moderated after persuasion from the White House, but I am not aware of any example of wage increases that have been moderated as a result of such persuasion.

I am aware of two points of view in the Congress hostile to the continuation of the Council. One holds that any government interference whatsoever with private wage and price setting, even if it is implemented only by persuasion, is an unwarranted meddling with the free enterprise system. I would agree with this if all of our product and labor markets were highly competitive, but manifestly they are not. To the extent that the existence of substantial market power in individual firms and unions is inherent in modern industrial society or is permitted by government policy, the Government must retain some responsibility to see that this power is not abused.

The second view is that the Council is so weak as to be useless, and should either be greatly strengthened or abolished to make way for something stronger. Proponents of this view usually want some sort of standby price controls for concentrated industries. In my opinion, the recreation of price control authority at this time would be most unwise. Giving any Government agency authority to control prices could provoke a rash of anticipatory price increases, some of which would then have to be rolled back. Moreover, compliance with the complicated regulations of price controllers adds substantially to the costs of doing business. Finally, I know of no evidence that price controls permanently restrain inflation-at best they seem to store it up and postpone it. Giving the Council's formal power to control prices would therefore be counterproductive-it is more likely to contribute to inflation than to restrain it.

Mr. Chairman, this completes my statement. I should, of course, be happy to answer questions.

The CHAIRMAN. Thank you very much, Dr. Rees.
Dr. Houthakker.

STATEMENT OF HENDRIK S. HOUTHAKKER, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY

Mr. HOUTHAKKER. Thank you, Mr. Chairman. I appreciate the honor of appearing before this committee, especially when doing so in the company of Barry Bosworth, who has been nominated to direct the Council on Wage and Price Stability. Having known and admired Barry Bosworth for a quite a number of years, I feel he is eminently qualified on both professional and personal grounds, and am pleased that the President has nominated him for this important responsibility.

I have followed the affairs of COWPS from a distance ever since its inception, sometimes with more than academic interest. In fact, if the 1976 election had gone the other way I might have been in Barry Bosworth's position, awaiting the advice and consent of the Senate. In my opinion COWPS has evolved into a necessary and useful component of the economic policy apparatus. During my service on the Council of Economic Advisers a large fraction of my time was taken up with matters that are now within the domain of COWPS, and this was sometimes at the expense of problems that are more properly the concern of CEA.

The two main functions of COWPS are equally important. One is to prevent government, through its rules and regulations, from contributing unnecessarily to inflation. The other is to monitor pricewage developments in the private sector and make suggestions for improvement. Both these functions raise difficult policy issues.

In the case of supervision of Government regulations COWPS is up against two formidable adversaries. One of them is old but as vigorous as ever: it is the pressure of special interests. Presidents come and go, but the client-oriented departments such as Agriculture, Labor, Commerce and Transportation continue to do favors for their constituents without worrying too much about the cost to the rest of the country. The inflation impact statement has proved to be fairly effective in keeping some control over these regulations, though much remains to be done. The role of COWPS in this field is somewhat similar to the role of the Office of Management and Budget in the area of expenditures. Like OMB, COWPS will be unpopular if it does its job properly, and this is why it needs full support from those concerned about the public at large.

The other adversary is of more recent origin but perhaps even harder to deal with. It is zealotry, the belief that some worthy cause is more important than anything else in the world. We live in an age of hysteria, in which claims for public attention have to be strident if they are to be heard at all. Rational policy, except perhaps in times of all-out war, has to be based on the notion of a tradeoff between various goals, but that is precisely what the zealots deny. Anybody who is not 100 percent for their cause is against it. Some of the laws passed by Congress, particularly the sweeping statements that tend to be made in preambles, provide a legal foundation for these uncompromising attitudes. Everything that can be related to one of these causes, no matter how trivial, becomes sacred and by implication immune from economic evaluation. Again the inflation impact statements is needed. to protect the public interest.

The principal problem faced by COWPS in the area of government regulations appears to be vast range of subjects that need to be covered. The Federal Register, which is presumably the chief trigger for COWPS action, consists of a fat volume every working day. Inevitably COWPS has to choose. A perfunctory evaluation is sometimes worse than no evaluation at all. It is my impression that COWPS is still in need of a policy on when to make its voice heard. One principle for such a policy should be that all government regulations (except perhaps for national security) are fair game; thus the energy field, which appears to have had little attention, should have heavier emphasis.

The policy issues with respect to the private sector are of a different nature. Clearly COWPS is not merely a reporting agency; it should comment whenever it has a considered opinion, and hold its peace otherwise. But what should its comment refer to? One school of thought, influential in the 1960's and by no means extinct, would have COWPS engage in jawboning. I have strong doubts about jawboning, based in part on some practical experience not only when I was a member of CEA but also when on the CEA staff in 1967-68; if the committee is interested in those episodes, I shall be glad to expand.

Jawboning attacks the symptom rather than the disease, and it is not very good even at dealing with the symptom. It does not take long for businessmen to catch on, and to announce price increases higher than they really want so that they can climb down amidst official congratulations on their statesmanlike restraint. The net result, usually, is that the Government winds up endorsing price increases whose validity should be tested by competition. Moreover, jawboning tends to be highly selective (in the 1960's at least half of it involved metals) and to institutionalize price leadership. Jawboning of wages is, if anything, more futile still and undermines normal bargaining practices. Neither can I see much promise, incidentally, in the unholy alliance between big business and big labor that my distinguished colleague John Dunlop is trying to put together.

Official efforts in the wage-price area should concentrate not on modifying the actions of those possessing market power, but at reducing that power by stimulating competition. COWPS can play a valuable role by documenting the many barriers to competition, and recommending measures against them. It should look not only at failures of competition among domestic producers, but also at the increasing restraints on competition from imports. The steel industry, the favorite target of jawboners, provides examples of both kinds of market imperfection.

The one thing that COWPS should not do is hint that price and wage controls may be used as a last resort if businessmen and labor leaders do not behave. This is an outright invitation to undesirable price behavior, and particularly to the suppression of the price reductions that are an indispensable element in overall price stability. Threats of this kind merely anticipate the common failing of price controls, namely that they make maximum prices into minimum prices. The history of price controls from Hammurabi through Nixon is one of almost universal lack of success; any remaining belief that our macroeconomic problem can be solved along those lines must now be considered irrational.

As the committee will have gathered, I favor extending the authority of COWPS. Indeed I would suggest a longer extension than 2 years because successive directors have had to spend too much time arguing for the life of their agency; the short life also causes personnel problems. This does not mean COWPS should be made permanent-the "sunset" idea has a great deal of merit. Four years would seem to be the optimal time span; this will permit reconsideration early in the next Presidential term.

The CHAIRMAN. Thank you, Dr. Houthakker.

Dr. Bosworth.

STATEMENT OF BARRY BOSWORTH, DIRECTOR-DESIGNATE, COUNCIL ON WAGE AND PRICE STABILITY AND CURRENTLY SENIOR FELLOW, THE BROOKINGS INSTITUTION; ACCOMPANIED BY ROBERT CRANDALL, ACTING DIRECTOR, COWPS

Mr. BOSWORTH. I testified before this committee last December in more detail about the problems we face. I have a statement but I

thought I would just submit it for the record and try to quickly summarize its main points.

The CHAIRMAN. The statement will be printed in full in the record. [Complete statement of Dr. Bosworth follows:]

PREPARED STATEMENT OF BARRY BOSWORTH

I would like to sketch for the Committee in general terms the intended future activities of the Council on Wage and Price Stability upon the extension of its authority. Since I have not been intimately involved in its past operations, my comments will be short on specifics. Mr. Robert Crandall, who has served in recent months as the Acting Director, has accompanied me to answer questions about past activities if they should arise.

I would like to focus my remarks on three areas: The general framework of government efforts to reduce the inflation rate; the role of the Council on Wage and Price Stability within that framework; and specific issues of the budget and the authorizing legislation.

GENERAL COMMENTS

It has become obvious that the causes of inflation are far more complex than any simple matching of aggregate demand and supply would suggest. Instead of focusing on aggregate measures, I find it useful to view the inflation process in terms of two distinct stages. First, there is an initial set of shocks that distort the existing wage and price structure. Such shocks may stem from excessive overall demand, but they can also be produced by numerous other factors, including serious disruptions of supply or demand in major individual markets, major exchange rate adjustments, or changes in government policies and regulatory activities in individual industries.

Second, there is a period during which these initial disturbances are transmitted and magnified within the rest of the economy as prices and wages in other markets rise in a reflection of higher production and living costs. Thus, the inflation gathers momentum and is sustained by the efforts of others to recover lost real income or to maintain their relative income position with others.

In the past, inflation arising out of changing price relationships within individual markets was ignored because these changes were viewed as selective price adjustments where higher prices in some markets would be offset by declining demand and prices in others. But for several reasons, there is considerable downward rigidity of prices and wages, and these offsetting adjustments do not occur smoothly and quickly.

We have also learned that attempts to restrain this type of inflation through deflationary fiscal and monetary policies can be extremely costly in terms of unemployment, rising crime rates, increased welfare needs, and other social ills which accompany the lack of job opportunities. Such a response to the increased food and fuel price increases in 1973/74 has placed us in our present predicament. At the same time, I believe there is a general desire to maintain a free market economy with emphasis on freedom of individual choice; and to avoid a turn toward government control over all prices and wages. Recent experience has illustrated the great difficulties, inequities, and complex problem involved in such control measures.

If we are to avoid the extremes of recession or controls, emphasis must be placed upon efforts to identify and offset specific inflationary threats at the level of individual markets and industries. Such a focus on the microeconomic aspects of inflation is the primary purpose of the Council on Wage and Price Stability. The Council's efforts are concentrated in two areas: (1) the identification of specific inflationary shocks or disturbances, with an effort to recommend methods of preventing their occurrence or dampening their impact on the price level; and (2) the development of procedures for dampening the transmission or momentum aspects of the inflation process, where everyone is engaged in a selfdefensive effort to protect himself from the inflationary actions of others.

Particularly in the second area of dampening an ongoing inflation, it would be very misleading to imply that the Council, or even the Federal government, can by itself solve the problem. Everyone is caught on a treadmill. One might be willing to moderate his own inflationary wage or price actions, but he cannot do so without assurances that others will do the same.

Even in the area of highlighting and attempting to propose actions to offset initiating forces for inflation, the Council's success has been limited by the conflicting priorities of those with the actual decision-making power. But, perhaps, if the inflation implications of specific public and private actions are highlighted, some mprovement can be achieved. I believe that a successful effort to reduce inflation will require that it be given greater precedence in both public and private decisions, and that some of our goals in other areas will have to be delayed or modified.

However, even if the Council's direct impact on inflation is small, the benefits can be substantial when we remember that the historical record implies that efforts to reduce the inflation rate one percent through restrictive fiscal and monetary measures costs between $50 and $100 billion in lost production and 1.5 million unemployed annually.

ACTIVITIES OF THE COUNCIL ON WAGE AND PRICE STABILITY

The Council's activities have been concentrated in two areas of (1) increasing the government's awareness of its own contribution to the inflation problem through decisions with respect to regulation and new legislation initiatives, and (2) the monitoring of inflationary developments in the private sector. In both of these areas the Council has the responsibility to highlight the implications for inflation and to promote the consideration of alternative actions which would have less of an inflationary impact.

Government Operations.-In many respects the government itself is a major source of the shocks and distortions which give impetus to this inflation. Through the initiation of new programs, with no consideration of the ability, or of the time required for the adjustment of supply, shortages have been created and prices increased unduly. In the area of economic regulation little consideration has been given to changing technology with has altered competitive conditions and reduced the need for detailed regulation of some industries. Today we find that the regulators have frequently been captured by those they set out to restrain, and the reduction in the degree of regulation is most vociferously opposed by the regulated interests themselves. In effect the government has provided the equivalent of a cartel in which competition is blunted and inefficiencies are introduced. In recent years there has been an enormous growth in the magnitude of "social" regulations which by setting standards for industries do significantly raise costs. I believe that there is substantial agreement that government mismanagement of farm policies was the primary factor responsible for the explosive rise in food prices after 1972. Just recently, efforts to restrict imports through tariffs, quotas, or so called "voluntary" trade agreements have become a significant inflationary factor through increasing prices paid by consumers.

Despite the magnitude of these activities, little attention has been directed to their inflationary effect. It is interesting to note that the steel industry action of raising prices in late 1976 was a cause for newspaper headlines. Yet, the decision to raise milk support prices, which had a substantially bigger impact on the Consumer Price Index, was given only passing notice.

These observations should certainly not be interpreted to imply that all of these actions should not have been taken, or that they were not desirable for other reasons. But, their inflation implications should be clearly recognized and made a part of the decision-making process. Also, there is frequently considerable discretion in the choice of the means for achieving these goals; and the alternatives should be carefully examined with the objective of choosing the lowest cost option. I sharply disagree with those who imply that these government actions should be immune from such considerations of efficiency or that economic impacts are irrelevant.

It is not the Council's task to decide whether these actions should be taken; but it does have an obligation to insure that the inflationary implications are evaluated and reflected in the decision.

The Council has been active in evaluating government contributions to inflation in the past, but doubts can be raised that those activities have had a significant impact. Primarily, this lack of influence has been the result of indifference by those in charge of the actual decisions and a belief that the Council's activities did not have the full support of the Administration or the Congress. Some efforts will be made to change this situation. As a means of avoiding the confrontation framework which has characterized the Council staff's relationship with some agencies, an effort is being made to set up an interagency review and