prevent families from evading the rationing system by increasing their number of workers in the paid labor force, Teenagers woufd not work to supplement their parents" income because to do so would reduce their own adult earning capacity. The economic costs of absolute limits on hours of work depnd upon one3 estimates of the relative importance of talent versus the willingness to sacrifice hours of time, As long as we are simply talking about hours of time, there i s na economic loss (other than extra training costs) when one ~ r s o n "time is substituted for another". To the extent that scarce taIent is involved, however, fociety is deliberately cutting itself off. from the consumption of a unique resource, The more speciat the talent, the greater the cost, The major enforcement problem would.occur in the area of paid hburs versus actual hours. There would be a strong incentive from both crnptoyecs and employers to devote substantial amounts of time to unpaid "preparation for work"" and then to pay very hi@

rates for a few hours of actual paid time, 'This would allow employees to avoid restrictions on hours of work and enable employers to avoid the training costs of having more employees, As a result, there is no doubt that there would be severe enforcement pra'blemrz. Work probably could be rationed, but there is na doubt that the end result would be a substantial increax: in economic controls. Many individuals would have to be forced do what they do not want to do. If ZEC is taken wriously, it dms not make much sense, "Small is kautiful" sounds hautiful, but it does not exist kcause it does not jibe with human nature, Main is an acquisitive animal whose: wants cannot be satiated. This is not a matter of advertising and canditianing, but a basic fact of existence. To try to straightjacket human beings into "smaXf is beautiful" is tto impose enomous cos@; yet the% would yield only ntdest benefits in terms of less pollution and slower exhaustion of resources. Other techniques can achieve these results at a much lower cost, A society that cannot sdve distributional questions in the current context would k required to solve distributional questions in a much more difficult context. Ever-y increase in income, every promotion, and every advancement would require someone else to give up something he had.

The Biskrib~lriowlCan-flic;ts Whife environmeataIism could easily lead to a higher-average real standard of living; it will not do so for everyone. For those who glace a low value on a clean environment and must share in the costs, their real standard of living will fall, If a high-quality environment is purchased with ZEG, very sharp income reductions will be allocated to t h m who car9 the greatest unemployment burdens. If a high-quality environment is purchased with eauent charges, income reductions will be allocated to those who now cmsume high proportions sf polluting goods and services. Tf a hi&quality environment is purchased with tax collections, income cuts

will be allocated to those who pay the mwt tmes. In none of these three options is the payer necessarily the p n o n who gfaees the highest value on a elean environment. The allocation of large income losses could be avoided if costs were alirocated to those that piace a high valtue on a elean environInent, but this is difficult both economicalIy and plitically., Exactly who places what value on a clean environment and how should the necessary revenue be extracted from them? Even an approximate economic answer to this question is dimcult but trivial compared with the political problem. Environmentalists are not suggesting that they should pay b r a clean cnviron~rtentbecause it is going to raise their real standard of fiving. They see pollution generated by someone else, and that someone else should pay the necessary cleanup bill. But "that someone else" "inks environmental cleanup casts mare than it is vvo~h. Yet we cannot raise the necessary revenue to elean up the environment unfess we can agree s n who should pay the?bill,

Chapter 6

Spreading Ru

ENVfRONMENTAltISM naturally leads to rules and regulations. Automobile producers are to meet emission and fuel standards. Electrical generating plirnts are to control sulfur and Ay-ash ernissions. Industrial firms are to stop dkharging wwtes into seeams. The list of environmental regulations is not endfess but cawrs thousands of pages, And these regulations can: bt: matched page for gage by regulations in other areas, Individuals often w o w about the growth of government expnditures, but government" greatest growth has undoubtedly b n in the area of regulations, White regulations have grown dramatically in the United States, we probably have fewer regulations than any other industrial country. L ~ Lwe I ~ impose regulations in an advisory legal system that makes what regulations we do have much more difficult tq implement. hng-time delays are common as we fi&t our way slowly through the court system to find out what the regutations reataffy require. Once a goal has k e n legislated into law, the fight has just begun. To a great extent the time delays and unsrtainty that this prwess creates have a mure advers egeet on tbe ecomrny than the regulations themselves. Occasionally regulations are a v e ~ l yi r n p s d to raise the ineon~eof =me group (fitmexs) and to lawer the income of some other group (consumers of f d ) , but more often they are p r o p a d on the

S p r e a d i ~ ~Rules g and Regulations grounds that they will accomplish some worthwhik social objective, Trucking regulations are defended by truckers sin% they raise the income of truckers, but the defense is based on the grounds that the regulations will provide cheaper or more reliable transportation t~ small ~omm~nities. Steel producers would not have lobbied far steel import restrictions if the= restrictions had not resulted in higher incomes far producers, but their rationale for doing so was ""national defense," But whatever the overt objective, the implicit objective is always to alter the distribution of income and this is almost always the real reason for the existence of any regulation. Because economic regulations are designed to raise the income of someone (and therefore lower the income of others), no one can say that a regufation is g o d or bad without a vision of what distribution of income should exist, and how this distribution ought to be created. In the abstract deregulation is a popular cause, Eveqone is for it. In practice each of us opposes deregulation. when it will Iawer aur own income.

The Growth of Reguhtionr A large number of factors have contributed to the growth of eeonomie regulations. Ta some extent they spring from our lack of ather kinds of government involvement, In Japan, where indusq is heavily dependent upon the Bank of Japan for its financing, government can issue marching orders to steel mills to stop air lution without detailed regulations. The firms know that if they do not ""voXuntariEymw r f o m the desired task they will have trouble with their ""friendly" hbanr, fn contrast, t7.S. steel mills can only be persuaoted to stop pollution with a host of complicated, cumkrsome legal restrictions which must be; legislated, drafted, enfsrced, and arbitrated in court over a substantial period af time. The same phenomenon is visible in Euro~x;where governments own many industries ( Volkswagen, Renault, British %eel), and &ms need government" help in the capital market, m e n gavernment owns or

con&ols, it obviously dms not need to write rules and regulations in the way we write rules and regulations, Historically, there have k e n three great bursts of regulatory activity in the United States, The first wcurred around the turn of the century. Antitrust faw were adopted to control man-ma& monopolies (oil, stml), and government regufatians were invented to control natural monopalies (railroads, electrical power). In both cases the aim was to keep monopolists from extracting monopoly rents from the incomes of either consumers or other producers. The second burst of regulatoq activity occurred during the 1930s. Various ineaectual schemes for curing the Great Depression by raising prices were &opted, but with the exception of agricultural price suppo~s,the fang-lasting regulations focused on canstmeting a legal environment that would make it easier for workers to fom unions. The thirtim esentiatly sr~eeptedthe idea of large businesses but sought to i h i t their pwer with the countemailing power of hrge unions, The third burst of regulatory activity accurred during the late 1960s and early 1970s, and we are still in the process of digesting its effects. While the mast recent burst has a number of facets, it essntially focuses on the problem of externalities and eeanomie security, Xn the ease of externalities such as pallution, one individual can impose casts (dirty air) on another individud without having to pay-eompensatian, The natural response of the xeond individual is to demand government regulations prohibiting the acts of the first individual, and this is exactly what has; been happening, ExternaXities have become important in our wiety for a number of reasons. As our society lbeeomes more technologically adactions much mare fievanced and more congest&, one gra~[p~s quentty impact another group" welfare-airport noise. But our technology has also exposed long-standing externalities that we previously did not recognize-the cancer danger of asbestos fibem, As we have seen, the rise in real incomes has also played a rote. Environmental interests systematically depend upon our income. In the fate 1960s the United States reached an income level where many p p l e were rich enough to tze conmmed abut a clean environment, This economically induced shift in concerns was heightened by

Spreading Rules and Regulations the fact that nature has some self-cleaning capacity, As long as the level of pollutants stays below this fimit, Mother Nature cleans up the environment fox us, If that fimit is exceeqed, however, the selfcleaning capacity often decreases, In the case of water, dissolved oxygen is the critical factor, When pollution rises a b v e the level where self-cleaning is possibfe, the level of dissolved oxygen rapidly falls and water" self-cieaning capacity falls with it. m e result is a situation where a small addition to the total amount of pollutants can lead to drastic inereases in the amount of pollution;, In the case of water poIlution, most rivers were polluted wet1 hfore the current interest In clean water; but in the ease of automobile-induced air pollution, the effects are often recent, The city of Denver is a g a d example of a city that shifted from relatively clean air to heavay polluted air in a very short pe"i"d of time. Air pollution is also of much more general concern. Water pollution can be avaided by dtaying away from polluted water, but it is much harder not to breathe than not to swim or boat. We have already investigated the rising interest in income security, In most circumstances, regulations are seen as the best means for preserving or obtaining this security: foreign steel is to be kept out, set-aside programs are to raise the price of agricultural commodities, and entry is to be restricted into the trucking industt-y. But to provide economic securiq, rules and regulations must be issued, Farmers must be told what and how much to plant, Government ends up setting the price of steel depnding upon its trigger-price regulations. To keep entry restricted in trucking detailed regulations must be written as to who can carry what" ""Unraasted peanuts are not roasted peanuts." 'The demands for protection. have grown hcause, in a real snse, we have abandoned our klief in the virtues of a competitive, unplanned economy. Political speeches are still offered up to the totem, of unplanned, cotnptitive economies, but at the first sign af trouble everyone runs to the government looking far protection. The same steel executives who can give speeches about the: virtues of comgetition ask for protection when competition arises. W e n deregulation of the airlines industry is proposed, the industry leads the oy?a&ition. Truekers may be in favor of competitive economics for others, but they want regulations for themselves. fn same sense we have

the worst af bath worlds, We have a centrally regulated eeanomy without the virtues of central planning. We won" admit what we are in fact doing, and thus every regulation is set up in isolation as if it were the only regulation in the system, We might gain in efficiency if we moved in either direetion-toward more comptition or toward mare central planning. -At one time it wtfs thought that all problems could be solved if the economy were only made mmpeti~ve,It is this beljef that lies behind both antitrust legislation and government regulatory agencies. The first is supposed to ensure that the biisic conditions of competition exist, and the second is supposred to ensure that naturd monopolies act as if competition did exist. For a number of reasons this vision has faded, but the regulations still exist and are now used to protect and raise incomes rather than to ensure competitive actions, A comptitive economy is without a doubt an economy fifled with a great deal of potential opportunities, but many of these opprtunities are bad. They result in income losses, risks, and uneerainties, We want opportunities for higher incomes (comptition) but security for our present income (protective regulations). And as oar consumption. riss, the size: of this desired, *cure base has a habit of rising just as fast as our incame. Unfortunately, we cannot have both. One man" security is another man's lack of opportunity. Thus we usually end up prescribing competition for others and security for ourselves, When we all da this, Inowever,.~end up with an economy full, of regulations that prevent .us &om growing as fast as we should, The attraction af the com~titiveideal has faded for a number of other reasons as well. Individual firms and unions are so large that even if tbey are, in fact, competitive, the whole system.daes not have the attraction that it did when individuals were seen as the principal econanic actors. General Motors versus Toyota may be real camptition, but it is hardly a form of competition. that wins the emotional support of the average man. We also now realize that many of our prablerns would not be solved with more competition. To the extent that we have problems with externalities, cornptitive markets are no solution at all. A competitive firm will generate as much, or mare, smoke than a

Spreading Rula and Regulations

-

X27

norxcomptitive one, m e r e is also the suspieion that the virtu@ sf small-scale comptit-ion ignore tbe problem of r e ~ a r c h ,r?tevefopment, and economic progress over time, Without the research and development of oligqolistic firms, the econmy might not grow as fast as it does. We pay a short-run price for some long-run gains. Finally we now have historical experience demonstrating that the antitrust laws do not, in fact, produce competitive industries, At best the laws break one very large firm into two or three large fims after a, very Iengthy and costly Iegal battle, and the industry becomes slightly less oligopolistic. But slightly increasing the number of oligoplistic firms does not seem to make much difference in market beftavior. The costs af enforcement are high and the benefits small, Antitrust laws have taken an a legal life of their own, but from the prspctive of economics, they have little meaning or rationale, But with the intellectual heartbeat of antitrust d e d , regulation remains as the only aIternative, Instead of creating competition, we get into the business of trying to cantrat oligowIistic behavior, As new probfems develop and conditions change, it is not SUPprising that new regulations have been written, m i s does not by itself, however, explain why the economy is becoming more regulated, Xf new regulations were matched by the ahlition of old regulations, the economy would not become more regulated aver time. Why aren't antitrust regulations abolished or substantially overhauled? W y aren" regulatory agencies abolished when conditions change? The failure of deregulation is centraf to understanding the regulatory process. To understand it, however, is to come right back to the problem of income protection. Regulations persist since regulations ageet ineames after they have k e n in plaec: for any period of time. Someone's iineome is higher than it would be if the regulations did not exist. Deregulation, ss a result, always poses eca~omiclosgs for someone, OI-ten the peopfe who lose are not t h m who made the orjgind income gains when the regulations were imposed. These are long dead or they long ago sold out: the capital values that reRected the value of the regulations. Workers have the: same vested interest, They enter an indusw tsxpecting some wage, but that wage depends upon the existence

of regulations. Regulations makg the trucking industry profitable so that it can agord to pay its workers high wages. With deregulation, profits would fall and wages would be reduced. Over time, workers have acquired some of the benefits from charging higher prices to consumrs, and over time they would lose some of &me knefits if forced to give consumers lower prices. As a result, it is not surprising that both firms and employees resist deregulation strenuously. Xf the rest of us were to get cheapr produc&, they must earn less money, Politically, there may br: more consumers than prducers, but the per capita income losses to producers are rnuch Larger than the per capita income gains to consumers. Intensity overwhelms numbers, and the resistance to deregulation may be much stronger than. the pressures for it. Regulations are held in place by economic self-interest. I; the sase of airlines, this was true even when it w;ls clear that profits would be higher after airline deregulations than &fore them. Total profits may be up, but some individual airlines will undoubtedly 8nd themselves losing out in the new environment, meir prdts will eventuaIly fall. In addition, the new warld is a world of uncertainty, and most are willing to trade some reduction in income for an increase in income security. In this, airlines are no didlFerent than the rest of us. While it is relatively easy to chart the conflicting pressures that have led us into the current regulatory morass, it is rnuch more di@cuIt to chart a way out of the morms, m a t is the appropriate role for regulation? What goals can it not achieve? m a t goals must be achieved by other means? Before this task can be undertaken, it is necessary to clear the decks of some old intellectual baggage, Most of the debate surrounding regulation is encrusted in a set of issues and positions not relevant to the real problem. X have orgstnimd the cobweb-sweeping process under eight hndamental propositions about rules and regut ations. ALL EONoMIES GBE SE= OF RULES REGF7LATloHS-THERE IS NO SUCH THING

PROPOSITION I:

AND

AS THE: VMmULATED mOMOIMIY,

Oftten discussions of government regulations are psed in the farm of a debate bemeen the virtues of reguEatad v e ~ u sunregulated

Spreading Rules and Regulations

3559

economies, While debates are g o d clean fun, there is nothing to be debated if the issue is cast in this format, There simply is no such thing as the unregulated economy. All economies 'me sets of rules and regulations. Civilization is, in fact, an agreed upon set of rules of behavior, An economy without rules would be an economy in a state of anarchy where vofuntary exchange was impossible. Superior force would be the sole means for conducting economic transactions, Everyone would be clubbing everyone else, AIX market economies depend upon a set sf rules and regulations that define how property rights are acquired md the conditions under which these proprty rights can be exchanged. One can have, and we have had, a market economy with or without the right to have slaves, Under current law one cannot even self oneself into slavery. The efirnination of slavery does not make the economy any more or less a market economy, Xt simply changes the domain aver which individuals can enter into market transactions, Xn one ease the market can deal in human bodies; in the other it cannot. Before a market; can be organized, the government must establish a set of ruIes and regulations specifying proprty rights, Without these regulations there is no theft (the illegal seizure of prop erty rights), and without theft there i s no room for a market. No one owns anything that can be exchaned for any other ownership claim. Therefore, the whole issue of property rights and transfer mechanisms must logically b-e considered prior to any debate about the merits or demerits of the market. Without government regulations there are no property rights, and without property rights there is no free mwket. While property rights of tong historical lineage often seem intuitively obvious, they are not. Xf my neighbor throws his garbage an my lawn, I have the right to caff the police to stop him and the right to seek damages. If my neighbar throws his garbage in the air (burns it), ]I typically do not have the right to call the police md collect damages, f have property rights to land but no g r o p e q rights to air, Yet clean air is pobably more vital to my existence than clean space. Each of us could give a good historical explanation las to why air properly rights have not been developd. In a rural envkonment, air pollution is so unimprtant that the ownership of air rights is

simply not importmt enough to warq a b u t . Clean air has a mrs maxket price, But as soeiety becomes more industridized and heavily populated, clean air starts to have a-positive market value, and its ownership becomes a real issue of concern. A similar change can tw;: seen in the Law of rhc: Sea Conference. ]It meets to define proprty rights to the, man floor. But this issue only becomes woah discussing w h e ~we have the tecbnoloa to mine the ocean Boor, We do not debate the ownership of the gXanet Pluto sinee no one has the ability to appropriate it, Technology may also lead to diEerent specificatioils of p r o p e q rights. Air moves around and is not easily appropriable in the way that lmd is appropriable. Da f own the air over my space or do X own some set of moteculesWhat happens if my air wanders? Air proprty rights have t s be cqllective property rights father than individual property rights. If they are collectively owned, then a set of rules and regulations for their colfeetive use must be written, If they are individually owned, then a! set of rules and regulations setting out the conditions of individual ownership must h written. B& in either case, there are going to be numerous rules and regulations. The issue is one of writing a set of rules and regulations, which society can live by, in an area &at has not previously h e n important enough to merit a set of rules and regulations setting out collective or individual proprty rights. This is not the place to argue whether the current clean-air rules and regulations are the right rules and regulations. It is the place, however, to point out that no matter how the issue is decided, there are going to be more rules and regulations than there were in the past, Without the rules and regulations, the strong will simply seize what they want from the weak and then the strong will have to invest real resources in defending what they have just seized, Property rights exist to establish a just (or at least a widely @reed upon) set of rules for acquiring and exchanging property h d to then reduce the cos& of production and cmsumption by agreeing not to seize each other's Thus the question of praperty rights is central to any ecanomy, regardless of its degree of allegiance to market concepts, Properv rigfirs are, however, nothing but a set of rules and regulations. A pivate proprty ecotiomy is by definition a replated ecdnomy. If

reid id in^ Rufes and Reguktio~ls

131

the state owned everything and there were rro private propay, there would be no need for government regulations spelliag out the nuances of prowrfy rights, There would need be only one regulation, All property &longs to the state, and it can do with it what It wishes. The real question and the real &bate revolves not around the virtues of the regulated versus the unregulatd economy, but around the question of what constitutes a gmd set of regulations. PROPOffTIOr\l LI:

WE=

ARE MAY11

SELLY GOVERNMEm REGULATXONS,

Gleefully finding silly government regutations has almost reached the status of a national parlor game, And nowhere i s it easier to p l y the game than in the domain of OSHA-the Occupational Safety and Health Administration. Whenever silliness arises, it is well to ask why. It could arise because we are chasing after silly ends, or it could arise because we are using inappropriate meam to achieve perfectly respectable ends. In the casr: of OSHA, the latter is clearly true, No one questions the virtues or the seriousness of reducing industrial deaths and injuries. The question is one of means. Basically the problem is not one of stupid bureaucrats but one of trying to write universal regulations in an area where it is impossible. A regulation that makes sense in one context may not in another. Take the problem of providing toilet facilities for f a m workers. A regulation that may Ire eminently sensible in: a densely populated truck-farming area (a toilet every forq acres) with hundreds of farm labsrers may not make sense on a Montma raneh where it; is miles to the nearest prson, and where there are bundreds of thousands of empty acres that seldom, if ever, see an agricultural worker, Yet for a set of regulations to be sensible in every section of a country as large as the United Stalies, it woutd have Lo be so fengthy that it would be equally silly, Suppose that someone were tto report that it took the government ten thousand gages of regulations to spell out the appropriate toilet facilities ifor eveq conceivable condition. Each of those regulations esufd be sensible, "yetthe stggregate effect is nonsense, The problem is using an inappropriate means to achieve a respectable objective, It is also well to remind ourselves that silliness is not limited to

public actions or to other individuals. Every example of stupid government action could be matched by a prj;vate example. The Wsel, for exmple, has entered our Iangnage as the paradigm example of a stupid action that wastd millions of dollars worth of resourws. Basmn" John Hancoek building, with its falling panes of glass, was a fiasco frm the day it was built, What would have happened if some government bureaucrat had built it? The U,S, steel industry misinvested millions QR opn-hearfh furnaces when it shauld have been building oxygen furnaces, Most of us would hayz to admit, at least to ourselves, that we have made stupid mistakes in our own budgets, W tend to excuse stupid private actions on the ground that the agents making the mistakes are wmting their own resources and that therefore their mistakes are their business. To some extent this is true, although it does not change the fact that all decision makers make mistakes. But to a very substantial extent, it is also not f corporations are not making mistakes with true. ~ a n a ~ e r s ' olarge their own money. Both they and the government bureaucrats ate playing the economic game with someone else" money, Wenever priwte or pubfie managers make mistakes, they are going to be wasting someone eke's money. And in general, it is much easier for a voter to replace a poor public manager than it is for a shareholder to replace a poor private manstger. clem fun, "eeounting examples of silly stupid actions is g& but in the end it doesn" prove anything about the virtues of regulation, No one doubts that there are both sensible and senseless regulations, "Ike problem is to maximize the proportion of regulations that fall into the sensible categocy. FRaE"C)SLTfON 111:

mmE;ARE

MANY A R U S

TEEAT SHOUW HAW FEWm REGUZAmONS.

What kdds the regulations in plwe? The answer is shX>Ee--inm m seeul-ity, Any long-standing set bf regulations ends up raising the income of someone. And usually this someone includes some capitalists, some workers, and some consumers. When regulations are repealed, those individuals stand to suffer income losses, Other individuals stand ta make gains, but the principle of terriwrial imperative applies in such cases. Peopte fight harder to protect what

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they have than they fight to get samething they do not have and have never had, Qften this is compounded by the fact that 'the income gainers are widely diEuse while the income losers are highly concentrated, One fights mueh harder to protect a large sum, than one fights to get a small sum. In addition, those who have been receiving help are usually well aware of this fact m d have thoroughly entrenched themselves to repel attacks on their privileges s mounting an attack, long Ibefm anyone t h i ~ k (af Consider the simplest case of a taxi medallion. Suppose these: medallions (a permit giving one the right to operate a taxi) sell far $20,000. What gives these prrnitsl their value is that some agencty holds the supply of tmis below,the comptitive level, and this Xeads to high profits, If medallions were simply issued to every patential taxi that met the required safety standards, meddlions would have no value. m e y have a value &cause there i s a monopoly supplier of medallions (the city) that is not issuing more medaflions (if holding the n u b e r of taxis below the competitive levef) and thereby is generating extra profits. Suppose the city were now to deregulate taxis and shift to a frw entry system. The value of the medalXianis would go to zero. Obviously, if you have purchased the right to operate a taxi for $20,000 you do not want someone destroying your $2Q,W0 aset. True, there are more passengers than there are tmi operatom, But each of them would only receive a small rductibn in fares if the sysrern were deregulated. The customer does not have enough financial interest to spend the time and money fighting for deregulation, but the provider has a very substantial interest in spending the time and money fighting for regulation, Or take the more important case of general transportation. Transportation is probably the best example of an area that should be deregufared from the point of view of economic eaciency. The Interstate Commerce Commission was set up in 1887 when the railroads were a genuine natural monopoIy, bfot only were they monopolies, but they were run by individuals who believed in extracting their full measure of monopoly rents, Regulations and regulatory agencies were necessary to protect consumers and other producers. But as time pasgd and we invented or pedected planes, autos*

trucks, piplines, and a host of alternative transportation systems, an indctstry that was at one time a natural monopoly has h o m e one that codd potentially be one of our mast competitive, Instezld of gradually ablishing the regulatians that made sense in 1887, we gradually expanded them to include th&e new foms of tramportation; Regulations which at one time had b r r used to hold p ~ c e s blow the monopoly prices which would have been chmged in an. unregulated market &came rcilgulatioq that were used to hold phces above the conptitive prices that would have b e n charged in an unregulatd mmket. As a result, the presicfent of the American Trucking Aswiation defends regulations in an interview in Fortune magazine.= A dmilar reaction occurred in the deregulation of airlines. M o objected in an o p 4 micle in the New York Times? Mat wme fwl who wmM to replate everyMng for the sake of regulating everything, but the president of American Airlines. Conventional wisdam maintains that rules and regulations have k n u ~ e dto stop railroads from eEectively competing with thew oaer modes'of trmsportation, and that the impact of the system has basically b e n a, transfer of income from the railroad inbusv to the= other forms of trmsportation, and to trucks in particular. The regulations have certainly hurt railroads and helped tmcks, but not in the: way it is cammonly envisioned. Railroads have been hurt not by regulations that stop them from cornpting with trucks, but by regulations that stop them from dropping unprofitable brmch lines and ~rvices,Railroads are asking for the right to drop tf.irtrse activities, but they are not asking far general deregulation. They also like monopoly pricing under the protection of a regulatory agency, Trucks and railroads have characteristics that make them optimal for carqing very different g p s of commodities. RailroiitcXs are optimal far bulk commodities (coal, grain, lumber, and so fo&h) that must be: hauled over long distances. Trucks are optimal for packaged g d s where door-to-door delivery and greater speed is importan t. When have some of the charaetefisties of b t h , we simply we truck-trdns a a t talc@advantage of b t h sets of characteristics, The big gains going to truckem come not bom protection from railroads, but from protation kom fam mcb, am

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millions of farm trucks that are only used part of the year in farming and could be used in commodity transprtation if it were not for regulations preventing their use, Xf farm trucks were used in this way, interstate trucking firms would be forced to charge lower prices and Iive with lower incomes, Since this extra income has over time kcome divided btween the owners of trucking fims and the Teamsters driving the trucks, both labor and capital have a vested interest in fighting deregulation. If one asks why the reguiatims are used to stsp railroads from dropping ttnprolitable services or from raising the prices on these services, there is a simple answer, Since railroads are the most efficient and cheapest mechanism for transporting butk commodities, any community that loses its railroad service is going to find bulk commodities much more expnsive. Communities fight to protect their real incomes, and this means opposition to deregulation. These particular consumers will suEer real income reductions when deregulation occurs, even though consumers in general will gain real income increases, Regulations often cause cross subsidies where profits on one set of activities are used to finance losses on another set of activities. Xn this case, consumers in major population centers pay hi&er freight rates in, order to lower freight rates in small ppulation centers, Other examples of cross subsidies occur in the post afim (rural areas and magazines are subsidized) and, if AT&T can bt? believed, in the telephone industv, Long-distmce calls subsidize local calls, Business charges are used to crms subsidim residential charges, While there may have b e n small income gains for some foms of transportation at the expense of ather forms of transportation, m setting up an indusbrid the peal ineome gains have come E structure that makes it possible for all-forms of transp&ation to raise prices a b v e the competitive level and thereby extract wme extra income from consumers--not from each other. Recognizing that any such system is always vulnerable to political attack, the transportation. industq has for generations h e n active politically, mrough campaign contributions and past favom, it has established a deeply entrenched position in both politic& g a ~ i e sthat vvould require a lot of political capital to overturn.

Qn the other side, transportation charges are small enough and hid&n in other prices so that no consumer thinks be stands to make a large gain in real incomes with deregulation. The aggregate gains spread across 220 million consumers may b very large, but no single one of these 220 million consumers may have enough of a financial interest to make it worth the time and ef?Eout to fight for ®ulation. As a result, the fact that there are many areas that should be deregulated does not Iead to the conclusion that there are many areas that will be deregulated, General economic welfare may i n c r e a ~ , but if our incomes were being threatened we also would be fighting derelfutation. Efffciency is never a virtue when our incomes are k i n g threatened. PROPOSXTXON XV:

1N THE UNITED STAmS REGULATIONS ALXXOST

NEVER ARISE; FROM IDEO

in many countries there are strong political parties committed to central planning, nationalization of basic industries, and regulatory control, Not in the United States, Were there are no strong politicd forces arguing for regulation for the sake of regulation. Regulations weur &cause the market fails to prfornr same task that the population wants performed of because our tolerance for failure has changed and we are no longer willing to tolerate long-standing failures. This principle can be seen in the infamous troika of EPA, OSHA, and ERISA (the Environmental Protection Agency, QCcupational Safety and Wealth Act, and Employee Retirement Income Seurity Act ) . The EPA arose because the automabife brought air quality standards to the top of the public health agenda in many parts of the country. Air quality levels were reaching intolerable levels. When sehoot recesses have to be abandoned because the air is dangerous to health, as is the case in. Los Angeles, it does not take a skilled political prognosticator to predict that there will be demands to do something. In this ease the formation of the EPA was also helped by dramatic proposals to cut down the redwoods and fiaod the Grand Canyan. Air pnllutian was the catalyst that started the EPA, but on= it was in place other long-smouldering issues such as water quality, endangered spcies, and wilderness areais bubbled to the

Spreading Rules alld Regulations top, Once some force is strong enough to break a political logjam, other issues will float downstream in the same current, The resistance to change has been broken and the advwates of clean air have a political interest in looking for allies, Given some important issue around which the public can be mobilized, the nature of the system changes dramatically, Some new legislation and ab new agency are put in place; but more importantly a professional cadre of individuals interested in, and dependent upon, environmental protection comes into being. Some of these people work for government, but many of them work far the lobby ing groups (Sierra Cfub, Audubon Society, and so forth) that supported the original legislation, Others are volunteers who have made this activity into a central concern of their fives. T'%e industries that produce air and water-pollution control equipment start to have an important stake in the regulations. High-sulfur coal producers in the eastern part of the United States help lobby to make those txtitlities burning fow-sullur western coal install stack scrubbers, since this will eliminate the competitive advantage of western coal, (More eastern coal wilt br: burned and the incomes of the eastem coal industry will be higher,) 'The public's attention will inevitably turn to some other issue, but this professional cadre can keep part of the public mobilized for a long fight and can sound the alarm whenever a dramatic issue surfaces. When it is necessary to mobilize the gublie to save the Grand Canyon, the system does not go back to the status quo ante when the Canyon is saved. BSMA arose in the context of dramatic industrial accidents (mine disasters in West Virginia, kepone in Virginia), and the development of new technologies that were able to determine the long-run effectsof asbestos, cotton dust, and the industrial poHution. A wide variety of substances could be shown to cause cancer in animals. Individuals were no longer willing to tolerate the bfaek lung and sIIicosis that their fathers had tolerated. Occupational health and safety standards were not getting worse, but they were not keepin^: pace with our expectations. Were again, once in place, the regulators are going to address issues other than the dramatie issues that led to the regulations in the first place, The ERISA regufation arose for the a;me reason, G very substantial number of elderly American workers were not going to re-

ceive a pension check they had been counting on because the firm (and hence the pnsion fund) into which they had contributed had gone brake before they reached retirement age, Others found themselves fired right before retirement so that firms could avoid paying their pension. Any of us who had h e n similarly treated would feel equally aggrieved and would dehmd &at &e goverment do something. As a. result, it is not surprising that the government did do something, In each of these cass it is fair to ask whether the rules and regulations actually adopted were the best solutions to the prablern; but this daes not after the fact that there was a problem that had to be solved in some manner. The mord of the story is &at it i i not very useful to be for or against regulations in the abstract, &mething is going to be done to meet a clear and present need. The real trick is to find a set of regulations which solves the bask prob lem without creating a host of subsidiary problems that did not previous1y exist. PRQPOSITIOH V:

IS HQ JdJWr

Sometimes the regulation debate is cast as if it is an issue of Left vefsus Right with the Left demanding regufatian and the Right resisting it. Xn fact, the Left and the Right regularly switch sides depnding on. exactly what is being discussed. Cornider the issue of drug regulation, What, if any, drugs slrould be bannedwhat, if any, drugs should be limited to presefiptions? We tend to think of drug-regulationsas if they date back to antiquity, but in fact &ey have been in place in the United States only since the late 1920s. If we talk about deregulating marijuana, the issue is generally wen. as a left-wing issue with the Left arguing for prmnal f r e d m white the Ri&t argues fag regulation. Xn fact, the issue is probably one that cuts across b t h conservative and l i k r d ffactions, with more than a few conservatives liking their occasional joint while puritanical likrafs hold aut For cantrols. Ef you take another &uf: such as faetrile, the issue is seen as fiht-wingers demanding the deregulation of the drug with left-wingers holding aut for regulation. The Left holds that people should be protected from inefiective

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drugs, while the Right holds that prsonal &*dam should reign. Here again, I suspect that in faet there are m e of on eitber side, And neither Left nor Right b o w s how to address our most dangerous and widely used drugs-totraceo and alcohol, W e r e do we enforce no smoking regulations? Should W subidbe tobacco fumers? What is the appropriate legal $Irinking age'! Can Mood tests be administered to automobile drivers? None of these questions can be solved in the context of Left versus Right. Is the fifty-five-mile-per-hour speed l b i t a bft-wing or a ri@twing issue? Xn fact it seems to be, a geographic issue. Are the rules and regulations protecting tfie U.S. steel iadustq a left-wing or a right-wing &sue? In fact they are supprted by evevane (Left, Right, and center) in steel-prducing comrnunitieies. Such questions could be multiplied many times, But the point is hopefully made. There is no consistent left-wing or right-wing position on rewlation. versus deregulation. They are both far regulation under eertain cireurnstances (often diEerent circumstances, but sometimes the same), and they are both for deregulation under certain ehcurnstaoces. Neither is consistent in its positions and neither has a firm grip an deregulatory virtue, IS NO SIMPLE COMELATIQN

BE~EEN WE DEGREE OF ZOMOMXC S W C C ~ S AND THE DECREE OF mOHOMIC m U L A T I O E .

Despite the vacal complaints, the United States is by far the least regulated of all the industrialized countdes. h other cauntl.ies there typically is a large nationalized government =tor Car seetars) -railroads and telephones everywhere, Volkswagen in Gemany, steel and autos in England, Renault in France, m d so forth), Elements of central planning are common. Tke Japanex have their MIm and the French have indicative planning. Government is o&en the prineipaj source of capital investment fixnds and cm canhrof as it lends. me most extreme example of this is in Japan, where most investment funds directly or indirectly flaw through government chmd nels, k i a l welfare legislation and environmental pro&ctian- me typically more a d v a n d . Germany has its determination where union m e m k n must be r e p ~ e ~ n t f f01 b1 the board of directam,

Xtdy is fmous for its complex rules and regulations. M e n it comes to the depee af regulatian, the United StaWs is a faflower, not ai leader. Yet, as we haw dre@y wen, these economies me outprlFoming us md our own pdsmance s h m the on# of Ihe Hew DeaI is b g e r than our p r f o m m e prior ts tite New Deal, Regulations e m be delibrately uwd to promote economic goMh,#asin. Japan, or rhey can be used to stop ecmomic grow&, as has been suggested by the ZEG forces, Either is pwsible. FROmSlnON V D :

mGVwmOMS

$mm individual economic actioas mcur in an integrated eeonomy, the adoption of regulatiom in my one sector of this economy is apt to have effe~tsh other parts. Xf you protect the steel industry amd raise the price of steel, p u are raising the cos& of building c m in the United %a@s and reducing the camptitiveness of the U.S. car indwm, mus a regtxl~tiondesign& to protect one group is apt to hurt anatha goup and lead to new mgula~onsprotecting the second gaup. If you protwt steel, you are much mme I&ely to haw to protect autos, We have already examined the spreading wave of regula~omin the enerw area, Each new regulagon f6rced us to yet add ano&er mgulatim. mMGRUN FMCE O M SHOW@BE AVOmm. Inmeahgly in our eRor& to prevent r&is&ibutionaX ehmgm from coming &but,bsih librds a d c o m m a ~ v aare asking lor price controls, protection, and subsidies for institu6ons-all in the n m e of protecting individuals, m i l e price eon&olscan be made ta work in some economic systems, they cannot be made ta work in our mixed econamy with its s p n n m to pliti_caf pressma. BtxsicalXy, pdce con&oh should be avoid& whenever s a ~ i e qis adhesing my long-range problem. Controls are only usefuX when miety faas a t e m p r q siwation (such a a war ar an embmga) &at is going to eau* a svere shafi-run dismptlon but end at some t h e in the hture, '!%is is a lesmn &at lrolh libeds and cawwaGves d i b , Oil csntroXs were 1957 ta bdd pdas up and in 1973-74 to batd pdm

P R O m m O N VIE:

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$41

down, mey were appropriate in neither case since the problem hing addres~dwas long run in both cass, First, let us consider the case where price controls are wed to hold prices blow the level that would weur in comptitive markets. Such controls are almost always instituted to prevent some dramatic price increases that threaten to cause m;ajor redwtions in the reat incomes of some group, For some reason, there has k e n a sudden shift in supply and demajnd relationsKps, and peaple respond to the threat of real income reductions with. &mmds for protection, Examples would include oil controls, natural gas regulations, and rent control, In the short run, price controls c m mitigate the real income reductions, but at the expen= of stopping someone else's income from rising, If the situation causing the rapid escalation in pice is temporary, a crop failure for examplie;, then there may bt: a case for preventing the sharp temparaq shift in the distribution of real income. Extsa price incentives are not necessary to restore production in agficulture, and industrial wages might be disrupted if agricultural prices were allowed to rise, If the problem is a loag-run problem, however, a very diBerent set of considerations prevails, Consider the regulations on natural gas. Beeaus of OPEC arzd declining U.S. prcxfuction, prices are not going to return to the old levels. Controls can be used ts bred one large real income shwk int-a sevmal smaller real income shocks over time, but they cannot restore the previous price level. m e n they are ugd tt, bold prices down for long periads of dme, they cause prversc: egwts on both the supply and demand sides of the market. Qxi the supply side, the incentive to look for new natural gas is reduced, and incentives are created to hoard old natural gas in expectation of higher prices in the future. The t ~ h n i q u efor alleviating the painful symptoms of the short-run shortages makes the long-run shortage worse and thereby increases the long-nxn p&., On the demand side of the market, the incentive to canserve is redued. f f other h m s of energy (coal) are not regulated, there is in fact an incentive to use mare natural gas since -it is cheapr &a competirjive fuels. Once agah this exacerbates the long-run problem.

Smce the dernmds for natural gas excwd the supplies of naturd gas at the con@oIledprice, the syskm h rquirm rules md regrules and regulau t a ~ a mfor allocathg the existhg supplim. &am usually end up alilwahg most of the availabje sepplies to Ifrw usrs wha have gotten namrd gas in the past. But these are o b n not the peaple who cm most efffciently use the now refa~velywmmr supplim of gas. Industrial users (glass m&ing) and h a @wfswho need clean wmws of etlclrgy may not be able to get it while e l w ~ e d power plma, who em W my f o m of eaerm, have it. As a result, &e gm is not bing w d in the plaas where it could creatcil the rnclst value, The gonger the price is held bIw its mmpGtive level, the such ineacie e, furt ortiom in the Ssituation &mc ~ a t m S h a mam natural gas is n ~ d e d gas , supplie~ssisa cantracts Er> b h g h LNG (Iiquifld natural gas) at pricm fm above the competitive price. They are alfowed to pass imported prices along to the consumer, and thus tfie consumer ends up paying more for gm in the long run &an if phces had b e n allawed to rise in the first place, The same problems can be seen in rent control, Sinm New York City is the only major city that has h& rent control for a long p ~ of dtime, the prablems are most visible &ere. First, those in con&oIIed apamenb have m incentive to hold o n h the cheap contrdled apaaments even after family needs have changd, h g e ents are occupied by elderly couples or single individuals bcause they are cheaper than smaller apmment;s suitable to thek nmds. mus, the egmtive supply of apartments is redueed a d the upwmd price pressures on the noncontr01fed part of the nnmket is increwd. Qm tlne supply side, landlords have neither the incentive nor the resourms to maintain their buildings, Eveq price is appropriate to same quality level, and if the price controllers will not allow a landlord to raise his price to comespond to the current quality level, fie em simply lower his quality Xevet to carrespond to the atflawred priee. Regulations can be written to try to stop this adjustment, but they are difXjicuftor impsible to enforce. Other optioais also exist. If ~ e buiidings w are not rent controjled, the amraprisk *ate= is for the landlord to let h-is building deteriorate (Xet the &nm& grdually teat it &W) and milk it for aft of its cash flaw

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during a period of deterioration. Once it has gone beyond the bounds of humm habitation, it is torn down and a new uncantroll4 buifding is erected, Or the building can be converted to cokdominiums. Renters are hrced to k ~ o m buyers e at the market priw or move out. Since housing is subject to strong neigbborhood externalities (the price of any one house depends ugon the quality of the neighbarhood in which it is lwated), any incentives to let housing quality fall can. have lalrge effects on others,-Rents will fall in a neighbarhood of deteriorating houses even if =me of tf2e houses we not deteriorating. And falling rents will mean that m~ntenanceis not financially possible in the previously well-maintained buildings, and they wiff begin to deteriorate also, Long-run rent wntrol is not the sole cause of New York City's housing problems, but it certaidy has made these problems worse, But there also is a question of equity involved. Price controls e m only stop red income reductions by stopping real income increws for someone else, To hold down the price of natural gas or rents it is necessary to hold down someone" income, Let's suppose that we have cfecided to cushion the incame sbwbs of market-priced natural gas or rents. This leads to the question of what is the fair way to raise the necessaq revenue, Should we dl have to pay through general taxation or is it fair to levy a tax on the owners af natural gas or apartments? They may be richer than the average cansumer, but there also are many other even richer people who do not own natural gm or apartments, m y should they be excused from paying? If price controls are effective in holding down prices, they end up creating even greater shomges and E g k r prices in the long m. Assets are frozen into egeient uses (LNG m k e ~ s ) EBoes . to Iegafty evade the regulations generdly lead to a set of p m e r R actiom that host subsidiary problems (deteriarating neighborhds), The effective tax that is levied to pay ior the income pmtection is p erally an unfair tax in accordance with neither horizontal equity (the equal treatment of. equats) nor veaicd equity (the eomect distribution of tax burdens betvvecn rich and p m ) . Using price controls to hold p r i m a b v e carnpetitive levels is probably even more common than the reverse. Farm price suppom,

transpoeaton regufatians, hpfi restfietions, and m i ~ m u mwages are only a few. In the long run, they create an equal set of problems. Fims that bnefit from contfolled prices often do not have higher rates of return on capitd than &W that du not bnefit. Initidly proEt rates are up, but this attracts more resources into the hdustry. Since price competition is prevented, the% resawces are typically used in various Eoms of nonprice comptitian-advertising, numbr of flights-or in excessive eapitaf investments (too many oil wells, too m a y tmeks). This use of g e t s is not campletely usr=less,but it dso is not the mast efficient use a2 its%ts. The result is some net reduction in our rate of growth and real living stFdards. If extra profits do emerge, thew also lead only to a one-shot g&. The a t r a profits get capitalized into the price of the controlled m=&, sand any new purchasers reeeivt: a competitive ra& of return on their hvestment, Taxi mdallions have a value because they h v e succeeded in raising the profits of mnning a taxi cab, but the regula~onsdo not help my new enf;rant into the W i business sin= he must purchase a medallion as weH as a taxi, W e n both cos& are considered, taxis earn a competitive rate af return. But here again, no one who awns medallions wants their value reduced even if they do not raise lon&run profits. The s m e is true in every other industry that enjoys protection, The post OBWis another example. Since pasta1 rates have been set at a Ievel far above the cast of delivering much of the mail, rep;ulatio~smust bt: issud and enforced thereby stopping others from going into the fir&-dass mail business. We are all familiar - with the news story of the post ofiee suing to stop gome child from delivering local mail, but the purpose is to stop real competition. he-result is a situation where the post office and postal workers have-little or no incentive to cut mail delivery eosts. As we have recently witnessed, this is true regmdless of whether the pwt o&e is organized as a governrnexlt department or as a profit-making carporatkn, Utilities, industrid mailing fims, and others would undoubtedly do to first-class rates what United Palr~eland others have done to parwl post if given a chance. Undoubtedly there are routin the Unit& States that could not be eomptitively wmiced with l an: a 'fifteen-cent first-class letters, But if low-pdce m ~ delivedes nation& god, then we ought to finan= this gad natianally and nat

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levy a tax on those who should be getting cheap mail. deliveries beam h e y five in places where: mail can be delivered cheaply, In the short run, price controls are always sductive. They mem a direct way of achieving mme objec~ve,but they end up causing enormous long-run costs to achieve some vesy limited sh0f.t-mn objective. And if this objective is desired, there are mmy o&er ways (dimct income subsidies) in which it cm be achieved. Generally we (3a not Mlaw the cheapr, more direct route of direct income subsidies for a simple pditicat reason. Voters wilt not put up with 1-e direct subsidies, but large indirect subsidies can be hidden from the voter if rules and repfationis are used. A@cultural subsidies are wofih hundrds of tSlousands of donas to some large farmers, but no Congress would ever pms a law simply giving large famem averat hwdred tfiousmd dollars apiece. The same Congress wilt, however, p m p"iee sums lehladon that daes exactly the same thing. Along with their greater emeiency, this is one of the reasons why direct subsidies should be used rather than indirect subsidies, If we would nat support them overtly, pmbably we should not support them covertly, 'This applies to both industrial subsidies and humm subsidies. If we wmt to raise the income of low-wage workers, a wage subsidy is to be preferred to a minimum wage. We then know what highet wags far low-income workers cost us and c m evaluate whether it is woflh the cost,

ff we are to estaMish a competitive economy within a &mework of international trade and international competition, it is time to recognize that the twhniques of the nheteenth century are not applicable in getting ready for the twenty-first century. The late nineteenth and early twentieth centuries witnessed a two-pranged cEast to create and maintain competitive capitalism. Antitrust lam were developed to break up man-made monopolies, and reelations were developed to make natural monapolies act as if they we=

competitive, While h& of these appraa~heshave had their prob lems, the time has Gome to r e c o p b that the antitrust approach has bwn a failure. The cos& it imposc=s far excwd a y hnefits it brings* law8 cm Elff seen The futility and obsolescence of the anti from a number of vantage points, First, with the growth of internationaE trade it is no longer possible to dekrzine whetjrter an effective monopoly exists by fmking at focal market shmes. Regardless of the share af domestic praduetion held by General Motors, General Motors is part of a competitive induswy and must deal with strong Japanese and Europan competitors. In markets where international trade exists or could exist, national antitrust laws no longer make gnse, Xf they do anything, they only serve to hinder U.S. competitors who must live by a code that their foreign competitors can ignore, One could debate whether international antitrust faws would m&e sense, but this debate would be completely i~elevantfrom a practical gerspctive, In the absence of anything resembling world government, and in the presence of wi&fy digering views on the usefulness of antitrust legislation, no enforceable, international antitmst laws are going to come into existence. IF competitive markets are desired, the appropriate policy should be ta reduce barriers to free trade, Whatever good competitive eE fects the antitrust laws have had on the behavior of the U.S. steel industry, they are completely dominated by the bad competitive effects st the reference price system designelJ to keep foreign steel out of the United Ssates, Whatever g o d competitive eflFects the antitrust laws may have had on the khavior of U.S. auto makers, they are smalt in comparison with the competitive pressures bropght by Japanese and European. automobile producers. If one measures the potential gains to be made by enforcing the antitrust laws, as apposed to reducing real barriers to international trade, it is clear that the large gains exist in the area of more interxlationclf. cornpiition, Scond, as incomes rise it keomes fess and less clear as to what is the relevant market to determine whether a firm has acquired a monopolistic ;gosition, Most goads we buy are not physiological necessities but luxuries that could be substituted by other g d s to

Spreading Rules and Regulatiolls produce just as high a real standard of living, Rolls Royces and Volkswagens are both ews, but the two prducts are in no sense competitive. Far those who buy an expensive ear, the wade+@ may be with a swimming pool, a summer home, or a wide variety of other praducts. Rolls Royce rnay have a virtual monogaly p s i tian in the production of very expnsive cars yet still not have a position it can exploit, Xf it prices its product too high, people will shift to different products., As an illustration of the same problem at the other end of the price spectrUm, camider the antitrust case in the breakfast cereals business, Let us assume that a few companies have established am ofigopolistic position with respect to dry breakfast cereals and are charging more than would be charged in a camptitive mmket. Since any individual consumer can, if she or he chooses, buy no-name brand corn flakes at a much lower price, the brand namm must be yielding- some psychic utiiity or brand name corn Aakes would not be: sold, Consumers may have b e n eonvineed of this psychic utility because of advertising, but so *at? At the income. level of most Americans, most wants have been determined by some explicit or implicit form af advertising. Physiobgical needs determine very few of our expenditure dwisions, Xndividuaf msunners rnay be making silly decisions (buying produe& at prices higher than they need to pay), but it is hardly the appropriate role of government, much less the antieust laws, to stop pople from making siHy decisions that do not afict anyone but themselves, But let% suppose that the no-name brands did not exist. Since corn flakes are hardly a unique, patented, hard-ta-produce product, the absence of no-name brand corn flakes could only mean that individuals are willing to pay for having brand name corn flalres. People are allowed to pay for the brand labels of efotbing designers, M y stop brand fahis here? If the brand premium gets too large, others can easily enter the no-name brand corn flakes market. But even if no-name brand corn Aakes could not be produeid, there are still a great deal of otlxer breakfast alternatives (bacon and eggs, no breakfast). mese other products malre the market a competitive market even If them is no competition wi(hin the dry cereals business. m i d , monopoly ren@ are inherently limited in an economy fug1

of lstrge canglomerate h s . Since wtabtiahed nnwket l-posi~omare usuaUly emier to defend thm to create, oligopgistie m s may be able to @x&w~ a sm* price premium &am &ek cwtomem, but this ability is ieenntly lixniM By the ability of other 1mge G m to enter the maket. Exwssive rates of return ateact a d ptenEjd eompti@m have the: abiXiq to en&r d l markeb that are not natural monopoliezr, m i l e the conglomerate movew merit may have 1umM activities togetfier that me not the m a t eacimt e t s of activities to be lumped together (to the same extent &is is a prduct of the mfiwst laws), if has also cmatd a set of large fims that scan a wide range of prdacts and namkets to scareh for profitable investments. Firms with no actual or potential cmptitors are few and fm btween. As a result, W apparent monaplistic psition is actually vulnerable from h& the dernmd and supply side of the market. Potentid customers have alternative uses far their incomes and gotentid comptitom am almat aXway8 waiting in the wings if profits appear too hi&. Fourth, it is not obvious that anything of economic v d u e is W complished even if an antitrust c m is won by the gpvemment. Consider the cument XBM ease. Suppm the government were to win and XBM were to be broken into three or four large fims ( m outcome that is highly unlikely given recent anlitmst; mprienee). M a t characteristics of the indusq would change? By now we should have enough experience to know that a three- or four-fim oligogoly daes not act noticeably digereat from a one-fim monopoly faced with potential competition (the Japanese) in its main business and actual competition where it is weak (in small computers). If Y ~ L Elmk at other industries where anti.trust laws hgve resulted in the creation of new eompti'SE)m (ail m& duminum) ar where they have swpedd iaeffcient producers from k i n g absarkd by competitors (steel and autos), it is hard to argue that these industries are more efficient or less competitive than the computer industry. IBM has dr-iven other large fims out of the industry (GBand RCA) tXlraugh king abIe to pravidle a htter product, ff the e w wre to succeed, the most likely winners would not be computer cmtamers but foreip computer mmufaeturers, No one questions

Spreading Rules and Regulations &at XBM bw a damirrant. market pition. But" this is not to say that it hils able to ex&wt cdppling manoply r a a from camputer cmtamem. In some ways the c- reads like a government sign saying, ""X t w not pay to be too efficient." Yet in a larger context, this is cerainly a slogan that we cfo not wish to h u e if we: me:Interested in Iang-mn efi~ienq. Fifth, the whde antitmt &ion s p h g s from a vefy nmw vi@w of competition, C o m p t i ~ o nmeans price competition-nothing more and nothing Xess, Yet p r b is clearly only one of the, m a y c~mptitiveweapons (advertising, prduct qualiry, md so f d ) and in mmy areas not the most useful or ugd weapon. We have a vision in the backs of our minds that if we only m a t e enough fims, firms will X>e driven to price camptition and have .kr abandon o&er forms of competition, mere are wveral problems with this vision, Even if it were true, the rquired numkr of fims is so much larger than the number that woultd be created by an antitrust ""win" it has no relevmm to mti&ust legislation. But more fundamentally, it is not true. 'T'here are many industries with thousands of snaIf-scale p r d u c m (red estate agents, lawyers, dactors, speciaftcy shops) who d o not eompete bafed on price, Many customeris would ra*er shop in elegmt surroundings than buy at the lowest possiMe p r i ~ Shopping . md the thril1 of being enticed may be a major part of the enjoyment of buying goods and sewices, To Imk simply at the degree of price corngetition in the economy is to grossly underestimate the degw of real competition in the economy. %mehow lurking in the backs of our minds is the puritan idea that if we could only strip away advertising, fancy surroundings, nonessential product characteristics, and the attractive salespersons, we would get back to true preferences that would create more enjoyment, Most of us think that wc: are ciever enough ta avoid beiq duped into doing anything that W do not really want to do, yet we: think that we must act to protect someone else from being led astray. Why? Let me suggest that there is no reason. Nonprice forms of competition are just as useful and valid as prim competition, W e n Industries do not engage in price camptidon, there usually is a perfectly good reason (other than monopoly) as to why they del

nat, It shply isn't the most eBcient way to campte, h a result, we we nat going to rmtore price camptiGon and puhtm simplieiq though ehe mtitmst laws. Given our m d e m economic envkonment, antimst regulatiom shauXd be stripped back to two basic propositians, The first would be a ban on predatov p~eing,Large firms sfiouId not be allowed to drive small fims out of business by sekctively lowerine their pdws in submarkets while they rndntain high prices in ather s u b mwkets, The scond propsition would be a ban on explicit or implicit cartels that share eitfier markds or profits. Firms can gfaw by driving competitars out of business or by absorbing them, but they cannot agree not to compete with each other. Tn an economy as complex as that of the United States, no ane can wifh 100 percent mrlaixxty say exactly how campetitian and industrial stmcture would change if the antitrust laws were reduced to the fundamentaits of prohibitingpredatory pricing and cartel f o m a ~ o n . Perhaps we would find that same unacceptable results would wcur and that same additional regul~lorxswould be necessw, If m, the: necmsary rewfations can be: written, when the a b u ~ appar. s mis is an area that has become sa complex and so little connected to economici goals that we need to start over and st=e what a modern economy nee& in order to remain a comptitive eeonamy. None of this is to deny that technalogieal advances witl from time ta tirne requirt: changes in the rules of industrial comptition. With the development of microwaves and satellites, the long-distmce transmission of messages may have changed from a natural me= nopXy to a potentially conpetitive industry. It so, rules and regalations gaverning the telephone busirzess should be changed to reflect this development. Whatever should be done, however, the correct answer is not an. antitnrst case against AT&T. A regulated manapty should be: governed by regulatory procedures and not by antitrust procedures, Xf the goal is a competitive industry in longdistance transmission, an antitrust cast=is simply not the means for getting to this objective. t)eregufation is k s t achieved by deregulation, not by a lengthy court caw basd on principtes that have nothing to do with regulratian af deregulation, nts. 'They em at-

Spreading Rules and Regulations tempt to set regulations that a u e n c e the groduc~onof some good or service. Them might be called q reguhtions shce they are htended to &ect quantities g~ectly.m, &ey c m a e m p t to levy taxes or subsidia to encourage or discoutage; the pmdwtion of =me 8 4 or service. mese might be called p regufatTons dace they ate intended to &wt priws, In general, we h m relid too mueh m Q - t wregulations and not enough on p-typeregulations, With p - t p regulatiom the ~gulator M m to take advantage ol srapket inanlives rather thaa aMempting to fight mwket incentives as is the c m with q r@@Iatiam. EBuent chmges are p qulations that lead to less e f u t i m . Insurance ehmges under the workman's compensaaan syste?m be rdwd to cover the maX c& at! hdus~af, acci&n&, to dlocate thaw costs to indusbries with poor health and artfety I a red inwn6ve hprave &ek health and sdety pdommrze. Ptivate pension funds em be federally insured in a system that =fleets the red probabilitia of default. 42' individuals could be allowed to buy extra pnsiaa bnefib thou& the aiaX security system, Such chmges have the advantage that &ey enwurage each individual economic actor to find the best method fat: reduchg plfutions and accidents or for assuring future pension rigXILs, The viI-tue,sof p regulations over q regulations are something that the economies profession has stressed for decades, There are undoubtedly sorne areas where such marker sogutions would be difficult to implement (esmeer agents with Bang-time delays might b.e: one), but they could salve the problems ia many areas where regulations are not rampant. Yet despite our professed social klief in the value of markets, such solutions are resisted by almost everyorre involved, Society has almost universdty emplayed q regulatiom when it sought to achieve sorne objective, Why? Understanding and curing these preferences is at the heart of the issue, FVby are we as a society so resistant to the idea af p regulations? Is it simply igno-ranee or is there something W wish to achieve that cannot be achieved with p regulatians? If one goes thr~ughthe fist of objections to p regulations, it is clear that they spring from a set of conflicting visians of the eean-

omy. h we have dready w n , t h m wha want to protect the environment or industrial workers o k n faIsely blieve that firms will shply pay ratI.ler thm reduce pollution or accidents. Q regulations =em more certain to achieve the desired objective than p regulatioq. Given our rwent history*?be b m i ~for this fatter klief is difficult to fathom. Many q regulations have b e n written, but the objectives have not k e n achieved. Lmpholes have k e n found (tmcks md vans replace cars) or the regulations have b e n junked (cornpulsory seat belk) when they prove unworkable or intolerable. Writing a regufatian does not guarantee.that some objective will be acconnpiisked. And by now we should have had enough graetical experience to convince anyone that this is true, P ~gulationsare ;also opposed on the ground that they will simply be passed on to the consumer, This is both true and desirable md dws not in my case distinguish them from g regulations. From the perspective of those wishing to reduce pollution or accidents, .there is a find charge that p regulatioms are unfair, since they a t l w the rich ta buy the right to pollute or crrus~accidents. As we have already m n , this is right, wrong, and irrelevant all at the s m e time, From the perspective of thaw wha are resisting pollution or safety regulations, there is usually just resistance' withwt any participation in the debate about appropniaite means. To get into h e debate between p and q regulations would be to undereut the arguments against both p and q regulations. The resisters do not want regulations and they do xxst want to pay far something that they have always had h e (the right to pollute). Blind resistance is only rational, however*if you ktieve &at ?he provanns can be defeated or avoided and frustrated at fow cost, Here again we have recently accumulated a mmiva amount of empirical exprience, matever the original vdidity of ?he bgef &at the programs wufd go away or could emily h h w a t e d , the belief has k e n proven urrang toy histaq. Regtlfati~ns will be adopted sin= a majority wants to achieve the stated goals. m e w regulations can be frustrated so that the end rmults are not achieved, but very subtantiaf costs will ba: impo& regardl- of vvhetPler the mgulations do or do not prsdua F e desired results. And if the ends are nat achieved, the result will not h a return to

Spreading Rules and Regulations

G3

the satus qua mte, but the d o p ~ o nof a new a d more: s e g e n t set of"q =@a~om. From tke p h t of view of a rcsisbr, it is obv3ausly muck ewier to live with a p regulaaan than withi a h a t of q regul&Gom.Yet it is very d m ~ u l for t a mister ts @ay a commctive role h deb%@s a b u t appropfiate te~hiquegfar achieving a god that he sr &@ wils =king ta frustrate. matever they recamme?nd will d w q s be w n as a vehide for hs&athg the desird objetive ra&er &an as a Whdque for achieving the degked objecdva with fewc~BBdesirable side egects, m e bminw c o m m u ~ qwould have h a better aR to abandm a pcllicy of total resisma and ins&& wncentrate on iduencing the medevelaphg t ~ M q a m live, e t h g to a set of p =@auriph which they could mare tiom after a .%lof q mgufatiam has b n adopted is gahg to EM1! one of the major challe;ng,c=s af the 1980s.

ribation Once Again Sin= the ulhate every w m p ~ ~ v e monoply p i t i o n it cm e m mam raae: of. return, mles and reguladons me n d e d to emwe &at nat too mmy compti~vefims sucmd in aehie*g &eir sbjw~vct-. At the s m e me rules and regulations can be, a d in mmy cm= have became, the: mems whereby comp~tiveAms and i n d u s ~ a achieve their monapotisac goals, By s ~ p p h gbdusM;zX mIw sad regdatians dawn t-a the bare emnads, there is much more to I s g a h d than to be lost. If we &o toa far aod abms emwge, they can be eomected, If new abum do not appar, &is is in f&cEa pi= of evidenw sbouring that we haw not sMppd away enaugk of the rules and regagations enerus~ngour aonamy. But h the end the mntrd problem remergeS. Matever &chnique is e h ~ to n reach difjFereat hmme is gokg to go darn. Rules and mplatios me na e x q d o n

.

The dktributio~trmferskom aae paup of h e ~ e m to matfier group of Amedciiuts aret not as QV@& and, *ible as thy we in the ~ e ofadirect &mfer parnab, but &ey are undoubtdly larger, VViaaut a vision t wmfitutes3 an. equitable distribu~anof incame, it is not to say wheaer we have a g& set of a d nplations or haw this set should tre modifid.

w

Chapter 7

Direct Redistributional

ALL VVBTERN GOVERNMENTS have become lhetavify involved in dtering the distribution of masker rescturms directly as well as indirectly, Ethically we have been cornmi@ed far mmy wnmes to the idea that a ""go@ society dws not let families s t m e on the s&eet, Wirh this commiment comes the respoxlsibiiity far providing a minimum family income if the family is, for whatever reasan, unable to take crue of itself, Exactly how this should be; dsne and what revel of minimum income shctutd be providect is one of our most contentious issues, but it is unavoidable, Our ethics force the issue upon us, but it is also not at all clear that m h d u s t ~ dsacieq witfii its delicltite social and physical interaegons eouEd tolerate ex&eme deprivation. It would simply be t m easy for those witib nothing to lose and evexytfiing at stake to disrupt the rest of our society and economy, With the collapse of the idea that mmket incomes are determined by impersonal forces outside of human control, direct redisdributions have atso extended far beyond that af simgly establishing a minihum income floor to prevent exeeme depfivation. In 1978 direct transfer payments accounted for $224 billion in annual spending,l Over 10 prcent ot: our C M wrts devoted to taking income frm ane ~ i v a t eindividual and g i ~ itg to anoZfier pdva& individual,

If one looks at the consistency in the dig~butionof fmiXy income (see table 7-1 ), ane might ask why dirwt redisMbutio~a@ so contentio~s,~ n o s e ap to government income tramfers have little rftason to complain since the distribution of income has not been made more unequal. T'he rich ase as rich as ever. m o w in fwor of government: income redistribution have litfle r e w n to ask for more redistribution since 9224 billion in annual expenditures have not succeeded in making the distributisn of income more equal. If $224 billion does not solve the problem, why will more money solve the problem? TABLE 7-1. Distribution of Family Income, f 947-77

b w e s t Quintile 2nd winrile 3rd Quintile 4th Quiatiie Wighest Quintile

5.0 f 1.9 17.0 23.1 43.0

5.2 11.6 173 24.2 41.5

murcr: U.S. Bureau af the Census, Current Populugan Rtp~ris.Cansumer lncoae 161)17, Scrics P-@. no. I f 8 (March 1979). p. 45,

Rectis~butlionis a contentious issue and is going to became m even more contentious issue for a shple reman, The cortsis&ncy h the distribution of family income has mlasked a market distribution of income (sett table 7-21 that h sXawly b e ; c a ~ n gmore mequal. The bottom 60 prcextt of the population. has been losing rigs, but its income has been held even with the rest oi the popuIatian through the rilpid rise in inwme eansfer pillyrxlents md labor force participation rates for women in &ese- economic classes (g@below). In the hture the trend towad a mare unequal disrribution of etzmbgs is apt to show arp in a more unqual distribution of f'amay incame. L a b r force paxticipa~onrat@ are now rising mast rapidly far women who are m a ~ &to men wi& high incomes. Al&ou& hcome trwfer paymen& have stop@ the econamic gap bmeen.

Direet Redis~ributiondIssues TABLE 7-2 Distn"bution of Wage and

S a l ~ r yEarnings for Persons

I-slwest Quintilc 2nd Quintile

3rd Quindle 4th QlurintiEc Highest Quintite

2.6

8,I 15.6 23.4 49-3

1.7 7.7 16.1 26.4 48.1

soullca: U.S, Bureau of the Census, Currenf Populalon Reppis, C~ngumer Income 1977, Series P-@, no, 118 (March 19701, pp. 226, 227.

the rich and 'the poor from rising since World War ff, they e continue to rise as fast as they have over the pwt two decades. With. income transfer payments slowing down and working wives eontdbuting to inequality rather than equality, tfie distribution of family income will start moving toward inequality in the i980s and 1990s. Given rising inequality, difect income redistributions are apt to become even more divisive than they now are, The zeresunn emnomic game is going to become hmder to play since more direct income transfers are going to be demmded. mese demm& may not be met, but they will have to be faced. To look solely at the tensions within the income tfmsfer system, however, is to miss much of the' direct redistribution& problem. Governments impact the disuibution of economic resources through two other direct channels. Whenever governments extract tmes they lower someone" income, but whenever that money is spent they also raise someone" income, Since gsverments do not s p e d their money on the same goods and r;ervices purchased b i private individuals, a transfer of purchasing power flforn individuals $0%ova ernrnent yields a digerent set of demands, and in doing so a digerent distribution of market incomes, Demands go up Em some skiXXs and down for others. Perhaps it is not surprising in a hmwraey, but each of these channels delivers most sE its benefits to dierent; ecoxxomie classs. T'he poor have their income transfer paymentf and the rZch have

their tax lo~pholes,which allow them tc, pay less &an their fak share of tags, mite h e mid&@cl- l m h down at the pwr and up at the rich and oftkn thiks that it pays far go its share of the benefits, &is blief is f a a a ~ t expn&mes (ro&&,shmls, parks) are heavily foc s of the middle class, But even mu= inzpoflmt, government is a mqor prayider of middle-class jab, Without government &ere would be fewer middle-class job, fewer midde+tws inl comes, and fewer middle-cl= fmilia. 'Ibis delic;ite plitieaf balanw is being dkmptd md it is not clea what will replace it, With idation there is a demmd to cut back on ut my cutback wiEl increw the ecof fewer incame &mferpameaQ) md the m a l e clas (fewer g d job%).Wi& slow go* them are demmds to fu&er cut taxa on the to invmment. But any cutbirek will n middle class. Pressures exist to dismantle the current troika of hnefia, but what happens when Ule cumnt system has broken down? With yyhat do we replace it? As large as the gap kttxteen the rich and the p a r may be, the major demands for recliistdbution exist not on this dimension but btwwn ethnic or sxuat groups. Should government ewnomic plieies fwus an eliminating diEerences in the economic outcome among such groups or should it fmus an helping indirviduals whose economic prfomance is in some snse; blow soeiety"s noms of xeeptability. m i s is a fundamental idedo@cat question facing the United Stales md mmt other Western industrialized countries, Both our pagitieal and our economic traditions have fiistorieatly focused attention on the individual. Individuals are awarded voting rights and individuals are to have an equal opportunity to achieve economic success, But ours is a swiety of groups, each demanding a larger &actionof the national pie. mese denran& have often b e n ignored in the past but can they be ignored in the hsturel

Directt Redistributional Issues

359

The Success or Failure of Cuwmt Redistributions W e n we talk a b u t the growth of government expenditures since World War IT, W are talking a b u t the growth af direct income transfers, While government purchases of goods and services were growing from 18.9 percent to 20.6 prcent af the GNP from 1956 to t 978, income transfer payments were growing from 4.1 prcent to 20.7 percent of the GNP.a Government purehass are up slightly (federal purchases are actually down from 10.9 to 7-3 percent of the GNP), but we are entering a perid of falling purchaes. SehooX enroflments are beginning to fall, and over 40 percent of all state and lacal expnditures are for schds. While the social welbre expnditures of tbe late 19Ws and early l 970s are often descrikd as a failure, they were, in fact, ex&emely successful, And nowhere is this mare true than mong the dderly. As has previously h e n ~ x m i n e din the chapter on inflation, the mean per capita income of the elderly now equals that of the rest of the population. If in-kind aid (medicare, food stamps) is considered, the: efderty have a hi&er per capi.tr;i ineome than the nonefderly. The gereentage crE the elderly living in poverty ( t 4 percent) is slightly higher than that f'or the whole populaeion (12 percent), but not much, ff social security were to disappear for the elderly, their incomes would fall by 50 percent. Half of the income going to the elderfy comes from government transfer paymenb. Among the rest of the population, income transfer payments have been equally successful, The distribution of family income is a, anisfeading indicator of success or failure far a number of reasons, First, it ignores 23 million single individuals who are not in families. We and, it does not take into account the fact that the average family has grown smaller since Wrfd War 11, Birth rates are down, ymng people go off to set up their own households at m earlier age, and the elhrly no longer live with their children, mis create8 more separate househall& with fewer earners per ho~ehald. A betrer Indicator of real welfare gains is the distribution of per capita housebdd income (see table 7--3).C Viewed from this psgective &ere has ken, I si8aifican.tincame gab for the lawwt &=

guintiles of the income disQibution, M e r e the tap q&de had eleven times as much income iis the haom quht"le in 1948, it had: only seven times as much in f 977, 'Ibis occurred in the face of 15sin&inequality in earnings (the top quintife of earners had ninetmn rimes as much as the bottom quintiie in 2 948 and Wenty%ight times as much in 1977)." TABLE 7-3 Distribution of Per Capita Hoclsehald Income

Lowest Quintile 2nd QuintiXe 3rd @intile 4th Quintite Highest wintile

4, I 10.5 E 5.0 23.5 49.9

5,6

t l.7 t 8, I 25.5 38.1

: U.S. Bureau of the Census, Cmreef Popularion Reports, Consrcnrer I rrco:r~e.

a r k s F 4 , nu, 517 (D=, 1978). p, 22.

WitIzoue income transfer payments, the shwe of income going to the bogtarn quintile of households would have been more than cut in half d ~ r i ~the l g post-World War I X p r i d e Government actions

prevented this from happening and aetuaily caused a subitmgal gain. in the income position of the pmr. Here again, m&ing a carrection for in-kind aid would make the gains even larger, m i l e it is difficult to piace a cash value to the recipient on mmy in-kind aid prsgrarns, wme'pcograms, such ;EIS food stamp, are fundable and just as valuable as c&. ff you da not need the stamps you can sell d purehas& with &ern) to someane else, In heal them (or the f 1978 food stamps represented a $6 billion increase in the red hcome of low-income in-dividuals. This repreen& a 25 percent increase in. the income of the bottom quintile--a sohrce sf income &at is not considered in official i a c s m statistim. In addition, manpower training prssams have k p t the dis&ibution of emifx&sfrom &coming even mare unquaf, In 1-9"i"approximately $10 billion w o ~ hof wages and salarim were pajid out under mmpwer training progrmse6 Almost all of this g m ta

workers in the bttom 40 prcent of the work force, md it acmunts for f 8 percent of their earnings, Without mmwwer trkning p r e grams the share oftotaf earnings going to the h n a m 41)prcent of the work force would have fallen from 10.7 p r m ~ to t 8.0 percent rather than to the 9.4 percent that actually occumed. T'be deteriorliition in the earnings pawer of the poorest workers was not halted, but it was significantly arrested. m i l e income tranffer programs have kept the b a a m quhdle of the population from losing gmuad, working wives cifoppd th@ wand and third quintiles from Xosing ground to the top turo q ~ n tiles, It is mong &is income class that fmde pmicipation rates are the highest, have risen the most, and are adding the most to farnif y earnin@, This source of houshofd inconne egualiw is probably alresldy in the grwess of vanishing. Under tfre impact of female 1ihaGan md the general long-run trend toward female work, fern&@padcipation rates are ROW rising most rapidly for wives of high-incame husbmb. Since p~ieipatianrates have fartfiest to r i s for wives of high-income husbandrs, high-income families stmd to gain the most gram future inaeases in female paxleicipation rat@. If you blievz: in. selective mating f men are nnahed to women wha make the s m e mount in a nondiserimhatoq, equal pdeipation world), then " padcipation eflects are apt to be magnifid by larger e m i for wives of highearnings husbands, At the moment, &e diBerenees for wives of highearnin@ busbmds and wives of lowe m i f i p fiusbmds are not subsrruttiai. Warking wives contribute: to equality since their earnings are much more equally distributed &m those of their husbands. Xn a nondiserirnhating, equal pmticiparim world, fernale earnings are 'apt to be as unequal ns those of men. The net result-a more u n q u d distribution of household income. As a consequence, one of the two wurces of consmt f m i b ine a fcruree of p a k r came shares is a b u t to revem iWf md inequality, We are entehg a prid of &ing inequaifi~whem eonventionA hcome trmsfer will be incapable of pmwming the cument degree of inequzxfity. And as the third quintilm of the bwme digribution Iae ground to the tap

~o qrrintiles, they are unlikely to support the k c r e ~ e in s inconre transfem that would be naessatry to keep the first ar p r e s t quintile from losing ground. The bottom three quintiles will be losing ground to the top two quhGles of the population. In the past two decades we have coped with rbing mwket inquality by increasing income transfers shaqly and providing jobs for the wives of low-wage husbands. Neitfier sofution iS apt to hie: possible in the next two decades. How are we going to c o p with rising inquality in household incomes? Ns one knows becaus we have never had a period of rising inequality since income data kcame available, &ommicdty there is a simple answer. We: could cuf taxes afld raise-tramfer papeats for the: bottom three quintiles while raising t a e s for the top Wo quintiles. But this is a pure xra-suni Qmsfer, Every dollar given to the bottom 60 percent aE the population must be; taken away Erom the tap 40 prcent of tfie population. Pditicdly this is exactly what we have W a unable; to do.

To deternine the impact of skills, the pattern of industzlia ings, it is necessw to estim;nt. characteristics. Total government employment hcludes direct gavmment empioyees who work on g nt pa"yro1ls a d indireet ent empIayees who technically work fsr private c o m p ~ e s but who prduce government g d s and services. From this p m p t i v e , tfie woodworker makhg schmi dmks for a private: furniture company is jcrst as much a government employee as the schwlteacher on the public payroll, The furniture m&er is shply

fa 1976 governmen@ (federal, state, and Xwd) &cegy employed 18.4 prcent of all those workers who worked. Of &em 19.7 million indi~duals,2.1 rni1Mon were fderal t l a 3 i t ~emplayws,

3.4 million were federal civifim employees, and 14.2 mitlion were state: and Xo~a.1employees, Government emplayd 21 permnt of aXE women, 16 preerrt of all men, 25 percent of all b-lacks, and 15 prcent of all fiose of Spanish ofigin.? If the oceugational skill mix (see table 7-41 of government is compared vvith that of the private economy, &ere is om s&iking diffcsrence. Government, and especially state and faeal governmen&, providt?s emploment far many more professinnd empi~yeesthan the private economy dws, Government.employs 34.5 pemnt of all male professionals and 49.9 p r e n t of all female profegsian&, m e n you consider a15 of the female schoolteachers, welfme workem, and nurses OR public payrolls, this result is not W surp~singa,% it first seems, but it means that highly educated women. are heavily dependent on government expenditures for &eir jab opportunities. If an acmss-&@-board cutback: in gove were to occur, workers wauld be laid off in proprtion ta their ernTABLE 7-4 Percent .of Occupational Employment Due to Direcl Govcirnment Employmmt Federal Gov't. hupation

Male

Female

State & E.acaf Gov't. Male

Female

Total Gov't, Malz

Female

Professional Managerial Sates Clerical Craftsmen Operatsves, Excl.

Translportatio~ Transptlation Owratives Nonfarm Laborem Private Household Service Wofkers Exef. Househald Farmers

Farm I L a b ~ r s ; TOTAL : Entrocleri f r m the U.S. Buccau of the -mm, wrts, C o w m e r lncom 1976, Ce~swstapes,

Gumnt P o p ~ l a l o m Rc-

pI~ymentin the government setor, A8 the government metor can* tract&, the privab mm wodd expmd, but expandhg priVa:& deman& wauld not employ the s m e skas r& by ~ovemment.Xf you exmine table 74,my male weupil;tianaf group that has m o ~ than 16 percent of i& emplc;lyment in government and my fern&@ paup &at has over 23 *rant of i& emplopent in government jab opp~unitiesand wags dhi&Snge8 Gonvemly, would h d i& who are undemeprewnted ia government would find aeir jab o p p ~ u ~mid ~ ewags s nishg as -the p~vatie;economy grew reEa~ve to the government emnamy, G a v e e a t employment dkmtfy &tern the smcmre of employthe diaMbutian d ment opportunitks, but it Jso direetXy wages, sin= government dcws niat nems;uriXy pay the s m e wagm as the private eeonamy, me of the m&avemi@~ a b u t gavemmerit employment is the ez&nt to which it "over pays." m e relaave earnings of full-time, fufl-year government wmkers me p r e s n a in table 7-5. Bslsicdly, higher wages arc: paid to warnem and minofitim. For white maks the higher pav of the fderal government is eounterbaf~ndby the lower pay of the state and local government. TABLE 7-5 Earnings of Government Workers Over and Above Those Received by Workers in the Poivate Economy (in krcent) Males White Black Hispanic Females White Black Hispanie Government Fdeml State dt k a l WEE:

he-

O 14 -6

Q IS

2 113

-6

9

Extracted from U.S. Burau

1978, Ceasm tapes,

gf

36 2

28 43 25

28 44 26

36 53 31

26 55 19

the Census, Camn# Pwul@iee Reprts, Conmnrcr

l%is teach to an argument as to whether government wages are higher b e a u x government hires mare skaled emplayws, becaw government discfinzinabs less a g a b t wamen and nnirrdtim, : nt simply gays more &m it shoutd. M i l e it L diScult to settle the discrimination issue, it is relatively eay, due to the mix of skills employd, to determine the extent to which government w a p are hi@;herthan those in the pdvate ecox~omy.

'This can be done by calculating the government wages that would be paid if ewfy wcupationar skill in gave: exactly what that s m e skill makes in the plrivah economy. I f government wages are higher than this calculation would iadicate, the extra skills of the government I a b r force cannot explain its higher wages. When such s skill comection is mabe, the -federal government's sapparent overpayment to white maks dtisappars. Government simply demands a higher-skilled labor h e : than the privilte econony. The same thing is true for whik women in state and local government, Once a correction is made for their skills, their appwent overpayment also disappars. The apparent premium for white female federal workem, however, is reduced from 44 percent to 20 prcent, but it is not eliminated.@Even after one corrects for skills, the federal government pays women substantially more than thk private economy does. Minority females end up with an even larger premium (around 30 percent) in the federaf government and a small premium (around S percent) in state and local governmenB. Minoriq mares receive a b u t a 20 percent premium in the federal government and are close to parity in state and local governments. Correcting for occupational skills increafes the.observant underpayment for white males in state and local gowtnments since they end up earning only 82 percent as much as they would if they were paid the wages existiq in the private economy, As a result, the question of overpayment really comes down to whether you believe that goyernment discriminates less or whether it simply overpays, matever the truth, government raises the earnings of women and minorities above what they would be if onty the private economy were to exist, In addition to employing 18 pscent of the tabor force directgyp government indirectly empfoys 11 percent of the private Xabar f'orce through its purchases of goods and services kom the pdvate economy. But this percentage diEers dramatically from induistq to industry Iser: taMe 7-61," Here again, any industry with more than If percent of its employment emanating from government wouEd lose if gowrnment were cut back, and any industry with Iess than I 1 percent of its employment attributable to government would gain as the private economy expanded, The Earge losers in the p ~ v a t e economy would be construction, professional services, and durable goods manufacturing,

Indirect Government (%) Fderal

State dr L s a l

Indiret Government as a Fractfan of Private Empiaymcnt (96"o)

A@icuiture Miming Construction DuraMe Goad Manufacturing Nondurable G d Manufacturing Transfiflatian and Utifities Tmde Finan@ Busbess %services Pemnat Servi~es Entntertdmenr Professbnal Servims Public

Administmtion Mifitary TOTAL m u ~ a :Cakuiatd f r m US, @ m u of Lhe ernes, < = r t ~ r cPep&tbn ~ Reports, Cons w w r Incame 1976. Cntgus tager =& U.S. Bpartment of LaWr )or~nput-C)ulpaput Isbabics.

ent reveals that it provides a gea&r dkect) generated by iddle-hwme rmge, pays a hi@erproportion of job i average wage, and generates a more equal &s&ibutisn of e ( x e table 7-7).111f government were to disappar or to be propo~onatelycut back, the dist~butionof earning would hcome more unequal. The earnings share of the bottom 60 prwnt of the work force would fall. 'The fourth quintile would break even md the: richest quintile would raise their t expnditures are munFor the middle class, cuts in gov tevr&uetive. meir tmes would go dawn, but their income would go dawn even fmter. In the end they would have a Bower red &mdard sf living. Matever they think, they are one of the prime bent=fieiaries of government in b t h direct md indirwt emplapent.

TABLE 7-7 Private 1Versw Bubfiic Ewnings Quintile (Poorest to Richegtj

Cove

of Ih?e amsw Cumrnr taws a d

f@7B,

Who Has the Tax ~oopholas Tmaean requires expli~itequie decisi~m.heame must be taken t expnditurm, but w h m hfrom someone to fitnanee gove come should go down? mere is no economic mswer to this qae* tion, An answer can only flow from your vision of what eam~Wm a just dislibution of after-tm income, M i l e taxation rquires equity decisions, nowhere is our inability to make equity decisions more in evidence, Intern& wnwadietions abound. Progressive and regessive taxes emxist, Often highly progressive nominal rates hideregressive effective rates once the eBe~Esof spcial provisions are t&en into aceaunt, Imp holes in the federat income tax are well-known, bat they are matched by even larger, but less w e l l - h a , loopIroks in every other tax we have, Periodic popular demands far progressive E@fams-usually just after the government has announced the number of millionaires (twenty-faur) that pay absogutely m taJres--coexist with the absence of actual refoms, The eilsiest explanatisn for these conwadictiom would be to m-

gae that they me meat& by the pliticd daire to do m m e m g &at is ~onomiedfy unfeasible. We waat to have a mom q u d diseibution of economic resources, but the need to maintain work ineentives prevents us from achieving this gad, UnEofluaately &is k an mgument that has long been breached in the economics literame even if it has not b e n heeded in public rhetaric, Work ineen~vea s e hportmt and it is p s i b l e to impse such high taxes that they inteffere with work effor4; but all of our empirical studies show that aur eumnt tmes are far blow the levels that create disincentives to work," m e highest marginal. tax rate on earnings is now just 50 percent. Repated studies have shown that highly progressive tax systems (much mare progressive than the tax system now in place) to reduce work egort. Income e@ects(the need to work do not more ta regain one" living standards) dominate substitution eflects (the desire for more leisure &cause of lower take-hame wage rates), and individuals work for a v&eq of' other rewm+pwer, prestige, promotions, satisfaaion, The tensions and contradictions in our tax system are generated not by "ewaomic ~ e m s s i vbut in ourwtves. &spite a recurring interest in progressive tax refoms, general tax reform programs have consistently failed to win plitical and wrhaps popular a p provat. There are two reasons far this: one has to do with our definition of "the rid$' and the other has to do with our conception of "individual merit." Discussions of '"he rich" tend to talk about income raaer tban wealth. Since many of the returns from vvt=al& we not counted as incoke (unrealized capital gains being the most notable), inequalities are reduad and the rich are prceived m less rich than they actually are, While the top quintife of all households has alxnost 80 prcent of total wealth, it hag only 44 perant of total hcome according to census definitions. Comecting census definitions to refieet all capital income raiss the income sbare of the top X percent af all households from S p r e n t to f l percent of total incame.'' But foclusiag on income Ieads to a more hndmental problem than the simple generation of misleading statistics. m i l e the top quintiXe of all households hats 44 prcent of total income, most memhrs of this group do not think of themselves-as rich, and what is more important, they are not thought of as rich by the rest of'

plam a howhold in the wiety. In. 1977 an income af $24, &p q ~ h d l e . ~Mmy ' howhold m in the tap quin~leh a w of the e B o ~of twa workers. A hrusbmd and wife each eming $12,W belong ta the top quin.tSe, but we: they rieh? Neiher they nor tfieir neighbars t h i d ss, The top 5 permnt af all familie8 have 17 prmnt of total incame, but only $38,00Q is necessq to place a fami2y in this exclusive class. A husband and wife each eming $19,00Q qualify. Mmy would fx: willhg to argue that even this fmiXy is not rich, mey are simply a hard-working, nniddle~lass fmily. But once you get up to income bvels where there would be generat agreement that the family is rich, there is so little taxable income, as it is aacialfy defimd, that it is innpsible to promise substmtjd income tax reduc~onrifor the rest of the p.opulatian by raising the tax rates of the rich, Ta tax the rich it i~ n e w s q LO chmge the oficiljil definitions of incame, but this hvolves clctsing Imphole8 that provide small dollar knefits to the middle class, dthough most of the b e n e h may go to the rid. The middte-clas sees the Impholes that it is gdng to Iose and fern that it will nat get m equally large general t a cut in re The middle: dmsk mbivatence to tax =farm creabs a dem r tax reform in the ah&act but not enough political fore@far my wncrete mfom pr* posals to h a m e law. Widely k l d conceptions of "hdiedud m e ~ t ' b l s o limitations an the income tm-transfer system, Most indi~duafg think of their earnings as something that m m e s to them ;xs a matter of personal. medt and productiviq, &kg a nne~adousawad, they can think of little reason why =me of it. ought to Irtc= t&en fram them and given to others. The net result k a tax r;ystem that is at hdge-pdge of progressive, regressive, and proportional taxes, md with many taxes there is s great uncertain9 as to who pays them. mis uncertainty is geat:est in the coTarate income tax: sin= it can be viewed as either a tax on a e rieh (the top 54 of one prcent of the papulation own 43 peremt af all coporate stoek) or a. sales t= on the middle class and poor

parate intzome tax is Qeated, estimates of the: incidenm of the:current tax system cm v q &om bing qui* pro@essive to quik

egmsiv@,Maever its a b l u t e hddence, howwez, the tax ~ 8 is b o m h g mare repggive m we rdm md papal!) md fewer the promdve m m The W& abut: am tax system, hawevez, is not that it is p p give or regemive, but teat it is unfak, Mmy hi@-3nc-e *ividuds pay tittle or no tax; many o&em pay hi@ mes. *me low-hwme indi~dualsgay high taes; mmt do not, This is me regmdla8 of wheaer you regad the tax sysknn. as pragmssive or ;in&viciu& with exaetf_y the s m e income end up paying very Merent taxeg in the U e i a Sta&s, TabEe 7-8 premnts one eswale of tfie &mMbudan af tax bwdem. To wderstmd who pays taxes it ;is n m g g q to look nd just 432 the tax W W ~ for O each ~ Bk ~ m GISS e but the ~ d 8 G 0 n

&am 16.8 percent for the pwrest 10 perant af the p a p a l a b 26.2 p w n t for the richest 10 percent of the ppulatioa.""" But around these averages &ere is an enormous p a d . The secand e d w n presetlts what me cslled the stmdmd deviaaaas aromd these mean values, Suppw that you were lmkiag at the m bile with an average tax rate of 22.8 prwnt and a stan-d d e ~ a ~ o ofn 5.5. This says that 68 prwnt of the tapayem in this b m e elalss TABLE 7-8 Variance in Tax Rates Dcciles of the Fapulatiion

Mean Tax Rate f%)

Standard bviation

~ W B : Josegh A. P ~ h r n mand &&amia A, Okmr, Who Bews thc Tezx Burdrn? (Wa*ia@w, D.G.: Thc Lmkings lostitutian, 19741, p, 67.

-

would be ineluded in m inkm81 &am 16.3 germnt (22.8 6.5) to 29.3 percent (22.8 + 163).To 95 percent of tbe tapayers p u would have to have an, intern& of twa standard deviar;i~n~ (22.8 +/- 13,0), and to include 99 prwnt. of aSI tmpayers, you would have to have an intend of three smdardr deviatiom ( Z . 8 +/- 19.5). With such wide. rmges n d d to inelude mast cl.f the -payem in, any income class, avwage tax rates mean veg little, They do not tell us what the average prson pays. 'The mtlt abut our tax system is not pragressivity or regessivity, but disprsionthe unequaf treatment of equals, I f the cuaent demands far tax cuts on capital income to accelerating economic growth were to be met, &is situation would borne much worse. Whatever the cunent degree of progressivity in the tax system, it would be lessened, and whatever the current degree of horizontal inequity, it would be magnified. Given that there is a potent political demand to cut taxes on capital income, it is worth spending some time looking at the generation md mation of capiQl income, This is an area where there is one legi~mateissue and a hmt af illegitimate ones, The legitimate issue is that of inflation, Wi& inflation, investors often must pay tmes on capital gains that are nor real capital gains, This should brz comeet& with an indexed tax system that only taxes real incomigains. But the same system should also exist for wage earners, mey dso get taxed on money rather than real income gains. Indexation should exist for both wage earners and capital investors. As we have already seen, capi&l invesment should be encowaged toy abolishing the coporale; income tm. Qnee this has b n done and the issue of idation indexing has been sumounkd, &ere Is no case far further cub in perwnal taxes on capitd hcome. m e n anyone starts talking about restructuring tmes to encourage saving and invesment, it is well to remembr that our tax systiem already tmes capital very lightly, if at all, The great cumerrt loophole in American taxation is the: fact that great wealth c m be generakd, controlled, spent, and passed on to one%children without ever being suf>jectto the levels of tmation taced by mdest wage earners. Dbcussions of Impholes often imply that there me loopholes far the

rich and not fok the p r ; this is inacemate, n e r e are many tax lwpholes far cslpitalhists, .rich or p m , and few tax l q h o l e s fax: wage eatners, rich or p r . Given our professed attachment to the ideal of hard work, tbk is perhap su~figing,but nevedelms true, m e of the miljor caum of problem is a system of income taxathe main path tc, wed&, In the tion that dmsn't succed rrrytholo~of getting rich, man s t a ~ wi& s =me irritid e m hgs powez. Out of the= e he patienCly saves, pays -CS, invests, pays taxes, sawes, and rehvests at mwket rates of here& mtiI he bcomes weal&y, The only &aubie with &is mde8 is &at it . does not de%Gbe how hdividuds wtudly beome rich. If: one examines the very rich, abut 50 p r w a t of the peat fortuna am gotten tfirou& i&eritance. &spite what we ofren hear iitbaut s e c d t d canfiscatoq ~ e f i t a n mtaxes, U.S. gift and inheritstnce me8 amount to a tax of only 0.2 percent on net wo&.lff For all praetica) purpms, the cument estara: and gift tax systm hag no impact on the dis~butionof wedth, If you am very rich and want to hand it on tc your children, notbhg gtops you from dol ing so.1T The more interestkg half, howver, is the half that did not inherit tfieir fodunes, m e w hdividuolls accumufit(e so much and so raigidly that it could not possibly have eome &rough-a prmess of paGent sa~ngs,taxa~on,md hvw-ent at mmket rates of interest, A d r m a ~ illustration, c of clhis phenomenon h a Forrune afticle that liskd thim-nke individuak who had made &om $50 to $700 milfim in the previous five years without inherieng wed& or haw in&previously b e n on the Fortune lists of the weatthkst Anrericans," 8 e prevzrlenm of instmt weal& is also visible if one look at the rimes of those who inherited great weal&. The Rockefefters, MeXlons, Fords, Wktimeys, and Posts may have inherikd their wealth, but thme fortunes were made very quickly at some paint in the pmt. To understrtnd haw this is done, it is necessary ta think in terns of t m difflerent capital markets, The first capital market is the mmket for physical investments. In this market, firms and individuals make real investments in plants and equipment, The second capital market is the financial market where individuats buy financial h-

stxuments (ownerstrip rigfi&) without directly managing real ptmt and equipment. Stmks, bonds, and real estate &us@we m m ples of the latter; facto~es,stamping presses, and latfies are examples of the former. Instant wealth arises in the prwas of capitalization. Consider a real investment in plant and equipment of $IQ million that ewns $3 million per year. Suppose that the masket rate of interest or the discount rate is 10 percent. Wi& a 10 p r w n t discount rate a $3 million a n ~ u a income l flow is WO& $30 million ($3 million/. 10) in the financial market, If the discount rate were 5 percent, the s m e investment would be worth $60 million. "This is true rqmciles of how much it cost to make the. initial investment. But in our example, the initial investor has now increasd his wealth instantly &am h e in;itiaf $10 mitXion to $30 mililion when the investment was sold, The purchaser who buys the stock for $30 million, however, has an hvestmenrt that only earns the maket rate of in&rest (1 Q prmnt). If the real investment opportunity were something that could be duplicated by the initial investor, his $10 million investment might k worth even more k c a u s of the future profits that similar investments could bring. It is this process of capitatizing above-average returns that generates rapid fortunes, Patient savings and reinvestment have Iittle or nothing to do with such fortunes. To kcome very rich 0nf3 must generate or select a situation where an abve-averslge rate of return is about to be eapitatdd, If real capital markets reached equilibrium quickly, large fortunes could not be made in this process of capitalization, Once a. new physical investment s p p r t u ~ t ywas diwavered, real hvestrnent funds would quickly flow into the mea and bring the real rates of return down to the market" average rate of return. Aboveaverage profits w u l d not be expected to fast very tang, and there would be no pssibility of obtaining a monopoly on hture- aboveaverage physical investment opportunities. Other people would move into the area and future physical invesments would only e m the market rate of return, In this case, physical investmenls are only worth what they cost to build and cannot cause sudden ardditions to wealth.

D&& on real eagitd newkets indicate little if any tendenq for real capitd mark@&to qproach equilibdum. Substantial, prsistent digemnces in real rates of return exist. The reaons for this fundamntaf dwuilibdum me many and v ~ d but , mast of theno spfing from a bmie chararzteristic of real investment markets. Invesment resources simply do not flow quickly acrass b s and industria aereby equalizing real rata of return. Most of our savinp are mt pemonal savings but consist of the al savings of bwinesses in the fom of retained earnine md depmiatian aflowaneas. But firms almost always reinvest theif o m internd Eunds md invest in a&er fims even if &ek rate of return on investmen&is far blow the natianal average. Tb explain why imrnai funds are I r o ~ ninto t b firm generating them it is only necessaq to &ink about the basic chaacteEfrisGcs of E3.S. capitalism. It is managerial capitalism. Large 6ms zwe cmtroIled by individual managem wha usually do not own any substantid fraction of the firm that they manage. W i k a stackholhr might like to we his funds invested in the highest rate of return industries, regardIess of who manPdges them industries, the existing manager clearly has other incentives. He wants to use internally &enerated savings for investments un&r his management, since this is the pattern of investments that brings him ineresing returns in the fizrm of income, power, and prestige. As a result, those who direct real investments are not simply profit-maximizing investors. They are intensred in maximizing profits, but only profits &om oprations that they themselves manage* ]If we ask why managers with large internal savings do not start subsidiaries in high-profit industries rather than reinvesting in their own low-profit industries, we come face to face with the entire structure of restricted competition in the U.S, economy. Barriers to entry are often high, and managers often do not have the speciaIized knowledge necessary ta make profits in another industry. The existenw of high praCts in the cosmetics industry, for example, dms not mean that iron and steel executives could earn high profits there, True, the firm might loc: able to e m high profits, but it would have to fire its existing managers and hire new managers, The existing managers are not about to fire themselves, and they me wise

enough to know, ox have learned via the unsuccessful conglomerate movement, that they could not run a successful cosmetics h. As a result, they stay in the steel industly and reinvest their internal. funds in steel regardless of the xlative rates of return. The existence of internag savings also ten& to diswa the Bows of those few investment funds that do flow through the real capita1 market. in the real world, lteaders face risks and uncertainties about actual returns. If they lend to fims with lwge flows of internal savings, they can have great confidence that brrowers are going to repay their loans regardless of the success or failure of the actual project for which the funds were lent. Because of the low risk of &fault, funds are attracted to those firms with Iarge internal savings, regardless of whether they are earning above-average rates of return on their capitSil invesments, The net rmuXt is a flow of externd savings that does not serve to equalize real rates of retum across the eeonomy either, While the process of capitalizing disequilibriunn rates of return explains instantaneous wealth, there is still the probtem of how these fortunes are allocated to individuals, This brings us to what is called the random walk. Since no one can predict where them opportunities for capitalizing real disequilibxiurns out of existence will appear, the winners are, as in any lottery, lucky rat;her than smart or meritoeratic, Far example, h the early 195Os you d g h t have hvt=st& in a class of fims that ineluded Xerox. In f 950 all of these fims would have looked alike and all would have had an, equal expcted rate of return. Looking back, some would have gone broke and disappmed; most would have emned the market rate of return; some would have earned more than the market rate of return; and a few, prhaps one, would have been an invesment such as Xerox. Those who owned shares in it &came wealthy, They won the lottery. The random walk is a prmess that wifl generate a highly skewed distribution of wealth, You cannot lose more than you have, but you can make many times what you have. Because most holders of wealth eventually diversiQ their portfolios, great fortunes remain even if the underlying disquilibrium in the real capital mwket eventually disapvars. f$ should be emphasized that there is na

equalizing principle in the random walk. Those who have had go& luck are no mare apt than the random individual to be subject to bad luck. What is the evidence far the rmdom W& hypobesk? First, an examination of large financial firms (such a$ mutual funds) indicates that none of them is able to outperfom the market averages, Professional financial managers able to make large investments in obtaining market infamation are not aMe to outperform the market average or a random drawing of stocks, Second, no one has been able to design a set of decision rules (when tr, buy and sell) that yields a greater than average rate of return, mird, tests indicate that stock prices quickly adjust to changes in irifomation (announcements of stock splits, dividend hcremes, a d so forth). Fourth, there is no serial correlation among stock prices over time. The price at any moment in time or its history cannot be used to predict future prices, When put together, all oT these findings form an impressive body of evidence as to the: existence of the random walk. While many of the great fortunes represent a combination of entreprexleuriaf. and financial investments, the sane random walk prwess probably holds, Ability is necessary, but within a group of individuals with equal entrepreneu~altalents a nonnsmal random lottery wcurs, There is an expcted rate aE return for the group as ai whole, but there existrs a wide bispmian in individual resuta around this average, Entrepreneurial talent is a necessary condition for entering the lottery, but it is not a suficient condition for making instantanwus wealth. The entrepreneurial random walk is, however, much less subject to proof than the purely financial variant, The unsuccessful entrepreneur does not remain visible for study in the same manner as the unsuccessful stockholder, The net result is a process that generates a highly skewed distribution of weaf&, Great wealth is created in relatively short periods of time, Personal savings behavior and one%sbi1it-y to postpane future gratification have little or nothing to do with the prwess. Once created, large fortunes maintain themselves either because the underlying clisequilibrium in real =turns remains or because inveestments are diversified and earn the market rate of return. If you read the Forrune biographies thbt accompany their lists of

the most wealthy, the winners will be descrihd as brighter than bright, s m a ~ e rtlrm smm, quicker than q ~ k k , ~But @ lwk beyond the description to see if they were simply lucky or possess some unique abilities. Remember that the unsuaessfrutf ea&epeneur of equal ability will not be featured in Fczrrme. To what extent were they like many other people but in the right place at the right time? The real test of unique abilitigs is to ask how many have repated their performance. How many have made a great fortune an one activity or investment and then managed to go on. to earn another great fortune on another activity or investmentflf the Fortune list is examined, it is impossible to identilFy anyone whose personal fortune was subject to two or more upward leaps. T'he tpical pattern is for a man to make a great fortune and then settle down and earn the market rate of return on his existing portfolio. What has b e n generate-d in this process is realized md unredimd capital gains, Realizd capital gains are taxed at less than half me mat taxb& at all. of nomal: rates, afld u n r e d M capitd g Those thifiy-nine, fie-year multimillionaires in the Fortuna artiefe undoubtecfly paid littge or na taes. Nor shodd oxle hagin@that it is impassible to consume unrealized capital gains without paying taxes. Simply go ts your friendly banker (if one is a multimillfionaire, there are many friendly bankers), take out a loan using your appreciated stock as collateral, and buy whatever you lib. The interest payments on the loan are even tax deductible. You can consume whatever you like and pay no taxes, At death, the principal c m be repaid out of that s m e appreciakd stmk. Since World War 11, aur aree-pm sysItem has been extremely viable--income transfers far the pmr, direct or indirect government jabs for the middle class, and little or no taation for wedthy capitalists. But cracks are appearing in the system like those cracks in the wings of the DC-10. Because of female work patterns, we are probably entering a period af rising income inequality where the second and third quhtifes of the ppulaGon m going to X w ground in their emings, mis, coupled with the view that inflation could tx cured if only government expnditures were cut, will undoubtedly lead to an environment where transfer papents do xxot rise rapidly enough to hold the poor and the elderly evm with. the rest of the populatjan. If g

or fall with falling scfrwl enrollments, income pressures on the middle elms will mount, At the s m e t h e , demmds to cut taxes on capit$ income in the n m e of accelerating eeonamic will raislil: the tax burden and Iowr the income shwe of those who are not capitalists.

Group D e w & In our society the whole issue of group justice is often w n as illegitimate. lndividuai blacks may have h e n unfairly &eated, but blacks have not been treated unfairly as a group. Consequently, remedies must come at the individuaf Xevel (at case-by-cme fight against discrimination or e medial education progmms flor individuals) and not at a group level. AEmative action or quotas programs that create group preferences are fought on the ground that t h q are unfair even if evefyone agrees that many or all mernkrs of the group to be heX@ have suEereb from unfair treatment in the past. Our economic theory is b;izsed upon the same tradition, Western economics is at its heart an economies of the individual, Individuals organize voluntary economic associations (the firm), but individuals earn and aftmate income. Croup welfare is, if anyt-fling, only the algebraic summation of the individual welfare of the members of the group. mere are no involuntary groups. Individuals join groups only when groups raise individual wdfare, No one assigns someone to a group to which he or sbe does not wish to bIong, e from this prspctive. Race and sex are not ~ o n o m i vafiables At the sarne time, our age is an age of group consciousness. Economic minorities argue tfisBt group parity is a fundamental component of economic justice and that an optimum dis&ibution af income consists of mare than an optimum distribution of income across individuals. In doing so, they are not advwating something new but extending,to themmlves old dwtrirres that are: invoked to help fanners and many other industries. White rhem is pbnty of precedent for helping poups in aur economy, a fater rate of powh

may call far ending help to digerent industrial graups, Should the same principles be used to resist instituting aid for other social groups? Is the correct economic strategy to resist group Wfare measures a d group redistribution programs wherever passible? Or do groups have a role to play in economic justice? We are a swiety that professes belief in "equal opprtunity" fafor individuals, but hour could you tetl whethw equal q g o m n i t y does or does not exist? In a deteministie world we could tell whether equal opportunity existed by seeing whether each individual reached a level of economic performance consistent with his or her inputs (talents, eEofts, human eafitaf), Individuals could. b.e identified as receiving less than equal treatment. But the real world is highly randam and not deterministic, Since evemyone is s u b j ~to t a variety of g d and bad random shoekrs, no one can tell whether any individual has been unfairly treated by lsQking at his or her income, Individuals may have participated in the same economic lottery, but in the end, someone lost and sorneone won. My low income and your high income do not prove that I was unfairly treated relative to you, You were lucky and I was unlucky. But I was not unfairly treated, and I did not suffer from cfiserinxination or some systematic denial of equal oppostunities. Since those variables that -we nomally think of as the deterministic variabfes-educatian, skifls, age, and so forth-only explain 20 to 30 prcent of the variance in individual earnings, our economy is one where the stochastic shocks (or unknown factors) are very large relative to the deterministic (or known) parr of the system,2LAnd the larger the stochutic portion of the system refative to the deteministic portion of the system, the less possible it is to identify individuals who have been unfairly treated. Xn the economic area, no one can say that any individual has been subject to systematic discrimination as opposed to random bad luck, This is a judgment that can only be made at the level of the group. T h i s can be: seen in the standard economic tests for the existence of discrimination. Earnings data are collected for different groups of individuals, and a statistical equation is estimated to show the relationship between earnings and the nomal human capital factors (work effort, skifls, education) for each of the groups, These equations are then examined to see if they are significantly diaerent, If

they are, the digerent groups do not participate in the same economic fattery, Using economic analysis it is impossible to determine whether any individual has sugered from the denial of equal oppTtuniQ. Within army goup-no matter how privileged-there will be individuals who have k n denied equal opportunities and suEet.ed from discrimination, but they have not k e n subject to a systematic denial of opportunities, Society may be concerned, but it is completely incitpable of doing anything about random discrimination, It is simply one type of random g d or bad tuck that agects us all, A Polish American may feel aggrieved and may have k e n denied equal oppo&unities, but PoIish Americans do not suffer from systematic denials of equal opportunity since iheir eamings functions do not meet the necessary tests. Conversely, within any group-no matter how underprivileged-there will be individuals who have not sugered from a systematic denial of opportunities. All socieq can do is to test whether the economic lattery played by whites is or is not statisticafly equivalent to the eeonomie lottery played by blacks. Zt cannot tell whether any individual, black or white, has k e n equally treated, Discrimination affects individuals, but it can only be identified at the level% of the group. As a result, it is not possible for society to determine whe;ther it is or is not an equal opportunity wiety without collecting and anafyzing economie data on groups, But the measurement problem also creates a remedy problem. If it is impassible to identib individual discrimination, upan whom should the remedies for systernatie discrimination be fmused? The inability to identify anything except group discrimination creates an inrtbiIity to focus remedies on anything other &an the group. We can attempt to create an economy where eveqone participates in the same economic lottery, but we cannot create an economy where each individual is treated equally. XE you believe current eamings functions, 70 to 80 percent of the variance in individual earnings are caused by factors ihat are out from under the conbal of even pedeet government economic policies. The economy will treat digerent individuals unequally no mattRr what we do, O ~ t groups y can be treat4 equally, Groups, rather than individuals, sre also goiag to enter into sur

decisions bcause we need groups to make efXieient decisions. At the same time, what is ""efiticient" far the economy is always "unfair" to same individuals, The problem is now to balance the gains from eficiency against the losses from unfairness. Suppose that you were the dean of a medical scheol charged with the task of maximizing the numhr of M.D.'s produced far some given budget, In the process of cawing out this mandate, you, noticed that 91) percent of aIX mafe admissions completed medical school, and that 99 percent of all male graduates go on to become lifetime doctors, but that the corresponding prcentages for warnen were each 98 percent. As a consequence, esleh male admission r e p resents '98 lifetime doctors and each female admission represents .96 lifetime doctors. %eking to Ex: efficient and obey your mandate to maximize the number of practieing doctors, you establish a ""male only" admissions policy, 111 this case, the dean of the "medical school is practieing statlstical discrimination, He is trreating each group fairly, based on the objective characteristics of the group, but he is unfairly treating 96 prcent of ail women because they would, in fact, have gone on to became practicing doctors, His problem is that he has no technique for identifying which 4 percent of all women will fail to become practicing doctors, and therefore he expands a very small digerence in objecti~echaracteristics (a one percentage point difference in each of the two probabilities) into a ;u=ro-onedecision rule that excludes all women, Xs the dean acting fairly or unfairly, efficiently or ineflfieiently? To be elffieient is to be unfair to individuals. Where is the balance to be drawnWherever the balance is drawn, groups become innportant since it: is eficient for employers to open or close opportunities to individuals based on the groups to which emplqers assign them. But since employers will of necessity use groups, government must become involved in the question as to what constitutes a legitimate group ar an illegitimate group. The option of prohibiting all decikions based an group characteristics simply isn%possible since the eaciency price wou'ld be too high. A controversy of just this type recently arme in, Massachusetb aver automobile insuranw rates, In the past, these rates have b e n set based on the age, sex, and geographic location of the driver and

the msmiated amident data, The hsurmw cmmissioner of the state: shifted to a system that rates drivers based u p n the numbr of years they have had a lice-, their ac~identrecord, and their mest rscord. Ditferent individuals will pay very digereat insurmce premiums under the t w systems, WXlich is the right set of groups? Ideally, group data could only be used far m&ing economic decisions where all mennbrs of the group had the same characteristics, Fair treatment for the group would be a fair treatment of each individual memkr of the group. Unfortunately, this situation almost never exists. Homogeneous groups do not exist. A trade-off must be madle ktween eacieney and justica. Since emplogrers are: only interested in efficiency, they will make the tratfe-off in favar of eBciency and in favor af unfair individual treatment unless they are restrained from wing certain group clwifications. As a result, the state is foreed to establish categories of illegitimate groups. Our social desires for individual justiw, at Xeat to same extent, take preceden* aver our social desires for efficiency. Since we have both a desire for eBciency and a degire for individual justice, we have a dilemma. Individuals have to be judged on group data, yet all systerns of grouping will result in the unfair tlrerttment of same individuals. Thus we must estaMish same standard as to haw large differences in mean &aracfefistics have to be kfare a paaicular set of groups is legitimate, Most of us would be unwilling to let the dean of our medical schml exclude women on the baIs of a f prcent di@erenc&in objective probabi_fitiw,but what would our judgments be if the objective digerenees were fifq preengage points or ninety percentage pints? At what point would we be: willing to exclude women? Yet if we did this at any point, we would be unfairly treating some individual female. But if we did not exclude them, we would be w-ing a larger and lager &action of our remurees, m a t this illustrates, however, is that every swieq has to have a theory of lep,itimate and illegitimate groups and a theofy of when individuals can be judgd on group data and when they cannbt be judged an group data. A concern for groups is unavoidawe. On first thought, mobiliq (or the lack of mobility) would seem to be an easy way to deternine what groupings are legitimate. Tf it is easy for m individual to leave any voup, then individuals in that.

group cmnot claim to be unfairly treated. The vdue of the p u g must exceed the c-& of the group or they would not belong, mey may remive less measurable income by behg a member of the group, but their psychic itleonxe from bing a member of the group must at least counterbalance the tower measurable income. It is precisely this argument &at lies at the heart of the recommendation that government should not have specid programs to raise the money incomes of famers. Famers maty have tower incomes than urban dwellers, but they could always cease to be f come urban dwellers. merefore, famen cannot Ise unfairly treated regardless of the relative in~omeof fame= and regadless of the soul.ees of this relative digerence. While this argument may sound remonabft to thosc: of us who are not farmen, it is equally applicable to regions or religions. Technically it is just as emy, if not easier and less costly, to move from one region to another or from one religion to am&er, Vet most of us would not be wifling to argue that one must change his or her ieligion to achieve economic parity. Why? What is the difference &twec:n changing one's occupation and one's religion? Individuals can certainly Ex: just as psychologically cornmitt& to a phrticular occupation as they are to a particular religion. Xf one looks at our smiaf programs, socieq certainly canmt claim to focus consistently on individuals as o p p a d to groups, Affimative action for economic minorities may h on the defensive, but we are in an age when industrial and regional progrms are expitnding rapidly. The same p p l e who oppose special programs for blacks support sgcecial programs far textiles, Imagine the furor that would arise if we stafled a program for blacks similar to that now in place for farmers. It would be denounced as ""un-American" from every rmftop. Given that our soeiety clearly is not willing to be consistent and use an individual focus when it m e s to plitically popular groups, it is easy to see why the insistence on an individuaE focus for minorities can be: viewed as simply a more sophisti~abdversion of discrimination, moss: who got ahead in the wonomic race stay ahead far a, very long t h e even after discrimination has c=ea=d to be actively practied, While we undoubtedly are not willing to use mobility as the sole test of whether a group is iIIe#timate-almost no one would be

witling to force individuals to thaw their religion to secure equal economic treatment-it is still the basic hgrdient. We need to be most concerned about discrimination. against groups where individuals cannot easily leave the group in question, In the case of industrial graups, this means that smiety should focus on improving the e a e of exit for hdividuals rather than aiding the goup as it; is ROW constituted. When ease of exit is high, we can concentrate on eEeiency, knowing that it will not kab to much unfairness. When the e w of exit is IOW, the reverse is true. In the end we have a problem. Various groups are demanding parity in their i~lcornep i t i o n and there is little reasan to believe that these- demands will disappear in the: future. Few are wilIing to stand up and publicly defend the idea that blacks, Hispanics, and women should prmanently earn less than white males. There are: many who object to every conceivable remedy, but this only exacerbates the tension without either solving the problem or causing it to go away. Nor will the nomaI actions of the economy cause: the problem to fade away with time, A simple Iwk at @hathas been hapgening can (mce anyone to itbandon the comfortable '"do-nothing" hypothesis. The essence of any rninorie group" p i t i o n can be captured with the: m s w r to three questions: ( f ) Relative to the majority group, what is the probability of: the minority's finding employment? (2) For thw who are employ&, what are the emings opprtunities ~ l a t i v eto the majority? (3) Are minodt;y group ntennbrg making a breakhrough into the hi&-income j o b of the aanomy? In esrch case, it is neeFssw ta lwk not just at eunent data, but at the group's seonomic histag. 'Where hm it ben, where is it going, how fast is it piag, and how fast is it propessing? fa terns of ethnic @rigin,&ere are three ewnomie minadties in hericam Indimg, Of the the Unit& States-blacks, Hispmics, d m a t $00 actiltian a&er Amedcms who list &emwlvm in the Gensus as having an ethnic odgin, afl have inwmes a b v e of Aineicans vvho list no efhnic origin, The highest family incomw are recar&d by Russian-Americms, followed by PoXkh-Amedcam md T t a l i m - h e A c ~ , "E&ict' ~ h e d e a n s w m e t h s talk m if they were economkalfy depdved, but they we actually prched at the top af the economic ladder. Femdes constitute thie other mat

jor economic minority, Mmy of them may live in famaies with high incomes, but when it comes to earnings oppartunitbs, they do not participate in the same economic ball g m e as men. If you examine the employmnt position of blacks, there hw been no improwment and perhaps a slight deterioration. Black unemployment has been exactly mice that of whites in each decade since World War Ill. And the 1970s are no exception to that rule. Whatever their successes and failures, equal opportunity programs have not succeeded in opening the economy to greater employment for btacks. Given this thirty-year history, there is nothing that would Iead anyone to predict improvernenb in the near future. To change the pattern there would need to be a major restructuring of existing tabor markets. Viewed in terms of participation. rates, there has hen a sli&t deterioration in black employment, In 1954, 59 percent of all whites and 67 prcent of all blacks participated in the labor forw. By f 978 white participation rates had risen to 64 percent and bTti3t6k participation rates had failten to 63'percent.'YT"h change erne about through rapidly rising white female participation rates and falling participation rates for ofd and young blacks, In the sixten to twenty-one age categoq, black participation rates are now fifteen percentage points below that for whites. At the same time, there has been some improvement in the relative earnings for those who work full-time, full-year. XR 1955 both black mates and kmales earned 56 prcent sf their white counterparts, By f 977 this had risen to 69 percent far males and 93 percent for While black females nnrnde good progress in catching up with wkit-e females, this has to be viewed in a context where white females are slipping slightly relative to white males. I f black males were to continue their relative progress at the pace of the last twenty years-five percentage points every ten years-it would take black males another sixty years to catch up with white males. While the greatest incame gains have been made among young blacks and one can find pa~icufarsubcategories that have reached pariv (intact college-educated, two-earner families living in the Northeast), there still is a large earnings gap among the young, BIstck males twenty-five to thirty-four yew8 of age earned 71 per-

cent of what their white counterparts emed in 1977. Among fulltime, full-year workers, the same percentage stood at 77 percent.'& Young black males are ahead of older black males, but they have not ached pariq. As with black females in general, young black females do btter than males, Females twenq-five to thirty-four years of age eahed 101 percent of whites, and full-time, full-year black females earned 93 percent of what whites earned. Using the top S percent of all jobs (based on earnings) as the definition of a ""g& job"", blacks hold 2 percent of these jobs while whites hold 98 percent." Since blacks constitute 12 percent of the tabor force they are obviously underrepresented in this category. Relative to their population, whites are almost seven times as Iikefy to hold a job at the top of the economy than blacks, At the same time, this represents an improvement in the position of blacks relative to 1960. Probabilities of holding a top job have almast doubled. sparate data on Hispanics only started at the end of the 2960s and is not as extensive as that available for blacks, but during the 1970s Hispanics seemed to have fared slightly ktter than Macks in the fabor market, Where their family income was once Xower than that of blacks, it is now higher, 'This is probably due to the fact that Hispanics are much more heavily concentrated in the sunbelt, with its rapidly expanding job opportunities, Instead of having unemployment, twice that of whites, unemployment is only 45 percent highereZ7Labor force pmticipation rates are rising even more rapidly than those far whies, In terms of relative earnings, full-time, full-year males earn 71 percent of what whites earn and females have rewhed 86 percent of parity.'" While there are substantial diaerences in family income amon8 different Hispanic groups, earnings are very similar among the miljor groups. In 1 976 Cuban-Americans, Mexiean-Americans, and Puerto Ricans were all within $200 of each other in terms of personal income, for those with income, In terns of the best jobs, Hispanics hold 1 percent of these jobs but constitute 4 percent of the l a b r force. Relative to their population, whites are three times as fikely to be in the top 5 percent sl the job dktdbution as Hispanic~,~Vn terns of breaking into the g& jobs of the economy, Nispmics are far ahead of bfacb,

American Indians are the smallest and p r e s t of A m e ~ a ' s ethnic groups. They are poorly de&ribed and tracked by afI U.S. stsltistical agencies. Despite the existence of the Bureau of Indim Agairs, only the roughest estimate for a e i r economic status is available. In terms of family income, reservatign Indians probaMy have an income a b u t one-third that of whites, Where nonrefervation Indians stand no one knows. Female workers hold the dubious distinction of having made the least progress in the fabor market, In 1939 full-time, full-yem women earned 61 percent of what men earn&,"@ In l977 they earned 57 percent as much. Since black women have gained relative to black men, white women have fallen even mare in relation to white men over this forty-year period. Adult female unemployment rose from 9 pefcent higher than men in 1960 to 43 .percent higher in 1978. From 1939 to 1977 the percentage of the top jobs held by females has fallen from 5.5 percent .to 4 percent although women rase from 25 percent to 41 percent of the labor force, Relative to their poputaition, a man was seventeen times as likely as a woman ta bold a job at the top of the economy in 1974. With the exception of breaking into the top jobs in the economy, much of this decline can be attributed to rapidly rising female participation rates. With more women in the labor force, there is simply more competition leading to lower wages m d more ummployment. At the same time, the results indicate that the stfucture of the economy has not changed, and women have not braken through into a world of equal opportunity, XR. S U C ~a world they would compete with men and not just with each other, At the bottom of the tabor force stand the young-our mdern lumpn proletariat. In 1978, 49 percent of all unempfoyment was concentrated among sixteen- to- twenly-four-ye8f-~~ds.~~ unemployment rates were three times that-of the rest of the population, Among male full-time, full-year workers, relative earnings s t d at 40 percent -Ear fourteen- to nineteen-year-ctfds and 65 pexent for twenty to twenty-four-year-sIdsSa2Among females the same percentages were 64 and 104, In terms of holding the tap jobs, sixtmn- to twenty-four-year-olcfsheld 43.5 percent a1t;fioughthey constituted 24 percent of the labor force. While low earnings can be dismissed on the grouxlds &at the

goup is acquirirrg skills and will in the kmre emn bigher incbmes, the unemployment is riot so ewy to dismiss. Unemployd young people or young peaple who have dropped out of both s c h d a& the work f o ~ e erepreeat individuals who are not acquiring skills and g d work habi&. m a t this pt-ends for the distribution of emings in the-future is ha& to s y since we have never kfo-~e had a pedod'where so mueh of the unempfoyment of our society is concentrated ammg the young and esgecialfy amyoung minorities. Cerlaidy it is hard to &ink that it will do anything except make the distribution of emiags more unequal in the hture. Wile it is convenient to the position that if we were just to eliminate discfimindion and create an equal opportunity world, tnino~tygroup problems would take care of themselves, this position is untenable in both practia and tbeoq, Imagine a ram with two groups of mnners of q u d ability, Individuals differ in their running ability, but the average speed of the two groups is identical. Im-sigixre that a handieappr gives each individual in one of the goups a heavy weight to carve Some of those with weights would still run fmter than some of thow without weigh&, but on average, the handicapped group would fall farther md fi;c*er bhixrd the group without the handicap. Now suppas that someone waves a rnagie wmd and at1 of the weights vmish. Equal opportunity has b e n mated, If the two poups are equal in. their running ability, the gap between. those who never eahed weights and those who used to eany weights will cease to expand, but those who suffered the earlier discrimination will never catch up. If the economic baton can k handed on from generadon to generation, the cument egects of past discrirnination can linger farever, If a fair race is bne where evefysne has an equal chtanw to win, the race is not fair even though-it is now run with fair rules, To have a fair race, it is xxecessq to (1) stop the race and start over, (2) force those who did not have to carry wights to carry them until the race has equalized, or (3) provide extra aid to those who were handicapped in the past until they catch up. m i l e these are the only three choices, none of them is a car;\snsus choice in a demmacy. Stopping the race and startihg over wou3d involve a wholesale redisaibution of physicd and human

wealth, This only happens in real revolutions, if ever. 'Ibis leaves us with the choice of handicapping those. who benefitted &om at: previaus handicaps or giving speeid privileges to those who were previously handicwed. Discrimination against someone unflortunately always means discrimination in favor of someone else. The person gaining from discrimination may not be the discriminator, but she or he will have to pay part of the price of eliminating discrimination. This is true regardless of which technique is chosen to eliminate the cunent ei-fects of past discrimination. An individualistic ethic is acceptable if society has never v& lated this individualistic ethic in the past, but it is unacceptable if swiety has not, in fact, lived up to its indiviciuafistic ethic in the past. To shift from a system of group discrimination to a system of individual performance is to pergetuate the efEects of past discrimination into the present and the future, The need to praetiw discrimination (pasitive or negative) to eliminate the eEects of past discrimination is one of the unfortunate costs of past discrirnination. To end discrimination is not to create '%equalopportunity." The problem of group demands cannot be: left to the eetlnomy to solve. Major elements of the prcsblem are not being solved at all and where prqress is being made it is so slow that economic minorities would have to be patient for many more yeas. Yet any government program to aid economic minorities must hurt eeonornic majorities, This is the most direct of a131 of our zeresunr con8icts. If women and minorities have more of the kst jobs, white males must have fewer, Here the gains and losses are precisefy one for one.

The Paradigm Zero-Sun Game m e n societ~~has to confront the issue of digerences in the- relative income of different groups-rich versus poor, black. versus white, male vetsus female, famers versus urfaaa dwellem-it is addressing the paradigm =m-sum game, Eve0 increase in tht: relative ineame

of ane paup i s a & m m in the relaave hcame of mo&er soap. me exacay counterbdmd by an equal, set of 1 the demands are not for m m but fof p d v , Yet. a m is not a; Wciety that believes in abolute equality, m m e s h o d parity dem a d s bc: met and where should parity &mm& be rejakd? m a t meiples should undezly this weeptaw or rejwb:on? Udess we cm l@= to mswer such ques~onsand hplemene out. -we=, our society is gahg to botb sta,pa& a d be @it aIong poup IIha. mere is no way to av~idthe problem, Benign neglst wiff not solve it.

Chapter 8

ving the Economic

VIEWED TWEWER, the problems of the 2980s sham h& a common s t of cause;s and a common set of cures, Eaerop paw&, and inflation are internelated on maay fronts, Wihaut g o w h s enerm supplieg, economic m w t h is dificult, an$ rapidly rising energy prices provide a powrful idalionaq far=, hBation leads to public policies that prduce idle capacity and severely retwd grow&. To adjust to a rapidly ehmging pattern of enera supplies, the energy indrtstq needs to be: deregulaited. But eliminating regulations, protection, and subsidies is also one s f the esmntial ingredienb in any sueeessful progrm for stimufating economic g r o a . beaus of its value elswhere in the economy and beau* it hvalves the fewest net cos&, &@ eliminatgan of regulatiom, protection, and subsidies becomes the prefemed route to controlling hfiation. Upward price shocks are deliberately counterballanwd with planned downward price shmks, Solving our energy and growth problems &mancl that government gets mare heaviIy invofved in the economy" major invesmeat decisions. Massive investments in alternative energy sources will not oeeur w i ~ o ugovernment t involvement, and hvwtment funds need to be more rapidlty channefed from our s u m t to sunrise indusMe8. To compte we need the natianal equivdent of a c ~ p m t iavmte

meat committee; Major investment dwisions have Mome tool i n p f l m t to be left ta the private maket ahne, but a way must be found to incowrate pfivate czovrate planing inta this prmss in a n o n a d v e m ~W$ Japm Inc. nwds to be met with W .S.A. Im, A united front cannot be created, howeler, by simply trying to bulldoze energ, growth., and antiinflation policies down the firoa;ts of all &ose who wauld be hurt, The losers in this process may not be a majority of the ppulatioa, but they are certainly large enough tcj prevent my such p l i ~ from y b h g adopted. A highquality environment is important, and even if it were not;, the time has come to admit that many people think that it is imprtant, Unless we are to be permanenay bogged down in. fighting a b u t the environment, goods md smices simply have to be produeed in ways that do not result in environmental deterioration. This means more expnsive goods and semices, Utility executives may not like stack scrubbers, but it is more impo&ant to get coal&& power plants built than to argue a b u t stack scrubkrs. Resistanee to those wha demand reasonabte environmexztal controls is silly since with a rishg standard of living f and it is rising) more and more pople are going to move inta the economic classes that wmt it clem environment, Environmentalism is the wave sf the future. As such, it makes much more sens far who are in@restedin wonomic growth to reach an accomod;ation with it than to try to iesist it. If protection, regulations, and subsidies were eliminated, large numbrs of individuats would suffer economic losses. If s u ~ ha policy if ever to be adopted, we have to develop techniques for paying compensation to the individuals who are going to be hurt, Supp r t for failing fims should be mimimiad, but support for individuals to hefp them move from sunset to s~lnriseindust~esshould be generous, ft. should be generous for the simple reason that if it is not, we will not be able to adapt the policies that the country needs, Economic growth also means that we must fully utilk the skills md talents of the economic minorities that are now kept out of the mainstream of economic activity. Wile our economy hars survived for a very long time with large income gaps between blacks, Hispanics, American Indians, and women an one side, and ufhite males

Solving the Economic Problems of the 1980s

X93

on the other side, the world has changed and it is dBcult to imagine &at it can survive as well in the Xumre. But even iE it could, old levels of pefiormmce are no longer g 4 enough. To reach the levels of prduetivity reached by others, we have to eliminate his divisive issue. It is not an issue that is going to fade away. Simil;;trly,7wehave to stand ready to prevent income gaps betwen the rich and the poor from hcreasing. The last twenly yems have been marked by success on this dimension, but it will be; more d B cult to be succegsful in the next Wnty years since we are em a pxiod of rapidly rising inequalities. Active gove meat in promoting economic growth will also make some Amedems richer. We have to ensure that the bttam 4% percent of the population does not fall behind, for if we don", we won't t able to adopt the growth policies that vve need. T%is means that tramfer paynnenb wiff have ta continue to grow for the p r and the elderly, and that our income tax system is gohg to have to refomulated to keep the after-tax incomes of the second and third quintiles of our households rising in pace with the rest of the economy, W e n one reviews what must be done-massive public investments, budget surpluss to gemrate more savings, large sation systems, inerernes in income trmsfer paymeats, md tax cuts for the lower middle class-it is clear that one of the basic ingredients of future progress is a tax system that can raise: substantiaf amounts of Mtvenue fairly, If enerm is to be derewlated and the massive in~onneredistributions that are implicit in this policy attenuated, substantial mounts of revenue will be ~ f e of this may come from taxes on energy-a Xarge excise tax on g a n fine consumption-but some of it will have to cornre from general revenue. Xf g d compensatory systems are to bt;?. devised for those who rnah economic sac-.1-ifims in the interests of society, fwge amounts of general revenue will be necessary, Xf we are to inerease in~ometzansfer payments and cut taxes on low-income families that are being squeezed by energy prices and growine; inequalifies in market earnings, Fair taxes will have to tx: cdlected from the rest of the population. At the moment, our tax system is so unfair &at it shply kn't

capable of doing what is demanded of it, We have to have a tax system that will be perceid as fair. Such a tax system would ible to raise the revenue that needs to be raised, but it would alss m a b it posibfe to adopt the expe-nditure pragranns that need to be adopted. More public money for praeess R&D will make some individuals rich. There is nothing wrong with this if &am rich individuals at the same time pay their fair shme of taxes, The need to construct a fair tax system simply emphszsizes our primary need. Our soeiety has reached a paint where it must s t a to m&e explicit equity decisions if it is to advance. The implieit, undefended, unmalyzed equity decisions that have b e n built into our tax, expnditures, and regulatory palieies of the pmt simply won't tcarry us into the future, To implement publie poIicies in the hture we are going to have to be able to decicle; when lasers should suger ineome losses and when h e r s should be cornpnsated. We bave to be able to decide when society should take actions to raiw the ineome of some group and when it should not take such actians, Tf we cannot learn to make, impose, and defend equity decisions, we are not going to solve any of our economic proititems.

T b Isme Cannot Be A u o ~ d

Decisions about economic equity are the fundamental stafiing point for any market economy. Individual preferences determine market rfemands for goads and arvices, but these individual preferences are weighted by incomes k f m e being communicated to the market. AB;individual with no income or wealth may have needs and desires, but he has no economic resources, To make his or her persanaf preferences felt, he must have these resources. Xft income and wealth mare distributed in accordancr: with equity (whatever that may h),individual preferences are properly weighted, md the market can eBciently adjust ta an equitable set of demands, If beam@ md wealth a e not distributed in accordance with quity, individuat ppreferences are not proprly weightd. The market em-

Solving the Economic Problems of the 1980s

195

ciently adjusts, but to an inequitable set of demands, It is as if we had an eflticient street sweeper who was sweeping the wrong street, To have no government program for redistributing income is simply to certify that the existing market distribution of resources is equitable, One way or the other, we are faced to reveal our cofiective preferences about what constitutes a just distribution sf economic resources.l Both politically and inteliiectually, our history is one of pretending that we can avoid making explicit decisions about the fair distribution of economic resources, Xntellectualiiy, we talk about equal opportunity. Presumably this phrase means that each individual should have an equal chance for economic sueeess, but this still leaves two fundamental questions to be resolved. First, what economic game is to be played-capitalism, socidism--some mixture? Second, whatever game is played, what is to be the distribution of economic prizes to those that win or lose? Choosing the type of game that you wish to play says little about the optimum structure of prizes, since most economies can be adjusted to produce a wide rmge of different prizes, Market economies, for exampte, can exist with or without slavery, with or without public ownership, and with or without ecanamic discrimination, What constitutes a ""fir" economic game? Do we fet corxsumers"references deternine the economic merit of an opera company or do we create, through education, a public demand fot opratic performances? Xs a fair game a game where each person has an equal chance to win"l)f chances of winning are to be equalized, do we handicap those born with advantages or compensate those born with disadvantages? What constitutes an equal start? Should evefy individual be subject to the same initial budget constraint? Consider inheritances, Is there any digerence between the individual who inherits one million dollars 'and the individual whose athtetic talents will earn him the same lifetime income? As these questions indicate, the rules of the niituraf Xatte~yare not intuitively obvious, The ruXes can only Ibe specified when. one knaws the desired distribution of prizs to be generated. htteries or market economic games can be formulated to yield any distribution of prizes, The market may be a ""far process'9zo which mast Americans are willing to submit, but it is necessary to stipu-

late some other principles to determine the equitable distribution of economic prizes within this game, The problem is identical to that of designing the rules of a football g m e . To design a fair h t b a f l garne, wveral decisions need to be made. First, what is the initial staeing score? Xs it zero-zero or something else? Second, how does one advanm the ball and score? Third, how often does the garne s t m over? The mswer to none of these questions is axiomatic in either the sporting world or the econamic world, At Oxford there is, for example, a rowing race that started only once, Every year boats begin where they Xef off the year &fore. The race is never over, Would we define the equivalent game as "equal opportunity" in the ecpnomic world? History decides the unequal starting point of each individual eeonomic runner and each economie runner is now allowed to hand in his or her baton to whomever he wishes and at whatever point he wishes. The race never starts over, Once a duke always a duke, But leaving aside the starting scorn and the problem af haw ofien do you start over, haw would you decide whether the rules of advancing the ball are fair or unfair? Presumably, it has something to do with a determination that players of equal ability have an, equal probability of scoring, if not winning. How do you determine this in m economic garne as complicated as that of the real economy? Xf women, for example, who work full-time, full-yea earn less than 60 percent sf what males earn, and that has been true for the entire forty years that we bave kept track of sueh statistics, does that prove that the rules of advancing the ball are unfair? It i s either unfair or you have to be willing to defe?ndthe position that women are inferior to men. As a result, it is not possible to retreat to the position that we shouid specify the rules of a fair economic game and then let this garne determine the fair distribution of purchasing pawer-an initial score, This requires an equity decision, Many fair games that produce many different distributions of prizes could be constructed, To pick which fair game we wisfa to play we must decide whi& distribution of prizes we want, There is no escap from having to make explicit equity decisions. While it is not possible to pick a value-free, fair e~onomiegme, there: is another welt-traveled route in clur attenrpts to avoid explicit 8

Solving the Economic Problems of the 1980s decisions about equity. Suqrisingly, this is a route that has h e n used by both conservatiws and Marxists, It is the dsctrine of superabundance and satiated wants. In Marx" utopia, there was no need to specify an equitable distribution of eeonornie resources since everyone bad everything they could want, Workers had no demands for additional goods and services, If everyone has everything he wants, there is nothing to fight about, The problems of equity, the nation state, and personal budget constraints all withered away. Conservatives often subscrik to this vision. m e y simply have .it different route for getting frorn here to there. Instead of proceeding frorn capitalism, to socialism, to communism, and then to utopia, they focus on economic growth and the process of getting to satiated superabundance. Today's inequalities are justified in terms of their contribution to economic growth and the achievement of economic justice tomorrow, If vve just grow fast enough, there is more for everyone and equity problems will disappear. Unfortunately our demonstrated ability to generate new wants has eliminatd the possibility-for bath Marxists and conservatives-of ever being able to satiate everyone" wants. Since the pmblem of unsatiated wants is always with us, the problem o.f specifying economic equity i s always with us. This had led to a retreat from the doctrine of satiated wants to the doctrine of satiated needs. me goai here is to satiate physiological needs as opposed to the wants that are artificially generated by society, What is the minimum amount of income a person (or family) would need fa have a perfectly balanced diet and as long a life expectancy as is medically possible? This is the basic question. But problems arise, since the answer to this question yields a very low poverty line. Consider the cheapest medically balanced diet, By combining soybans, lard, orange juice, and beef liver (edible, cheap, nutritious, but hardly enjoyable foods) a medically balanced diet can be created that costs less than 80 dollars per person per year (according to t 959 prices) .Vft would be a better diet, medically speaking, than most of us now eat. But are we ready to compel popIe to eat it? Similarly, how much housing space per person is necessary in order to live to a ripe, old age. The answer-very little. Am: we then prepared to i p a r e t-he housing wmts of poor people?

And what does society do a b u t p r familia that are ignomt, heficient, or stubbm? W s a family have m u m e t need if it dws not h o w the cheapest w i f ~to have ai mediedly balanced diet? Does a fimily have an bnmet n& if it dws not want the diet &at it knows it should have and can aord2 Does a family have an unmet need if it simply refuses to eat an anapptizing or unwud diet? Since the United States has very few pople in p v e m , when pave- is based on suck a definition of physiological 'keeds,"" poverv lines were specified in terns of ne&-but beed itself ww &fined in a relative manner (that is, in terns of ""wants'" Given that a flan?% is going to want to eat as other American fmilks, and @ven that it is going to manage its resourws in, the: same ineacient manner, how much income does it nmd to get a medically bdanced diet (in spite of itself, if you will)? Given b a t it is going to want to consume somahing like the same mount of heat per prson, how much heat dms it need? But the minute that "nwds" are defined in terms of "wants," the concept of need 1-S its eoncreteness, Wants kcome necessities whenever most of the p p l e in society blieve that they are in fact newsities. Anyahg to which we have grown accustomed and tbat is generally availaMe Isecomes a necessiv, Nmds, thus defined, grow fight rrIong with average incomes, Like satiated wan&, satiated needs wiII not occur. T%isphenomenon can be w n in Gallup polls that have repatd l y asked, " m a t is the smallest amount of money a family of four neds to get along in this community?" The respoMs are a rather consistent fraction af the average income of the time at which the question was asked-but the sum grows in absoluk terns, The answers to this question hdicate that families estimate &eir own minimal nmds to be a linle more than half of &c: average family's consumption of that day. Similarly, when aked to categorize popfe as " v r , getting along, comfortable, prwprous, or rich,'* the public rather comistently does so relative to average inc~rnes.~ m a t sociologists call relative de;priv&rionis a very real feeling in a tiMa1 demmracy. Studies irr this area. hdicate that individuals have a veq strong fwfing that emnomic knefilts ghaufd b propartionat to costs (thd is, egom, har&hips, Men&, and the like), but that equals should be treakd qudIy. Sinw &ere me v ~ o u s ).

w s of such "c:osts" in any situation, a& digerent rewmb (hcome, est==, status, power), the problem hmed?iatt:ly ~ % as$to hsw equals are &fin& and how proportionality is to be detemind. T M has led to the dacult problem of reference group deterp people do you compare yourself to mination. Ta what ~ o u of detemhe whether youi are being treated relatively equally and propaaionalfy"t Reference groups seem to 'be both stable and restrict& by the fact that people look at groups that are czconomically elme to themselves. 'This explains why inequalities in the distribution of eeonomie rewards that are much larger than inequdities in the distsibu~onof personal charactefisties seem to caum little dissathfactian, and why people tend to ask for rather nadest mounb if they are asked how much additional income they would like to be making. The happiest p e w smm to be those who do relatively well withrin their own reference group rather than thme who do relatively well across the entire population, Xt also explains why e w anger at the welfare system among working people. n o s e on welfwe are clearly a group where bnefib axe not proportion~lto costs. mey do not need to incur any casts (make m y e E a ~ to ) receive benefits, Apart &om obvious ca=s such as welfae, where knefits and costs are out of proportion, our conception of what constitutes proportionality and relative equality ten& to be heavily detemined by history and culture. Distributions of the past me fair until proven unfair. Great mcial shocks, such as wars and economic depregsions, seem necessary to change specifications of relative deprivation. m i s is evident in Americm histofy. The only recent pexlih of rising msurket income equality in the United States oecctnred dufing the Great &pression and World War 11. From 1929 to t 941 the share of total income gaing to the bottom 40 wrcent of all families rase &am X 2.5 percent to 13.6 prcent, while the share af ineame going to the top 5 percent fell from 30.0 percent to 24.0 percent, and the share of income going to the top 20 prcent fell from 54.4 prcent to 48.8 percent. From X 941 to 1947 the share going to the bottom 40 prcent rosr: fufier to 16.8 prceat, while thte share going to the top f prcerzt fell to 20.9 prcent, md the shme going to the top 20 permnt fell to 43.0 ~ r c e n t , ~

h the Great bgreaion, an economic conapse urm the mechrtfar ehmge. Large iacames shpty had f u d e r to fall thm small incomes, In Wargd War I1 &ere was ia consengus that the ecanamic burdens of the war should be $hared relaevely equdly (""equafsacrifice"); cansequenay tbe f d e r d government used its economic controls over wag= ta achieve more reiattive equality. Wage piieies during World War I1 were a nnanifestatjon of a change in the sociology of what eons~tuted"fdr" wage daezentib, or reladve depriva~on.As a cansquence- of the widespread cansasw &at wage diEerentiaIs should be: reducd, it wzts possible to r d u w wage dserentidtfs delibrakly, Afkr they had bcome @mbdd& in the 1abr mmket for a numkr of yeam, these new daeren~atsbecame the new standard of relative deprivation and wage digerentids, even after the egdiwere regarded as the ""jstZr" tmian pmssures of World War I1 had disappemed. The impdant thing to note, however, is &at %henew stmdm& were not hposed by gavmnment on a reluctant population but w r e imposied on the mmket by ppular 'beliefs as to what eonstituM equity in waflhe, No one bows how to emginar such chmges in less exBern sitmrram,

Equity h & d u d &am purely facmajt 01.. I~gicaXstatments, f m un&r na illusiom that the saaes~am &at foflow will mmt with ~ v e r s a approvai. l At the s m e ~ e , they illuslrate a prwess that eveqone must go thraugh in reaching &eir awn equiq deeisiom.

Let me start by suggesting a possible specification of'economic quity. Xn the Udt& Stata there is a S@-g dlegimee to the prineipIe Xhat p p E e shauld fajr2y compk for a diswbution of mwket t the s m e time, &ere i s the recwitioa &at the mmket hen evevane an equal chace to win, The grou comes closest to our ideal vision of the natural lottery is m m

Solving the Economic Problems of the 1980s of fully employed white mdes, mey da not suEer kom the txmdi.=p% of discdmination, lack of skills, or unemplopent, IEf we lwk at their eadngs rahexl than their income, inherit& wealth, plays a relatively small xde in heir eument posi~on, h t me suggest that our genera1 equilt)l goal should be ta establish a distribution of earnings far everyone that is no more unequal &m that which now exis& for fully employed white males B (SW table 8-11, Shce th& distribution of e m h g s is the cument incentive structure for white males, there are no problems with work incentives. Wilrh more than half of the l a b r farce (rrxeitsured in hours of work) now patieipating in this natural foaery, it is hmdly a distribution of economic resourws that anyone could cansider un-American, TABLE: 8-1 Distribution of Earnings in 1977

Quintiles

Full-Time, FiuIf-Year A11 Other Workers (9%)

White Males (5%)

1

7.7

2

13.9

3

18.2 23.5 36.7 S 16,568

4

3 Mean Earnings

mma: U.S. Bwmau of tbe C a m , Curre& Pop~latian Reparts, C m s u w r I ~ e e mt@77,gtfbF - 4 , no. f 18 {March 193I2), P. 228.

Unless one blieves that the culture in which women, mino~tieg, and mderempl~yedwhite males exist is &Herentfrom the cultme in which empfoye8 white mafes exist, &eze is every reason to believe that a reward stmcture: that is capable af keeping white males on their economic tms is also capable of keeping oher h e r i c m s on their ecmamic tws. Inequalities greater than those &at now m u r in the emings of fully employed white males me not newssary to keep the economy functioning. They are, in fact, counterP~Q~uGGv~. As b dear from table 8-3, the; m a n earnings af hlly employed wEte mdes ate &out three times as high as thorn for fhe m t of the l a b r farce, At the t h e , the a ~ b u t i o of n inwme mong

fully employed white mdes is mueh more qua9 than that far the rest of the population. The earnings of the top quintile of fully employed white males is five times as large as that of the ibsttam quintile, but far the rest af &e papulatim the s m e gag is me*%yen ta one-mare thm five times as large,@The namal arguments against more equality are couched in terns of the need to sustain work egort, but full-y employed white mates keep working with a five to one gap. W y should the rest of the population require a twenty-seven to one gap? M i l e we could probably argue a b u t whether a five to one gap is equal enough to constitute economic justice, it is so far from where we are that we could use it as our interim equity goal for a long tine b e h e we had to worry about what else, if anything, should be done, Since many individuals only want to work part time, achieving this goal would not lead to an overall distribution of earnings of five to one, but if eveqone had an opportunity to participate in the ""natural"" economic Iattery enjoyed by white males, the distribution of earnings would be much more equal than that which now exists, How e m we go about organizing a soeieq where everyone gets to play the same economic g a m as that of fully employed white maltes? 'T'he standard monornic solution has been to attempt to q u a l h e the distribution of human capital. h a simple supplydemand auction market for labring skills, this would be the eorrect solution. If you pump a mbre equal distribution of skills and produetivities into the economy, a mare q u d cIistr;rbution of e m ings must flow oat of the economy. But &ere arc: a numhr af problems with this solution, The first is that empiri~aflyit-isn't warkiag. If human capital is measured in terns of educatian, as it mually is, by any measure: we b m substantially equalizd the distribution of human capitd since World War If. Yet as we have seen, the distribution of earnings has Wome more unequal, This is true for Wth the entire l a h r force and far white males. If you think back to the four lrepXacement hypahess that dlqwed us to understand rigid ,wages, the reasons for the failure b c m e clear. Education is an important background characteristic it is that affects our cm& of acquiring job &ills, but by i-lf

Solving the Economic Problems of the 1980s seldom a productive skill. Working skills and asswiated earnings are learned on the job, The allocation of jobs deternines the altlocation of skills and hence the allocation of earnings, Economic minorities will never catch up with white males unless they have an equal opportunity at the job opportunities open to white males, Reshuffling the current structure of job oppoaunities might bring equality ktween diEerent groups, but it would not mmt our equity goal. The basic problem is to change the structure of the economy so that the entire economy generates the kinds of jobs that we now open to white males and ensures that there are enough of these job opportunities to go around. Cantrafling inflation without idle capaciq is essential sin= we now start from a position where there sirnpIy aen%enough jab, gwd or bad, to go around, The problem is not just pcutliar to this periari of stagflation, Lack of jobs h a been endemic in pacetime during the past fifty years of American history. Review the evidence; a depwssion from 1929 to 1940, a war from 2941 to 1945, a recession in 1949, a war from 1950 to 1953, recessions in 1954, 1957-58, and 1960-61, a war from 1965 to 1973, a recession in 1969-70, a severe recession in 1974-75, and ano&e~ recession probable in 1980, 'This is hardly an enviable economic performance. While monetary and fiscal policies could be used ta stimulate the economy to the degree that it would provide g d jobs fsr everyone able and willing to vork, macroeconomic policies will not be used for this purpose, 3"he reaans are many-feam of more inflation, time lags in decision, processs, incompetence-but whatever the reasons, we need to face the fact that our economy and our institutions witl not provide jobs for evevane who wants to work. mey have never dohe .so, and as currently structured, &ey never will. When it cones to unemgtoyment, we are consistently the industrial economy with the worst record, As a result, the principal way to narrow income gaps between groups is ta restructure the econmy so that it will, in fact, provide jobs for everyone. Since we regard the United States as a work ethic society, this restructuring should be a moral duty a well as an economic goal. W consistently preach that work is the only ""etl.ricszf" way ta receive income. We cast aspersions an the "wel-

fare" smiety. merefore we have a mord respnsibility to guar=tee full employment, Not to da so is like lacking the church. doors and tt.len saying that p o p k are not virtuous if &ey do not go to church, Sbee phvate e n t e q ~ s eLs h~apableof guaranteing jobs for everyone who wanes to work, then government, and in pmiculm the 1Feshraf government, must institute the necessaq pragrams. Na one should attempt to deny &at a real, opn+nd&, guaranteed jab progrm would constitute a major resmcturing of our economy, Patterns of 1abr market b h a ~ o rand the outputs of our wonomy would be fundamentally Aterd. It should h poinM out, howeverp that real economic campdon would almost cedaialy increase. If the guarmted jobs are to be real jobs, then any parsulk& job program must firduce some wonomic outpub, mesa: outputs mi@t consist i,f street eleanirrg in competition with public sanitation hpmmenls, or the rebuilding of railwq roadMs in comptition with private industry, The problem is not finding wo&hwhile things to do. Anyone with even a little imagination can think of maxly thing8 that could be done to make this miety a better one, ff the option is tw=Ween idleness ancl work, the choice is shple, As long as any w f u l output is prduced, a work project takes pmedence over involuntq unemployment. A guaranteeci job program must have several chasacteristics in order to achieve the objwtives for which it is intended, First, it carnot be a program of employment at minimum wage rates. The objective is to open to everyone a structure of efonomic work opportunities equivalent to those o p n to fully employed white males, Thus, the progrm would have to smcture eamings and pmotion oppoftunities ia the s m e way as they are structufed for Mty emplayed white males, mere would be same low-wage jobs and some high-wage jobs, but most jabs would be; in the middle. %me or all of the warkers might be unionbed, Second, the progtam must b opn-ended, providiag jobs to eveqone who is able and willing to work ~egardlessof age, raw, =X, or education, Abilities ancl talents will play a role within the distribu~anof jofi oppmnities, but no ont: who desires full- or p m - w q work will be denid it. mkd, the; pmgram should not: be viewed as a k m p r a y anti-

Solving the Economic Problems of the 1980s recessionary meauret. The lack of employment opportunities is not a temporary, short-run aspect of the U.S. economy. It is pemanent and endemic, Even if this were not true, the progrm would still1 need to be permanent, since no industry could be expcted to go in md out of business aver the coursr: of the business cycle and still operate efffcientiy,There is no rewon, however, why here coulcf not be temporary, short-run jobs for people who, for a limited pc=.riod,are unable to find work in the conventional private or p u b Iic seetars of the economy. If the guaranteed job program w r e structured to provide tfie kinds of job opportunities now open to white males, the private economy would have to adjust, fn our current economy, we can play two diaerent economic games at the same time, since most people aren? allowed to pIay the primary game. If the primag game were open to everyone, everyone woutd abandon the secondary game or it would have to transform itself to provide the same working conditions and opportunities, f n the face of competition and threats to its own survival, f have no doubt that it would transform itself, What would such a program cost? Pwments for labor, materials, and capital might be high, but as with aEI economic projects, the costs would depend upon the difference between the value of output produced and the payments made to factors of. production. ff care is shown in project selection, there is no reason why the projects could not generate substantial net benefits, If you are ernpfoying idle economic resources (workers without jobs), the red economic costs (opportunity costs) would be substantially less than the monetary costs, How many people would need to be employed in a guaranteed job program? XI six million people were unemployed, the answer is obviousIy many millions, If a guaranteed job program were actually instituted, however, the performance of macrwconomic policy makers would improve, I f policy makers did not implement fiscal and monetary policies to ensure that private industry would want to hire most of the U.S. labor force, then they (governments) would be: forced to hire directly all the people who were left over. li suspect that interest in maximizing private employment opportunities would suddenly ariw. The num'ber who needed employ-

ment would be lwge, but much smdler &a cunenay unemployd. One of the subsidiq bnefitrr of a gumate& job progam is that it would eliminate the endless sterile debata &butwhat &%ctian of the unemployed are l a y and mwillhg ta work. Instead of wguing a b u t it, let's put it to the: test and see on= a d for all how anmy people realty wmt to work a d how mmy people are, in fact, lazy. ist tor if ally, one of the interesting things about our economy and politic& stmcture is that we h d it much easier ta set up welfare pmgrams to @ve p p l e money thm we do to set up work p r o p m s to give pople jobs. Transfer payments s t d at $224 bjiXXion in l978 while only $10 billion was spent in subsi&md j0bs.l Yet public rhetoric would lead one to believe the opposite, If an equitable distribution af economic resource8 is ever to b-e achievd, it will requinr: the provision of jobs for everyone who wsuxts to work. Politie&Iy, we are reluctant to give jobs, bcause to do so would require a major restructuring of the economy. A new source of competition would arise for h t h public: agencies and private firms, To the extent that we were unable or unwilling t s hold the private wononny at the full-employment level, we would have! a socialized wonomy. The time has come, however, to admit that the pumuit of equily md equal economic opporluniity demands a fundamental restructuring of the economy, Eveqonie who wants to work should have a chanee to work, But there is no w;rry to achieve that situation. by tinkering marginally with cunertt economic policies, The only sdution is to create a socializd sector of the economy designed to give work opportunities to everyone who wants them but cannot find them elsewhere. X am not naXve enough to think that such a plan is about to be adopted, but the basic problem is already of Iong standing. Can you really imagine continuing for another thirty years with black unemplayment twice that of whites? Fult-time, full-year female workers have earned less than fiO prcent of men ever since record keeping began more than forty years ago. Can it continue for another forty years? Perhaps, but X doubt it. Should it continue?

Solving the Economic Problems of the 1980s X have no probbm mswring in the negative, Will it. continue if we don" do something to change the structure of the economy fundamentally? f have no problem answering in the psitive, Will we fail as a swiety to address this fundmental ~oblenxmd let it drag us down with it? Perhaps, In the records of history, we certainly would not be the first society that failed to came to grips with its fundamental internal problems, Xf we were to achieve a distribution of earned income opprtunities for the entire pogufation, such as that now enjoyed by fully employed white males, mueh of the welfare problem would disappear, But there would still be a problem among the elderly and those families without earners for medical or other reasons, Xn the case of the average elderly prson, the problem is maintaining the income parity that the social secuaiq system is now p m iding, For the poor, elderly, or otherwise, the aim should be ta establish an income transfer payment system which provides a standard of per capita living that is approximately half that exljoyd by the rest of the population. This is what the public opinion pfls seem to indicate that W waat, Xnterestingly, it is ajsa almost exaetfy what the official poverty line speeifted when it was first established in 1863 and what many northern and western states w r e providing in welfare in the early 1970s. Our tax reform goals should focus on two prinei.ples, First, wherever psible, refoms should be taken to reduce the dispersion in tax rates, Proposals that increase the dispersion in tax rates for those in the same income cXstss should be avoided, matever the right degree of verticaf equity, horhontal equity (&e equal taxation of equals) is an important principle that our current tax SFtern cruelly violates, %cod, the appropriate degree of vertical equity depends u p n how cfasiely we came to achieving an equitable distribution of market Camings, If we reached a distribution of market earnings in accordance with that suggested above, a proportional: tax system would trae appropriate, To the extent that we have not achieved an equitable distribution of market earnings, the tax system should be structured to move whatever distribution. of market earnings does exist toward an after-tax distribution of income that approaches our equitable distribution of market incomes,

h a n perid, taw general Is, but taxes are m infdor secondary approach to the problem. They are to be mum fundmental &ages can be put In place. The god is not a system of taxes and tramfew that leds to an equibble distribution of wanomic rwurces, but a system of market eminllfs that is quiabl~. mce:we agre on a spification of economic equity, we we in a pasition to deal with the prabXenn of economic change and earnpnsate t h m that get hurt when public policies me altere8. m e n should & x a p r adjustment ~ assistance be paid to economic lwm, and when should it. not be paid? One of the pcuXidties of our mixed %onomy is that W? have p o r to nonexistent systems far compnsating indieduds who EegithateXy lam when projats are wdertaen in the general interest. The only recoume of i n d i ~ d ~ d s in this situatim is to stop the wonamic progress &at threatens them, If we want ai world with more rapid economic change, a g d syskm of transitiond aid to individuals &at does not lock us into current actions or cunent institutions would 'br; dwkable. Adquate individual compensation systems are o p p s d for a numkr of remans, &metimes wmpensation mufd have to be paid to &a= who are already rich compared% with the rest af the ppula~on.Sin= the rich are seen as avoiding their fair share of the &X burden, cornpnsation. fm losses is seen as d~ub.tyrmfair, The appmpriak corrwtion for this problem is not to resist compnsation systems but to establish a fair tax system. P r a j ~ edeveloprs (government or private) are used .to getting what they want without compensation, and they resent having to gay. To pay compensdion is to admit that governments and firms have income distribution rmpnsibitities, f~cumesdo not gu up and dawn beau% of impersonal mal.ket forces, And since many factors taus incomes to go up and dawn in a large economy, it is difficult ta decide when comgensation should or should not be: paid, Not all losses can s r shouId be compensaM. All of these objections have merit, but even tagerker they do not constitute an adlequate C= against eomwnsaition. We sbply a better syskm if we are to have any hope of making the economy more dynamic. If rich people are hurt and are rich in accodma tas

Solving the Ecowmic R o b s of the 1980s with our spcification of wonomic eqdty, &ey demne to Be c m pnsated just as much as the . P r @ ~mmagers t may resent current choice: is kween payhaviq to pay eompfisa~orr,b ing compnsationt or never getting the project undernay. Government dms have income distribuGon respsrmsibilities, md we simply aren't eeuaomic fatalists- axlpore, b y compensation system will, to mme atent, be a b i t r w and fail to help someone that it should help; however, a second-&% system is not perfect but b t k r &an no system at .!l& Existing compensation sy&ems simply illustrate the prablems. Instead of being run as if they we= intended to give pneraus compensation for losses actually suffered, they are run as if the aim is ta depdve the citizn of his in~omem mpital. PalFsirnony m&er than generosily is the mle. In urban renewal, compensation is paid for praperty and moving exflaw, but a very hmow irxteqretatian is talken of what constitutm a lam, No cumpnsation is paid for Borhkds-friends, mmdbmpting fives or far the lass of fartable habits, and so fofih, m e w l an: undoubtedly dificult 1. Not king willing m to quanltify, but they are nonettrtet able to quantify them precisely, we: act as if they were not l a m at atg. The same approach is fdlawed .in the Trade Adjusment Assistance Get, Since the benefib of frep &ad@are geaera2, while the costs art? usually iocalimd, it would m m fair to compensate the losers fram the @;eneralgains, Yet until mwntly, austmenl assistilnee has b e n run as if the aim were not to spend any money or find my c w s of valid disruptions and 1 ~ ~Administratively, s . the programs are o&eneven less generous &m tfiey -m on paper. To mnduet eitt.ler public or private business, mare adequate cornpensarian systems are gaing to have Xo be developed in rhe future. That? who suger the lwdhed costs &at generate universd benefits are going to have to be eompmated. But this is &ss Eikely to make a change in the mixture of the mixed econmy, singovernment will undoubtedly be called u p n to help decide what constitutes cornpasation and haw the necessary Even* sbould be collected. If we cannot develop k t & r campfisatlaa systems, then recommendations to end protection, sulbsidim, and p d a are useless, Individuals want cxanomie wulrity, and to shply recammend that they give it up is to shout at the wind.

There are two possible avenues. One avenue is that fallawed by the Japmese, whew Isge h s are delibrately structured on a conglomerate bmis md then hel@ to shi& resources from sumt areas to sunrise meas w i ~ the n same firm. Individuals me pr* tected sin~ethey know that they will also be Warzsferred from the sunset weas ti3 the sunrise weas, The o&er avenue is that fdlowd by Sweden, where an attempt is made to provide m incfi~dudsafety net. An elabrate swial welfare system cushions economic shacks, and Xarge amounts of resources me used in retraining the work force to move &am one a e a to mober. Given that the private economy already w m s to be moving toward a conglomerate fom of organization, this should be encsuraged and develom into a system that promotes prduetivity and =onomic security. Ixlstead of grohibitixlg mergem, fims should be encouraged to engage in different activities. With our patteni af heay internal financing &orn r e t ~ n deadngs and depreciation allowmces, investment funds are much more apt to flow into hi@-productivity weas if managers can invest the fixnds in &eir own firm. Like the rest of us they want economic security and tend to reinwst in low-prductivity areas if that is the only way to protect their economic ecurity. 'This would improve the alltcation of both htemal, savings and externid fun&, External lenders are only interested in king repaiid, and often low-productivity bnowers, such as the steel industry, are very safe risks hcause of their large internag s a v i n ~ .If &e htemill funds are more eBF'leiently all* cat&, the external fun& will automatically be more eseiently allocated. Fims should be encouraged to move into new areas md out of old areas, but only with the understanding that they are expected to take their warkers, as well m their managers, with them. 'IBe individud safety-net approach also needs to be used. Trandtional aid for =training, relwating, and getting through a perid of unemployment should, if anything, be overb generous. The goal is not to spend the least p s i b k , but to prmote a rapid rate of: economic ehmge, m a t we lm in overly generous cornpernation, we will mare than make up in faster economic chmge. m a t needs to be avaided is the institutional, safeg-net approach

Solving the Economic Problems of the 1980s where firms are protected from faiture in. the nme of po&eGng individuals, Wage and retraining subsidies should be attach4 to individuals, They r n q be cashed by firms who employ them individuals, but subsidies should not be given to firms directly. F e n is a sharp distinction t s be made between proteeting the failing individual and protecting the failing fim,

IC)ecMort~. to Be Made Whatever- the process for getting there, and whatever the spc%cations of economic equiq, there are four major deeisiom that eveqone rnust make. First, what is the minimum economic Boar t s which you will let any individual or family sink regardless of the cause of their fai1ureWnless you are wifIing to tderate starving fmilies.in the" streets, this is a question that must be answered by evevane. X suggest a minimum floor that would provide a standard of living just half as large as &at of the average American, Second, what is to be the distribution of eeononxic rewards lFor those that participate in the economy? I sumest &at stmcture of rewafds that now exis& far fully employed white males, Third, given that tax revenue rnust be collected to finance gavernment expenditures, haw sbouId this burden be: distributed? Given a fair distribution of economic rewards in the marktplac~, a proportional tax system is desirable, but without large vasimces among individuals with. the same real income, To the e x m t that the distribution of market earnings has not reach& the desired level, a progressive tax system should exist to move the distribution of take-home incomes toward the desired goal.. Fourth, what compensatory payments should be made w k n public policies cause large income losses? One can be a purist and answer ""never,"' but f argue that we need a pnerous system of transitional aid to individuals, but not firms,

m i t e this has b n a W k on ecunomic prublems, &em problems a d their solutions fwus attentian back an our ~ I i G e dprmss. our habilig to act re&ct hndmentaf heconclilable &vithat no pliticd prwess could owzcome, or b there =methhg wrmg with o w pliticait system? &me of our pardysis is due to imwon&fable digerenws, but some of it is &W beeausr? of a that emnot m&e deeigiom when a_tl &isions result in substmGd hcome losses far someone, This is not a fault shared by other foms of g same extent. Everyvvhere else: in the industrial world, parliamentq foms of government have haoions~atdthat &ey cm pttndb automobile Qrivhg, even when everyone Mvm and I m s it, Veq high tmes can be levied on gasoline efswhere, but nat here. Our problems a ~ m beau=, in a very reat-=nse, we do not have pfitical paaies. A plitical p m y is a group that cm force its elect4 membrs to vote for that pafly" slutions to wielyb problems. With a mil)odty and miriarity paw, the majoriw is expcted to m1ve the nation's econamic problems. Xf it ern", it is repXaeed in the next election, and the minority kcomes the majority. Respansl,bifitityfor success is clear, and failures can be punish&* Instead af having two putim, we have a system where each y is free to establish his own party elected oficial is his own p a ~ and pfatfom, Parties are merely vague e l e c t d alliances. But this means a splintering of pwer that mahs it impossible ta hdd myone respnsible fjor failure, No elected ofieial ~ s l a'Lte: e x p t d to solve the problems by himself. Failure can-always be blamed on mmmne else. mere it no majority that must solve problems or be held accountable. Xxl comparison, the diEusian of resgonsibility that we so often castigate in proprtional representation ~ m mild, We have the ultimate in proportional representation, where every cbcted omcial is a one-man pliticd party. men. na one can be held respnsible for failwe, it h o m e 8 p s i b l e for everyone wha canthbuted to the failure to bt: reelected time after time. Each individual mentkr of Gangress r e p ~ 40s his

s

Solring the Economic Problems of the 1 wnstituenb that his wlutians to the problemis were Wled by mm* one else, but he is f & ~ hard. g He or she c m also reprt that they also suc~essfullyfoufit. ta prevent their padcuf ar electorate &am having to suger any of the c a t s that would have wcurred if =meone else's ssotutions to the pmbfems had k e n &opt&, k i n g suecessfuf in stopping programs that would hurt fheir electorate, and giving the apparance of working towad sojiutiorus, each congrew man can be reelected with the pro61ems unsolved. Since no one has the power to solve the problems, no one can h fired for not sotving the problem. iinte~atedpofitiGaX p a ~ i e sfails us But not having a~eounbbte~ in an even, more fundamental way. Since all economic soludans require decisions a b u t the distribution ok income, we should be voting pIiticaI parties up or dawn b a d on how &ey af.e gdng to allocate the economic lows necessary to solve our problem^. Not having political parties with a common position on this issue, there is no way that voters can come to a majority or minority psition on who should bear the inevitable losseg, Each individual congressman is free to argue that all of the losses should tx: &l+ eated to someone elsels csngressional district, and this is exactly what his voters want to hear. Presidential candidates cannot shift the Iosses to someone else's electoral district quite so easily; therefore they retreat to the p sition that they can solve the problems without hurting myone, We are told about the large economic gains that each of us will make if they were elected, but losses either don't exist or are quietly ignored. To pretend that there are no fosses, however, is ta guarante that once elected, a president will not be able to impose the necessary Iosses, He has been elected on the bsrsis of na losss far anyone, and he has no etectocal mandate to irnpse the losses. In contrast, a British conservative government was elected an the platform of tax cuts for the rich and tax inereases for the Xower middle class. Having k e n elected on this redistribution platform, the laws implementing it could be quickly passed, In our system, proposals that yield economic losses come as a surprise, are treated as a betrayal, and result in fierce piitical resistance that makes It innpassibte ta impose the programs,

There is no eay p&& for g e h g &am here to there, but mmehaw we have to mabXish a pligca-f s y s w where m m m e em Bc: kid resp~miblefar f ~ l w e . .am only b done h a system w h e ~&ere are disciplined m a r d q and r n i n a ~ qpaxlties, Eveq potiacim with his or her own platform is the American way, but it is not a way that i s going to be able to solve; America" seonomic problem. As we head into the f980s, it is well to rememh that there is really only one impfiant ques~anh politic& econamy. If elaM, whose incame do you and your party plm to cut in the prams of soldng the economic problems facing us? Oar wonomy and the wlutions ta its problems have a subtantial mro-sum element. Qur t but we are e;canomic life k o ~ l dbe easier if this were n ~ tme, gohg ta have to barn t-o play a mrwaum aanomic gme. If we cannot Iem, or prefer to pretend &at the mresarn probtem does nat exist, we we simply gaing to fail,

Notes

Chapter 1 l , International Monetary Fund, International Fi~anciafStarisrics 32, no. 4 (April 1979): 122, 156,214,352, 356,390. 2. Ibid., p. 228. 3. Irving Kravis, AIan Reston, and Robert S u m e m , ""Real 0 D P for More than 10Q Countries," Economic Journal, June 1978, p. 215, 4. International Moneta~yFund, Internariiznal Financial Sratisfic~32, no. 4 (April 1970): 43,354. 5, Ibid., pp. 154, 214, 390. 6. United Nations, Yearbook o f National Account $ratisrics, 1977, vol. 1 (New York: United Nations, 19781, p. 348+ "I Malcalm Sawyer and Frank Wamrman, " h a m e Distribution in OECD Countries,""Q E D Economic Outlook, July 1376, p, 14. S, U.S. Rpartment of Commem, Bureau of Ronomic Anttfyds, Tke Nirrfianal Xncurne and Prad~crAccounts o f the United Sfafes, 1 929-1974, p, 3 12. 9- U.S. &parXment of Commerce, Survey of Curreef Business 59, no. 7 (July 1949): 43,

10. Richard Easterlin, "Bxs Money Buy Happiness'?""The Public Inrerest* no. 30 (Winter 19731, p, 3. l 1 . See Chapter 7. 12, Edward E. Lawfer 11, Pay and Organizational a@ectiveness: A Psycholclgicat View (Mew York: McGraw-Hill, 19711, p. 37.

'

I, U.S. kpartment of Commerce, Survey o f Current Busi~ess59, no. 7 (July 1979): 35. 2, U.S. h p a r m n t of Commerm, Statistical A b s t r ~o f the Unitl.d States (Washington, D.42,: U.S, Gwemment Printing Otfise, 13781, p. 488. 3. CalcuXated on the assumption that all energy pn"at?swould have risen pro-

partionally to that of oil on a W U basis. I. See Table 2-1.. 5. U,%.Fe8erat Remwe Board, ""Swey of Ananeial Characteristics of Consumers,"" Federal Restrrve Bulletin March 196.4, p, 285.

6. Rob& S, F i d y ~ k ,3% SZr~ctareof World Emrm h m d s (Cambridge, MW,: MIT P m , 19791, p. 43. 7. Par a discwion of emrgy and t b enviro

Chapter 3 1. Soe Table 2-1, 2, U.S. B e p a e n t of Commerce, Bmmau of b n a m k h a l p h , IThe National l ~ c o m eand Prcd~ctAccamts of the United States, 1929-1974 (Washington, D.42,:V.$. Government P~ntingQ-, 19751, p, 264, 3. Wd* 4. U.S, Rpartment of Gammerce, Statistical Abstract of the Unirtti States (Washiagam, Dec.:17,s.Covemmmt Printin 1, p. 713, 5, U,% mp&menl of Commera, Survey w'mm 59, no. 7 (July 2979): 26,

6. Ibid. 7. Council of &onamic Advisers, Ecommic irndiearor~~ Sept. 19'19, p, 5, S, Ibid-, p, 2. 9. %a: "fable 3-2. 10. U.S. mpsrrtment of Canmrm, Survey of Carreat B ~ i m m59, no, 7 (July $979): 39.

11. U.S. Bureau of the Gemus, Current P~p~lation R c p ~ s Consunrer , Incow 1977, Series P--@, no. I19 (klwch 19791, p. 5. 12. U.S. Bumau of the C e n a , C~rrenrPopulalion R e p ~ f sC, @ ~ & m Income er 1977, Series F+, m, 117 {Eke, 19791, p, 34. 13. Fmnw Mdigliani md Rkhard A. Cahn, "Ma~om;,htional Vaiiwatian, and the Market,"" Finamial Analysis Jo&mal 1O (MarcbAp~f1979): 3, 14. U.S. bpztrtmnt of Labr, F @ m l O c c # ~ t i o m l F ~ a i n i ~of g Ad< ?"The

Public Inictrst, no.

30 (Winter 1973), p, 3.

15, International N m t w Fund, Inrercrtioml! FimncW Srcltislics 32, no, 12 (Dec. 1979): 165,369. 17, 'West's IfnffatianRate Fou& Aakmtirng," New York Times, Jmne 13, 1979, g. D-5, X

X9?90): 39.

ktes in Tabk 3-3.

Notes

2=7

3, a u a c 2 of b a o m i e M v b m , Ec~nonzl~ R e p r t af the President, Jan. 1979, p. 226 of Conamem, Slatisrid Abstrat of the United Star#s .S, G o v e m m t Frhting O%m, 19781, p. 622. of C e m e m , Survey o f Current Buslness 59, no. 7 (July

1978): 26.

6. U.S. bpactnaent of Commerm, Survey o f Curre~tBwines 59, no. 7 (July f 979) : 52, 56, 7, See Chaptor 8. 8, U.S. Bmmsu of tbe Cemas, Curxenr Popularion Remrfs, Consemer lneome 1977, bries P-@, no. 117 (&c, 19781, p, 19.

Chapter 5 X, Cowcif of b a o m i c Adviwra, Economic R e p ~ r to f the Freddent, Jas, 1979, p. 226, 2. Ibid., pp. 246, 209. 3. bid. 4. Eke Chapter 2. 5, Council of Economic AdviQ"bm, Ecmomic Repart of the President, Jam. 1979, p. 181. B. CsIeuIated by regming relative income on the nagom1 ummplayment rate. 7. US, Bpafimemt of bk,Employment and firnings 26, no. 1 (lan. 1979): 181.

1, Charles B. Bw&, T h e Pros and Cams at hm@lat& Forrune 99, no. 12 (fufy X8, 1979): 140.

Tm~kem,~

Chapter 7 1. U.S. Depament of Cammrce, Srrrvey of Current Bgslactss $9, no, 7 (July 1979): 16. 2, Se;e Tabb 7-1. 3. euacI1 of bnarnk Mvimrr~,Ecanomic Report of rlze Presidefir, Jan. 1979, pp; 268, 269. 4, see Table 7-3. S, See Table 7-2. 6, U.S. Ikpa;rzmeat of Cctmerce, Survq of C g r m ~ Bwiwss t 59, W . 7 ( J d y 1979): 44. 7. See TaMe 7 4 . 8Tabh 7-44.

9. These numbem sue cafmtated from the same Census tapes as the data presented in table 74, 10. See Table 7 4 , 11. See Table 7-7, 12. Daniel M. Holland, 'The E%e@ of nxation an EEoxr" eager at hpmceedings of the 62nd National Tax Aswiation Oct. 1969), p, 428. 13. Joeph A, Pe~hmanand Benjamin A. Okncr, Who Bears the Tux Burden? (Washington, D.C.: The lilrwkings Institution, 19741, p. 46. 14, U.S Bureau of the Census, Current Population Reports, Consumer Income 1977, S%riesF-60, no. X 18 (March X929), p, 45. X5, See Table 7-8. 16. U.S. kpartnxent of Commerce, Survey of Currenr Business 59, no, 7 (July 1979): 38,40. 17. Ceorge Cooper, A Y o l u n r a ~Tar? New Perspectives on Sophislicated Estate Tax Avoidance Oj7lrashington, 1D.G.: "be Brwkings Institution], 11.179, p. 40. 18. Arthur Louis, "The New Rich,"' Forrune 88, no, 3 (Sept. 1973): 170. 19. Two excellent survey airticbs of the random walk are Eugeae F. Pama, 'Tficient Capita1 Markets: A Review of Tht?ary and Empirical Works,""Journal of Filtance, no. 25 {May 19763, pp, 383417; and Miehael C. J e n ~ n ,Yapital Markets: Theory and Evidence,'" lrhe Bell Journal of Eco~omicsand Mu~agememt Science, no, 3 (Autumn 1972], pp. 357-398. 20, Ibid. 21. Jacicob Mincer, Schoolr'ng, Experience, and Earnings (New York: Wadonail Burrtau of Eccmomic Resarch, 19741, p. 112. 22. U.S. Bureau of the Census, Current Population Reports, Popularion by Ethnic Origin 1972, SEries P-20, no. 249, p, 26, 23. U.S. BepaHmenE of Labor, Ernploymefit and ;Eorminga 26, no. I (fan. IW9): 156. 24. U.S. Bureau of the Census, Current Population Reports, Consumer Income 1977,Series P-60, no, 118 (March I979), p. 234.

25, Ibid.

26. fbid, 27. U.S. Departmnt of h b r , Employment and Earnings 26, no. I (Jaa. 1979): 189. 28, U.S. Bureal~of the Census, Current Population Reportst Consumer Xncame 1977, Series P - a , no, 118 March 1979), pp. 218,222, 29, IJS. Bureau of the Census, a r r e n f Populatio~Reports, Persons of Sp~nish Origin, Series P-20, no. 339 (March 1978), p. 27. 30. U.S. Bureau of the ensus, Current Popuhfion Rsprts, Consumer lmome IP77, Series FAO, no. I 18 {March 19?9), pp. 22?,23 8 . 31. U.S. bpartment of b b r , Employment and Eumi~gs 25, no, l (Jan. 1979): 156. 32. 21.S. Bureau of the Census, Currenr Populatim Reports, Consumer Income 1977, Series P-60, no 1X8 (March 1979), pp, 197, 198.

Chapter 8 I, &ononxic aeofy avoids ewity decisiom by retreating into what is called P a ~ t oeeciency-a fancy term fox" "mom is btter than less.'' If a purblic pm@am moves the economy from State R to state & and js state B everyone Is 'bctter off than, or m weIl off as, they m m in state! A, €hen we can say that thc publie plicy L Fwetwfficienl and sh.houtd be a&ptcd, But sbm there is always-

Notes

$29

someone who is worn of£ after any change, nothing is BaretwBcknt in the real world. As a result, we retreat f a d e r to the weak f e r n of Famto efficiency. In this weak form, state B is ParetwBcient if the ewnomic gainers in state B could compensate the ecanomic loam in state B m that everyone is as vveM off or better oR. n i s , of mum, is always w s i b b as long as total msources in h t e B an: Xarpr than in state A. Therefore any policy that raiss the GNP is ParetoeEcient, The pr~blemin the real world is that the compnmtion from winners to losers actually has to be paid, yet is almost never paid, As a result, we annot avoid making eeanomic equity decisions in puMic plicies, even &ough we a n elimiaate them in economic theary, 2. Vietar E. Smith, Electroaic Compgtarlio~~ @l[ Human D i m , M.S.U. Business Studies (E, Lansing: Michigan State University, 1964), g. 20. 3, Lee Rainwater, "'Poverty, Living Standads and Family Welt-king,""WamardMIT Joint Center for Urban Studies VIforking Paper no. 10, p. 4.5. 4. Herman Millet, Imome Distribution in the United Slates (Washington, D.G.: U.S. Bureau of the Census, 1.9661, p. 21, 5. !&X Tabk 8-1. 6. Ibid. 7, U,$. &partmeat of Connmerw, Survey af:Current Bmi~ess59, no. 7 (July 1979): 16,

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Index

Accidents, industrial, 151, 152 and, l48; international competition Acreitge controls, 45 in, 148; regutation of, 122, 140 Advertising: camptition and, 149: Atttomobiile insurance rates, I8 1-82 wants deternlined by, 147 Affirmative actton, 178, t 83 Age-sex n ~ i xof labor force, 85 Agr~ctrltural price supports, 46, $5, Balanced government budgets. 74 124, 125, 143, 145, 183: abandon- HaIkanizrttion, I4 nlent of, 69; exogenaus price shocks Bank of Japan, f 23 Banks, national investment, 96 and, 72 Black lung, 137 Agrrculrurail societies, 20 Agriculture: pradrrctivit y In, 87, 89-91 : Blacks: discrimination against, 178. t80, '183-86; economic growth and, 192; rapid price escalation in, 45, t 41; regovefnment employment of, f 63: search and development in, 95: SPP household income of, 52; impact of al.$