Comments and Recommendations
In concluding the presentation it is appropriate to make some general comments with respect to the results of the work. First, let us consider what has been learned about the two basic questions raised in the introductory chapter: (1) Why has progress in the economic field been so slow and uncertain compared to the progress that has taken place in science? (2) Would the application of scientific methods to the subject matter of economics speed up this unsatisfactory rate of progress?
Our findings show that the answer to question (1) is that sustained forward progress is not possible without a sound theoretical foundation, and sound theory can only be constructed on a solid factual basis-what actually is true-it cannot be based on emotional judgments as to what ought to be true. The explanation for the failure of economics to establish any record of accomplishment comparable to that of physical science is that the economic profession has no general structure of theory that is valid in application to the real world.
As mentioned earlier, it is admitted in professional economic circles that present-day economics has no theory applicable to the kind of an economic system that now exists in the United States. For instance, J. K. Galbraith couples an acknowledgement of the effectiveness of the American system with an admission that this success is inexplicable on the basis of accepted economic theory in this statement, part of which was quoted in Chapter 1:
The present organization and management of the American economy are also (like the bumblebee) in defiance of the rules-rules that derive their ultimate authority from men of such Newtonian stature as Bentham, Ricardo and Adam Smith. Nevertheless it works, and in the years since World War II quite brilliantly.14
The complete inability of economic theory to deal with major problems of the economy when they develop confirms Galbraith’s contention that the American economy does not operate according to the economists’ “rules.” As Heilbroner and Thurow point out, accepted theory is as helpless today against inflation as it was in the 1930’s against depression.
Against this terrible reality of joblessness and loss of income (in the thirties), the economic profession... had nothing to offer.
In many ways the situation reminds us of the uncertainty that the public and the economics profession share in the face of inflation today.210
The most bitter antagonists of the individual enterprise system, the Marxist socialists, also freely admit that their theories cannot explain the remarkable results that have been obtained from what they call the “capitalist” system in the United States. Earl Browder, former head of the Communist party in this country, has devoted an entire volume to an examination of the failure of Marx’ theories in application to the American economy. In this book, Marx and America, he concedes that if the basic assumptions of Marx and Ricardo “are accepted as valid, then the rise of modern industry in America constitutes an unexplainable miracle.”211
When the most successful economic system in existence operates “in defiance of the rules” laid down by the economic theorists, and is beyond the understanding of the economists of two worlds-inexplicable to one and an “unexplainable miracle” to the other-then it is evident that the rules and the theories of the economists of both schools of thought, and the conclusions that they draw from these rules and theories, are not authoritative statements applicable to economic systems in general, or to the American economic system in particular. If they have any validity at all, they are applicable only under special circumstances of a kind which do not exist in the United States. In order to explain the American economy and to predict its response to the various stimuli that may affect it, a completely new theoretical structure is required, the kind of a solidly based emotion-free theory that is presented in the two volumes of this work.
The existing situation in the field of wage theory is an outstanding example of what is wrong with present-day economic thought. More than half of the human race lives under the precepts of Karl Marx which contend that “The very development of modern industry must progressively turn the scale in favor of the capitalist against the workingman, and that consequently the general tendency of capitalist production is not to raise, but to sink the average standard of wages, or to push the value of labor more or less to its minimum limit.” Anyone who does not close his eyes completely knows that American experience has been diametrically opposite from what Marx predicted, but there is a widespread tendency to regard the Marxist theory as correct, and to attribute its failure to work out in practice to some unspecified matters of detail. Browder, who quotes the foregoing statement by Marx, and admits that it missed the mark completely, still contends that “it is on the ground of historical evidence that this dogma must be refuted, and not on the grounds of logic.”212
Few non-communists are willing to be quite as explicit in endorsing the logic of Marx’ theory, in view of the strained political situation now existing, but a substantial segment of present-day economic opinion accepts the basic premise of the theory, the view that a conflict exists between the interests of the employers and those of the workers, in which any gain by one party means a corresponding loss to the other. This school of thought attributes the conspicuous lack of success of Marx’ predictions to the development of a counter-force in the hands of the labor unions and the government that has made the contestants more evenly matched than Marx anticipated.
Keynes did not fall into either this or the basic Marxist error. He recognized more clearly than most of his colleagues that the money wage rate is meaningless as a measure of the compensation that a worker receives for his services; that the real wage rate is the significant quantity, and that the “struggle about money-wages” does not change the average real wage rate. The latter, as he says, “depends on a different set of forces.” But the economic profession in general, which accepted Keynes’ deficit spending theories with alacrity and whole-hearted enthusiasm, has practically ignored his analysis of the wage situation. The question then arises, Why did these two theoretical products coming from the same eminent source meet with such radically different receptions?
The answer to this question is the key to an understanding as to why progress has been so slow in the economic field. The economic profession in general refuses to accept Kaynes’ analysis of the wage situation, not because the premises on which it is based are deficient in logic-which they are not-nor because it conflicts with the observed facts-which it does not-but simply because today’s sociologically oriented economists do not want to accept it. Their emotional reaction to any such idea is antagonistic because, as Dale Yoder expressed it in the statement quoted in Chapter 20, if this viewpoint is correct there is “little anyone could do to improve the status of wage earners,” and improving the status of wage earners is one of the objectives to which they are dedicated. The deficit spending doctrine, on the other hand, was promptly accepted because the socially conscious economists want more government spending, as they are more in sympathy with the projects on which the government funds are spent than with the purposes for which the individual consumers use their income.
Here is why the economic profession has no valid structure of theory that can be applied to solving our present-day problems. Too many of the principles upon which the economic theorists are basing their reasoning are not natural laws based on experience, but assumptions that are emotionally acceptable to them. For example, Samuelson and Nordhaus, who classify themselves are being in the “mainstream” of American economic thought, give us this picture of “classical” thinking on the wage issue:
The classical economists preached an economics that was the dismal science of unalterable distribution of income. The wages of labor, the rent of land, the profit of capital were determined by economic law, and not by political power. If labor unions or reform political parties tried to use the state to modify these facts of life, they would be ineffective in the end.
These authors then went on to say:
America of the 1960s would accept no such limited conception.213
They do not cite any evidence to invalidate the “unalterable distribution of income”; they do not even say that it is wrong; they simply say that America, and by implication the American economists, will not accept it. Here we have a clear illustration of the economists’ attitude toward their subject matter. Even these “mainstream” members of the profession seem to take it for granted that they have the option of accepting economic laws or rejecting them and substituting assumptions that are more to their liking.
Attempts to solve real problems by applying such unrealistic inventions are doomed to failure from the beginning. This is the kind of a situation in which replacement of emotional judgments by the cold-blooded factual methods of the scientist can lead to significant advances, and in the preceding pages such gains have materialized. It has been demonstrated that when the emotional approach is laid aside, and a sound structure of theory is constructed on a factual foundation by the same effective and efficient methods that are used in the physical sciences, most of the obstacles that have stood in the way of progress in economic understanding are eliminated.
A rather ironic feature of this situation is that in many cases the factual analysis shows that the automatic reactions of the economic mechanism produce results that are more favorable from the economists’ sociological viewpoint than their own ideas as to how the the economy ought to operate. For example, we have verified the classical economists’ contention that the distribution of income is fixed and unalterable, and we can accept the quoted statement of their views on this subject word for word, except for the characterization of these views as “dismal.” But we find that the net result of the fixed distribution pattern is quite different from what the economic theorists have anticipated, and it is, in fact, far more favorable to the workers than the results that would be produced if the preferences of either Marx or present-day economists could be put into effect. According to the findings of economic science, the workers get all of the benefit of increasing productivity, and they get it automatically. Political or social pressure can do nothing more, because there is no more. Certain occupational groups or labor unions may make additional gains, but only at the expense of all other workers.
In applying scientific techniques to the economic field we have first separated the factual aspects of economics, those aspects that can be treated by the precision methods of the physical sciences, from the matters of opinion and judgment with which the present-day socially oriented economist is mainly preoccupied. We have then analyzed those factual aspects of economic life in terms of the flow and interaction of quantities that are capable of specific definition and are conserved. By dealing with quantities of this nature that can be followed from process to process with quantitative accuracy, in the same manner as energy, mass, and the other basic quantities of the physical sciences, rather than using the vague and ill-defined quantities in terms of which orthodox economics operates-such things as “demand,” “propensity to consume,” etc.-we have been able to establish the basic laws and principles governing the relations within the economic mechanism on a definite and unequivocal basis.
Application of these principles to the fundamental economic problems then enables us to see clearly what objectives are realistic and attainable, and what actions are necessary in order to achieve these objectives. With the benefit of this information we are then in a position to analyze the various measures for dealing with economic problems that have heretofore been proposed, or that may have been suggested by the investigation itself, and to determine specifically what contribution, if any, each is capable of making toward the designated objectives.
In some respects the task that has been carried out in this work resembles that of building a house on a steep hillside. The preliminary work on the site and the construction of the foundations may be far more of an undertaking than the erection of the house itself. The most tedious and time-consuming phase of this economic project has been to clear away the underbrush of erroneous concepts and beliefs that characterizes so much of modern economic thought. Once this tangled mass of misconceptions was removed so that a clear view of the true situation could be obtained, the cause of, and remedy for, the particular problem under consideration in this volume-the stabilization of business conditions-was practically self-evident.
Just as soon as we understand the operation of the auxiliary stream of purchasing power created by the introduction of money and credit into the economic organization, and the role that this money purchasing power stream plays in the economy, it becomes obvious that variations in the flow into and out of the reservoirs located in this stream are the cause of the economic fluctuations that we call booms and recessions. It is then likewise obvious that these fluctuations can be eliminated by controlling the reservoir flows in such a manner as to equalize total input and total output.
The foregoing, simple as it is, contains the essence of this entire work, so far as the stabilization problem is concerned. When we undertake to develop practical methods for putting these findings into effect, however, the situation becomes more complicated because each of the practical programs has collateral effects of one kind or another. Selection from among the various feasible alternatives involves not only the question as to how effectively each accomplishes the primary objective, but also an appraisal of the advantages or disadvantages that will be experienced as by-products of each program. The alternatives have been analyzed from these standpoints in the two preceding chapters, and our conclusion is that the necessary control can be exercised most effectively and efficiently by an interchange between credit goods and credit money; that is, by the open market operations of the Federal Reserve System, modified to operate on the basis of counterbalancing the net reservoir input or output.
Since it is evident that any supplementary measure that has the effect of reducing the amplitude of the fluctuations that are to be neutralized by the control system will contribute to the ease of operation of the controls, various possibilities of this kind have been studied, and two of these are recommended as part of the complete stabilization program. It should be understood, however, that the use of auxiliary measures of this nature is not essential, it is merely helpful, and if there are too many objections to one or more of the proposed auxiliary measures, these can be modified, or even eliminated. The only absolutely essential feature of the program is the direct control mechanism, not necessarily the particular mechanism herein recommended, but some effective control. The interchange between credit goods and credit money by means of the open market operations could be replaced by some other direct control measure-an appropriate program of tax flexibility, for example-but an effective direct control is essential.
With this understanding as to the nature of the recommendations that have been made in the foregoing pages, we may summarize these recommendations as follows:
1.Set up the necessary machinery to make a continuous measurement of the flow of money into and out of each of the purchasing power reservoirs.
2.Dampen the cyclical movements of reservoir input and output by
a.Basing the maximum legal loan value of securities and real estate on the long term trend of value rather than on the current market appraisal.
b.Utilizing the credit control facilities of the Federal Reserve System to reduce net reservoir inputs or outputs when these movements become, or threaten to become, abnormally large.
3.Eliminate the remaining fluctuations in the aggregate reservoir levels by putting the open market operations of the Federal Reserve System on a definite and automatic basis, requiring the System to purchase or sell securities to individuals or non-bank agencies at frequent intervals in amounts just sufficient to neutralize net transactions into or out of all other consumer money reservoirs.
4.Be prepared with a program of flexible tax rates for use in the event that stronger measures are necessary to meet a temporary situation.
If these recommendations are put into effect, the alternation of booms and recessions that we call the business cycle will be eliminated. This will not cure all of our economic ailments. Indeed, one of the most serious weaknesses of present policies is that the Federal Reserve System, which has only one kind of weapon-monetary management-in its arsenal, is being expected to take case of a whole range of economic problems. As stated by J. S. Duesenberry,
The Federal Reserve System has been concerned with four major objectives of economic policy: (1) full employment; (2) price stability; (3) economic growth; and (4) a satisfactory balance of payments... at times the different objectives appear to be in conflict with each other.214
The reason why it is not even clear whether such a conflict exists-why it can only be said that they “appear to be in conflict”-is that monetary policy has only an indirect and uncertain bearing on three of the four objectives listed. The existing difficulties in these areas can be effectively resolved only by measures specifically adapted to each separate situation. The requirements for full employment and for the optimum growth rate were discussed in The Road to Full Employment. The actions that are necessary to correct the present adverse balance of payments have been defined in Chapter 17. Monetary management is not capable of achieving any of these three objectives, and the attempts that are now being made in these directions are simply reducing the effectiveness of the monetary tools in accomplishing the significant task to which they are well adapted: the stabilization of the economy.
If the nature of the stabilization problem is clearly understood, the misdirection of effort in pursuing objectives that cannot be reached by monetary policy is discontinued, and the monetary tools are properly applied in accordance with a program of the kind outlined in this volume, the cyclical fluctuations can easily be smoothed out. In the resulting stable economy, business enterprises will not experience the artificial kind of prosperity that now exists during an inflationary boom, when even very inefficient operations are able to earn profits, but they will have a good, consistent, and predictable working situation in which it will not be necessary to worry about the possibility that their calculations may be upset by a downward turn in the general state of the economy.
Cyclical unemployment, including both the severe loss of jobs that occurs during major depressions and the significant, but less drastic, increase in unemployment that accompanies minor dips or recessions in business activity, will be eliminated. The chronic unemployment that now exists even during periods when business is relatively prosperous will still remain, but the way will be cleared for the development of additional measures of a purely employment character to take case of this remaining problem. The previously published volume, The Road to Full Employment, is devoted to an examination of the cause of this quasi-permanent type of unemployment, and to the formulation of a program that will provide self-supporting jobs for all.
Inflation will no longer be a problem for the economy as a whole.; that is, the real purchasing power of the average consumer will remain stable at the level established by average productivity. The problem of an equitable allocation between different economic groups will still remain, but the questions involved in this problem, such questions as to whether the present “bargaining” method of wage and salary determination should be replaced by a system that is less biased toward certain favored groups, will require some additional decisions by the general public, and are beyond the scope of this work.
It should be understood that this stabilization program is specifically addressed to the elimination of money inflation. Cost inflation, the type of inflation due to increases in wage rates and business taxes, will not be affected by the proposed measures. Money inflation has adverse effects on the economy as a whole (mainly because it must inevitably be followed by deflation). Elimination, or reduction, of this type of inflation is therefore clearly desirable, and is already a recognized national objective. The application of economic science to the problem is therefore definitely in order. Cost inflation, on the other hand, has little effect on the general economic situation, and does not alter the ability of the average consumer to buy goods. The increase in money wages does not change the average real wage, nor does the increase in business taxes (which is passed on to the consumer) alter the total tax burden, which is determined by the amount of government expenditure.
The objectionable feature of cost inflation is that the actions which cause this type of inflation, especially the wage increases, favor some individuals or groups, at the expense of the others. While this policy is certainly discriminatory, it has strong support from those who gain, or believe that they gain, from it. The question as to whether or not cost inflation should be eliminated is thus a social and political issue, rather than the kind of a factual problem for which economic science can provide an answer. It is therefore up to the community at large to decide whether the fruits of increasing productivity should continue to be allocated mainly to certain special groups, or whether market forces should be allowed to exert more influence. Whatever decisions are made on these issues can easily be implemented without any significant effect on the general economy.