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It is probably true, on the whole, that the dispersion of wages for similar work by similar workers is larger than it should be from the point of view of either efficiency or equity. But the wage comparisons made in collective bargaining disputes often have little or no relevance either to resource allocation or to equity. Very often the wage comparisons in collective bargaining are only part of a game of follow-the-leader which, at best, is irrelevant to resource allocation and, at worst, speeds up a wage-price spiral.

Many recent instances in which outsized wage agreements have emerged from collective bargaining-based on claims that such increases were necessary in order to achieve wage comparability—have created more problems of inequity and inefficiency than they have resolved. Meaningful wage comparisons should be made not only with wages that are higher but also with those that are lower. Otherwise, wage increases to achieve "comparability" may actually reduce it. Unions can always find some group of workers more highly paid than they—whether or not all other conditions are similar. If all corrections of such "inequities" are upward, labor cost inflation is inevitable.

One recent important collective bargaining dispute produced a highly inflationary uniform percentage increase for the entire work force involved. The justification was that an increase of this magnitude was necessary to correct what may have been genuine disparity between the wages of a small group of specialized workers and similar workers in other employments. The mediation committee which recommended the settlement recognized that, for the great majority of the work force involved, wage rates were already as high as or, higher than those for comparable workers. But they could not recommend destroying the customary relationship between the wages of those workers for whom the disparity was found to exist and the wages of all other members of the work force. This is a clear recipe for inflation.

Another exception frequently urged is that, in industries with rapid productivity gains, wages should rise faster than the average. If such an exception were made, it would necessarily impart an inflationary bias to the system—for no one argues that wages will or should rise less rapidly or not at all in industries with little or no productivity gain.

It is clearly in the public interest for unit labor costs and prices to fall in industries with relatively high productivity gains. In the long run, falling unit labor costs do result in falling prices (except where there are offsetting increases in other costs). But the long run may be too long for labor's and the public's patience. And sometimes the very factors that produce falling costs may work against price reduction. For example, the industries in which labor costs are falling are often those in which demand, and thus production, is expanding most rapidly—a situation which weakens rather than strengthens the competitive forces driving down prices.

If there is a long lag between a reduction in labor costs and a reduction in prices, it is difficult to make a convincing case that high wage settlements

in industries with high productivity growth are not in the public interest. As the 1964 Report (p. 120) put it:

Such circumstances pose a most unattractive dilemma from the viewpoint of the public interest. On the one hand, extra increases in wages or fringe benefits might tend to spread to other industries, creating a general cost-push from the wage side. On the other hand, there is no justification, on either economic or equity grounds, for distributing above-average gains in productivity exclusively through the profits channel. The real way out of this dilemma is for the firms involved to remove its cause by reducing prices. That statement is as important in 1967 as it was in 1964. Indeed, it forms one of the most significant elements of a national price policy for 1967.

Another of the reasons given for an exception to the wage guidepost is ability to pay. In practice, this refers to the profits of the bargaining employers. Ability-to-pay considerations are, of course, often related to the industry's own productivity trend. Industries with rapid productivity gains, falling labor costs, and stable prices are industries in which profits have risen.

But ability-to-pay considerations arise independently in another context. In any period of rapid expansion toward full utilization, profits inevitably rise faster than total employee income-just as profits fall more rapidly when utilization rates decline. The past 5 years have been such a period of rising profits. It is not surprising that trade unions seek to share in the profits generated by prosperity.

The record shows, however, that attempts on the part of unions to redistribute income from profits to wages through excessive wage increases in high-profit industries results primarily in higher prices in those industries. When this happens, the effect is to redistribute real income from the rest of the community-who are mostly other wage earners to the workers in question, with very little redistribution from profits to wages.

To avoid a wage-price spiral it is therefore essential that firms with discretion over prices—and particularly those with unusually high profits— pursue price policies which will not invite excessive wage demands.

Price Policy for 1967

The foregoing discussion (and that of Chapter 2) has indicated the essential character of the problems which businesses with pricing discretion will face in 1967:

(1) Wage contracts newly negotiated in 1967 will tend to raise the unit labor costs of many firms and industries.

(2) Nevertheless, many important industries will continue to operate in 1967 under labor contracts negotiated in 1965 or 1966, which often will be consistent with declining unit labor costs.

(3) Although the cost of purchased industrial products may frequently be higher in 1967 than in 1966, the purchase cost of some raw materials will be lower.

(4) Many firms in 1967 will be using new and modern capital equipment installed during the past year, and will be under less pressure to operate marginal units. Often this will involve substantially lower costs.

In short, the cost picture for price setters in 1967 will continue to be a mixed one.

Although average profit margins of manufacturers declined in the second half of 1966, they were higher for the entire year—at least as a percentage of equity-than in any prior year since the highly inflationary year of 1950. In the past, profit rates like those recorded in 1966 endured only for brief periods. Profits rose rapidly in cyclical expansions. But as the economy reached and quickly passed a cyclical peak, reductions in capacity utilization retarded the growth of productivity and intensified competitive pressures, with a resulting erosion of profit margins. If public and private policies now succeed in maintaining a steadily expanding economy, it follows that the profit margins which were feasible only in the boom stage of a boom-bust economy-and therefore may have been appropriate in that stage are inappropriate in a steadily prosperous economy.

Once firms can become accustomed to operating in a more stable environment, the profit margins which they now seek to achieve in periods of high utilization can be reduced, as no longer necessary to make up for the low and frequently inadequate profits of periods of slack and recession. In fact, profit margins not only should be lower than in the boom phase of a cyclical economy, but should be reduced on the average because operations in such an environment carry lesser risk.

It is true that an adjustment to lower profit margins may be feasible and appropriate only if steady economic advance can be maintained. But it is equally true that such an adjustment of margins may itself be required if a steadily high employment economy is to be maintained.

In an economy which grows steadily but does not outrun the growth of capacity, there will be vigorous competition, and, ultimately, profit margins in most industries should seek an appropriate level. But competitive pressures work slowly. In industries where a small number of leading firms. possess strong market power, they work very slowly indeed. Firms in those industries in which market power, combined with strong demand, has pushed profit margins to record levels, have a special responsibility in price-making at this critical time.

If, in 1967, firms with discretion as to their prices should follow pricing policies which even maintain present margins, the opportunity for a significantly improved price record will be compromised. It would speed up the rise in living costs, and it would again pose inviting targets for inflationary wage demands by unions.

To assume steady movement toward price stability in 1967, the public interest requires that producers absorb cost increases to the maximum extent feasible, and take advantage of every opportunity to lower prices.

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Chapter 4

Selected Uses of Economic Growth

GREAT FINANCIER is said to have remarked that compound interest is the eighth wonder of the world. No doubt he was referring to its remarkable properties in enhancing private fortunes. However, those concerned with national policies for economic growth have also become aware of the power of compound interest. If the American economy continues to grow at 4 percent a year, output will double in 18 years, triple in 28, quadruple in 35. If that potential is wisely and efficiently shared among competing uses, great advances in the economic well-being of all Americans are assured.

Literally billions of private and public decisions determine the distribution of the growing gross national product (GNP) among consumption, investment, and Government purchases, and—within each of these categories— among the myriad of individual goods and services the economy can provide. Consumption decisions of households and the investment decisions of business firms determine the uses of output in the private sector. But these decisions are inevitably affected by public policies. Monetary and credit policies and changes in tax rates and tax incentives restrain or encourage consumer and business outlays and influence their composition.

The budget-making process at Federal, State, and local levels determines the share of output used to meet public needs. Taxes and public spending represent a substantial share of the national product. Moreover, in a growing economy with given tax rates, tax revenues move upward strongly over time and call for continued decisions on increases in public expenditures, tax reductions, and debt management. Public policy cannot be neutral in its impact on the allocation of the gains from economic growth. How these gains should be distributed must be squarely faced as an issue of public policy.

PRIVATE AND PUBLIC GOODS

Households directly purchase the greater part of our national output to meet their wants and needs as consumers. Personal consumption expenditures now constitute 63 percent of GNP. The share has been as low as 52 percent in World War II and as high as 83 percent in the depression

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