1970: The Year of Transition

MR. MACDONALD:

The fact that economics is an art as well as a science perhaps explains why our economic literature is sprinkled with varying definitions of its purpose. However, this characteristic is not as evident in other parts of the world as I discovered, over fifteen years ago, in conversation with a Russian professor in Moscow. He suggested that economics had a universally accepted definition in the Soviet Union. "Economics," he remarked, "is the science which studies the self-destruction of the capitalist system." Today, we are privileged to welcome an economist who has the principal responsibility for advising on the preservation and improvement of the American economic system and for ensuring that some other definition of economics will prevail.

In the United States, the business community provides the operational components of the economic engine, the President and Congress attempt to control the direction and speed of that engine, and the Chairman of the Council of Economic Advisers provides the traffic signals and navigational aids. Considering the obstacle course over which American economic policy-makers must manoeuvre, the navigator is called upon to display unusual skill and intuitive judgment. In the face of those requirements, the choice of Paul McCracken as Chairman of the Council of Economic Advisers came as no surprise.

The Chairman must not only be a good economist, but also a persuasive advocate. He must not only diagnose economic conditions, but he must also convince the decisionmakers of the potential effectiveness of his prescriptions and remedies. Dr. McCracken's success is as much the product of his skill with the English language as of his analysis of the economic world. He acquired that skill very early in his career. As a young graduate of William Penn College in Iowa, he taught English for three years at the Foundation School, Berea College, Kentucky. Yet he must often have pondered the reasons for the peculiar economic conditions of that period, 1937-40, because he was prompted to take up graduate studies at Harvard University, leading to an M.A. and PH.D. in Economics.

For the next twenty-eight years, his career followed a pattern familiar among so many American economists. A sojourn in Washington as a young economist with the Department of Commerce provided him with a view of the world of politics and bureaucracy. A period as financial economist and director of research for the Federal Reserve Bank of Minneapolis exposed him to the secrets of money management. He then assumed the role which became his principal career--a faculty member in the School of Business Administration at the University of Michigan, where he held the Edmund Ezra Day University Professorship.

However, the call of government service has been persistent and he has responded with admirable bipartisanship. He was a member of the President's Council of Economic Advisers from 1956-59, a member of the Task Force advising President Kennedy on the Domestic Economic Situation and the Balance of Payments in 1961, and a member of the President's Commission on Budget Concepts in 1967. Nor has Michigan held a monopoly on his services as a teacher, for he has been a guest lecturer in Japan, India, and various parts of Western Europe.

That tired old platitude which suggests "when the American economy catches cold, Canada catches pneumonia" is one I would normally ignore were it not that the physician who must prescribe the cure is with us today. Your willingness, Sir, to assume your present responsibilities should indeed be cause for our profound admiration. After all, no one has yet found the cure for the cold, any more than we have learned how to immunize ourselves against its multiplier effects. However, we are adopting, today, the best available form of preventative medicine, by inviting Dr. McCracken to describe to us: "1970: The Year of Transition."

The Empire Club is accustomed to hearing from men of distinction, from men of responsibility and from men of influence. Gentlemen, I am honoured to introduce Dr. Paul W. McCracken, the Chairman of the Council of Economic Advisers: a distinguished economist, a responsible public servant and an influential adviser.

DR. MCCRACKEN:

Thank you very much, Mr. Macdonald. I certainly want to express my profound appreciation for the opportunity to be here today. This area is a vastly exciting, explosively growing segment of the economy that would thrill any economist.

I have been paying visits to Toronto periodically for about 20 years. I can certainly testify to the metamorphosis which has occurred in those two decades.

I am also delighted to be here today for a far more practical reason, and that was simply to listen to that introduction.

I would like to let the matter stand at that point. And it really, of course, is not courteous for a guest to correct a Chairman. But, you will note my name; I have a certain Scottish loyalty to integrity here, and I think I really ought to tell you why one or two things actually did happen.

I did not leave Berea College and the teaching of English because I had come within the grip of concern about the cosmic things that were happening in the economy. They were indeed happening, but I was unaware of them at that point.

The main reason was that after my third year of teaching English at Berea College I was assigned a practice teacher who turned out to be, I thought, an extraordinarily attractive blonde, who subsequently became my wife.

Now, the problem was that she was a major in English. I was not. And I found that very low on her list of academic interests was economics.

So here I am.

The second correction which I feel compelled to reveal here is one which some of you have heard me cite before. The fact of my being Chairman of the Council of Economic Advisers is really very simple. It is that if the three Republican economists in the United States had not been willing to do their duty there would have been no Council of Economic Advisers at all.

I think most of us who follow economic developments closely had a particular appreciation for the comment which your Prime Minister made, I think, about a year ago when he was in Washington. He alluded to the fact that being next to the U.S. economy was a little bit like sleeping with an elephant in bed. No matter how benevolent the beast might be, every twitch and groan constituted a crisis. And I am sure that is the case.

Economists, as you know, are not a notably optimistic group of people. And this has been the occasion of a good many rather snide comments from the poets.

We are all familiar with Carlyle's dictum about "those professors of that dismal science".

I think that my Poet Laureate for the economics profession would really be Wordsworth, who summarized the whole discipline in a quatrain when he said:

"High Heaven
Detests the lore
Of nicely calculated
Less or more."

And when you stop to think about it that is most of what economics is all about.

In spite of all of this I would say that if I have any message to bring to this audience here today it is one of some confidence and optimism.

The first reason for some degree of optimism and confidence as we look ahead is that we are now beginning to make real progress in trying to get the long overheated U.S. economy cooled off.

This has been a struggle. And I think we ought not to have been particularly surprised that it has been a struggle.

Here was an inflation which had been underway since the latter part of 1965. Inflation occurred because on successive occasions, as economic policy started to face up to countering the basic problems, our national leaders backed away from difficult decisions. Given this repeated tendency for economic policy to avoid a confrontation with the basic issues, and the simple fact of the long-sustained inflation itself, it was not at all surprising that we were faced with a deeply hardened skepticism about the responsibility of Government policies.

Let me hasten to say that I am not trying to give a partisan speech or to imply that the forces of light took over just about a year ago and that prior to the transition all was darkness. One of the key turning points in this battle was the effort that finally led to a substantial tax increase in the middle of 1968. The budget, which had been in a state of massive disequilibrium finally culminating in a twenty-five billion dollar deficit in fiscal year 1968, finally got back into a state of reasonable balance. In addition, monetary policy became progressively less expansive, and after about April of last year became really quite stern. These policies have now been in place long enough so that they have had a chance to start exerting their effect on the economy.

We had to go through the inevitable skepticism. As the months wore on in 1969 a rather common refrain on the part of those who came into my office at least was, "Well, your policies aren't working; the indexes of business activity in the last month don't show any restraining effects at all."

That was true; they did not, in most cases.

But what was being overlooked was something very fundamental. It does take time for basic changes in fiscal and monetary policies to start to exert their bite on the economy. I think it is now evident that we did mean to face the basic issues; there are a good many pieces of evidence now that the economy is finally starting to come around.

I suppose the last area of skepticism that remains is whether this adjustment in the economy will have any therapeutic effect on the price level and on the underlying costs.

I think that this period will go down in the annals as one in which we learned a great deal about the nature of economic processes. If there is one thing that we have learned by this kind of research over the years, it is that the initial effects of any policies of restraint almost never show up early in the game in the price level. They start to show up in terms of slowing down the economy, and only later get to the price level.

But the notion that something basic has happened and that consequently we will never be able to get the economy to come around, or the price level to come around, is actually a refrain which has had several incarnations in my increasingly long history as an economist.

When I was a graduate student in economics at Harvard we "knew" that our kind of economy would probably never again be capable of sustaining full employment. That belief seems a little silly now, but it was very real at that time.

And it is only about ten or twelve years ago that a leading journal of economic opinion carried an article, the title of which was "Dollar Shortage Forever?" To be sure the title had a question-mark at the end; but this was a pervasive concern. I understand that the largest number of books and articles published on the dollar shortage appeared in 1958, just when the thing turned the other way.

We need to be very careful about this doctrine of inevitability or ineluctability. It has had earlier incarnations and has come a cropper. I think we will see the effects of the economic adjustment on the price level.

The second reason for confidence as we look down the road at the economic scene has to do with something that is more international in character.

I think we have done some things which have established a far stronger basis for a viable international trading and financial system. The prospects are better now than they were not so terribly long ago.

We have had a realignment of some important exchange rates which has removed an element of strain from the system that was tending to produce recurring crises. This adjustment is all to the good.

We have taken some significant steps (such as the activation of the SDR's) to come to grips with the need for growing liquidity as world trade and commerce expands.

And I consider it to be quite significant that, at the annual meetings of the International Monetary Fund in September, a decision was made to explore some of the elements of the adjustment processes that may improve the capability of national economies in this world scene to adjust to one another in a more resilient and orderly manner. We know that the positioning of economies in the world scene will tend to shift a little from time to time for all kinds of reasons. Governments have different objectives of economic policy. And technological factors themselves may change.

The decision to study carefully ways by which a little more capability for adjustment might be built into our system is a good one. It was, of course, supported by Mr. Jenkins in his important speech there, and also by the Secretary of the Treasury of the U.S. Government, among others.

I might add that there is an excellent discussion of this subject in Chapter 5 of the President's Economic Report.

The third thing (and here I want to talk rather specifically about the U.S. setting) that leads me to have some greater degree of confidence is that I think there is beginning to emerge a new realism about the fact that, rich as we are in this part of the world, and expanding as our economies may be, we must confront the basic fact of economics that what we want to do with our productive resources still far outpaces the productive resources that we are going to have available. (This is why poets have always held the economists in such contempt. They were always telling people they cannot do something.) I think our increasing realism in considering the difficult priority questions is the important first step toward better and more rational decisions in the public sector.

Now, what I have in mind is this: for too long, indeed, for much of the professional lifetime of people my age, we have thought too much in terms of relieving present constraints by some painless method, such as growth of the ever-expanding fiscal dividend.

For example, when I was beginning my studies of economics about the time the war broke out, we could make our computations about how much we could do, or how many of the needs we could take care of in the nation by regaining full employment.

There was a vast increment of output which was there to apply to the needs that were not being met at that time. And that was absolutely true.

Now, this took a slightly different form then. Toward the end of the war we did regain full employment. But of course production for the civilian economy had been held pretty static. Thus we calculated what we could do once we could unwind the war effort and allocate that productive potential to the needs of the civilian economy.

In more recent years we have spoken of the "fiscal dividend", a perfectly legitimate concept which rests on the fact that any given tax system in a growing economy will automatically produce an annual increment of revenue.

In the United States this annual increment of revenue at the Federal level is about twelve to fourteen billion dollars. Unfortunately, most of that increment for fiscal year 1971 has been eliminated by the planned demise of the surcharge.

When we expect this increment of revenues to provide the funds for all our desired projects we overlook some fairly important points. One of them is that a large part of our growing capability to produce goods and services will be claimed, as it were, by consumers because as material levels of living rise aspirations also rise.

This is why we will never reach a state of affluence at which everybody is happy and we can devote whatever increments of production we then have to something else.

Here we are with per capita incomes now at forty-five hundred dollars or something like that and the list of things that people want to do as soon as they can get a further increment of income is probably about as long as it was ten years ago, or even 30 years ago. The items on the list are different, of course, but the list is equally long.

In the next ten years, the United States is going to have, as the President indicated in his State of the Union message, a 50% increase in the economy in real terms. I think that is a reasonable expectation. In percentage terms, Canada will probably do somewhat better. But one thing we need to bear in mind is that as the economy grows and per capita incomes increase, a significant part of that output will be claimed by consumers exercising their right to spend this additional income.

We decided that in the Economic Report this year we ought to push the horizon back a little bit so we could get a longer-run look at our problem. Our analysis is summarized in Chapter 3 of the Economic Report, that goes by the extraordinarily fascinating title of "The Uses of the National Output." Governments seem to have a genius for camouflaging their prose with great titles.

What we did was to look ahead for five years and to say that on the basis of the kind of analysis that we can make (and it is said to be fairly accurate) the economy, if it stays at reasonably full employment, will be moving along a certain path. That constitutes the total output of which the economy operating on reasonably full employment would be capable of producing in each year.

But we know that consumers are going to be wanting to exercise their claims against a substantial part of that growing output just as they have in the past. And that has been, of course, the basic contribution to welfare, to material welfare, that our economies have traditionally been making--the doubling of material levels of living every generation which we have achieved here on this side of the ocean.

We also know that, given the rate of increase in the labour force, there will have to be a slightly larger percentage of our gross national product allocated to capital formation if the stock of productive capital is to move along pari passu with the more rapid growth of the labour force. If it does not we jeopardize our capability to sustain the growth in productivity on which we are counting.

We also know that we are going to have very heavy housing needs. Indeed the Congress in the Housing Act of 1968 even set an explicit goal of building and rehabilitating 26,000,000 housing units within a decade.

And then, and this I think was perhaps the novel element, in conjunction with the Budget Bureau we took existing programmes in the budget and attempted to price them out annually over the next five years.

Many of these programmes, even if unchanged, will require increased outlays from year to year; social security is a clear case. As the numbers on the rolls increase with no change in the programme, outlays will of course rise. And this is true of many other programmes.

We then tried to price out the new initiatives to which the administration had already committed itself, such as the new family assistance plan, revenue sharing, and the control of pollution. What we found was very interesting.

So far as the whole economy is concerned, there is no elbow room; there is no margin of unclaimed resources out ahead for about two or three years, and very little even out as far as the year 1975.

What this means to me is that if we can start seeing the problem in these terms, then we can begin to see the implications of what we say when we talk about governments accepting vastly increased responsibilities for our very real urban problems and social problems generally.

What we are saying here is that the assumption of such responsibility carried with it automatic implications for taxation. Because there is no magic increment of growth to be obtained from regaining full employment a la thirty years ago, nor will the annual fiscal dividend, which is the more recent melon which we thought each year would be just ready to cut up the next year, be the solution.

The fact of the matter is that any major new initiatives will carry with them automatic implications for taxation.

I say, "automatic implications for taxation". But of course it is true we have discovered that budgets do not necessarily have to be balanced.

Can we not rise to the sophistication of possibly taking care of the needs even if it is necessary to run an unbalanced budget? The answer is no for a very good reason--that you may solve the problem of what you put in the budget that way, but you cannot allocate resources beyond the gross national product available.

If we continuously run deficits then the Treasury will have to dip into the national savings stream in order to cover the deficit in the budget. This will use resources necessary for financing the housing and capital formation that we also need.

Therefore, decisions within the budget carry with them implications about claims on our total productive resources. The matter of a strong budget is not simply some gesture toward an ancient canon of finance of balancing the budget.

Unbalanced budgets are not necessarily sinful. But they carry with them consequences. And one of the consequences of this exercise that we have gone through is that we will not only need a balanced budget, but we are probably in a decade when what we really need is substantial surpluses year after year in order that the Federal government's fiscal operations will be supplementing the national saving stream so as to finance the housing and capital formation that we want to achieve during this period.

I do not consider that this is a pessimistic conclusion. I consider it to be quite the opposite. I think this kind of analysis, this kind of framework for setting the problem, is going to make for more rational public thinking about the kinds of economic policies that we are going to need south of your border if we are to have the kind of orderly and expanding economy that we need there, and which also has relevance to you.

In other words, as I have studied economic policy over an increasingly long period, I have myself come firmly to the conclusion that where there has been a significant miscarriage of economic policy it is because the public did not really see clearly the nature of the problem. In a democracy, if the Government will perform its obligation of making clear the policy issues so that people begin to see the nature of the problems that we face, then we can generally count on public opinion rising to the occasion and supporting the kind of policies that will be essential.

And it is for that reason that even an economist, I think, is entitled to his moment of optimism.

Dr. McCracken was thanked on behalf of The Empire Club by Mr. H. N. R. Jackman.