SIDES

Clashing Views
on Controversial

Eighth Edition

Thomas R. Swartz
Frank J. Boneilo
 Clashing Views on
Controversial
Economic Issues

Eighth Edition

Edited, Selected, and with Introductions by

Thomas R. Swartz
University of Notre Dame
and
Frank J. Bonello
University of Notre Dame

Dushkin/McGraw-Hill
A The McGraw-Hill Companies
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introductions by Thomas R. Swartz and Frank J. Bonello. 8th ed. —
Includes bibliographical references and index.
1. United States — —
Economic policy 1971-1981. 2. United States —Economic policy
1981-1993. 3. United States— Economic policy—1993-. I. Swartz, Thomas R., comp. II.

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PREFACE

Where there is much desire to learn, there of necessity will be much arguing.

—John Milton (1608-1674), English poet and essayist

Presented here are 19 debates on important and compelling economic is-

sues, which are designed to stimulate critical thinking skills

and initiate lively
and informed discussion. These debates take economic theory and show how
it is applied to current, real-world public policy decisions, the outcomes of

which will have an immediate and personal impact. How these debates are
resolved will affect our taxes, jobs, wages, educational system, and so on; in
short, they will shape the society in which we live.
It has been our intent throughout each of the eight editions of Taking Sides:

Clashing Views on Controversial Economic Issues to select issues that reveal

something about the nature of economics itself and something about how it
relates to current, everyday newspaper headlines and television news sto-
ries on public policy issues that deal with economic considerations (and
almost all do these days). To assist the reader, we begin each issue with
an issue introduction, which sets the stage for the debate as it is argued
in the YES and NO selections. Each issue concludes with a postscript that
briefly reviews the arguments and makes some final observations. The in-
troduction and postscript do not preempt what is the reader's own task: to
achieve a critical and informed view of the economic issue at stake. Cer-
tainly, the reader should not feel confined to adopt one or the other of the
positions presented. The views presented should be used as starting points,
and the suggestions for further reading that appear in each issue postscript
offer additional resources on the topic. At the back of the book is a list-
ing of all the contributors to this volume, which provides information on the
economists, policymakers, political leaders, and commentators whose views
are debated here.

Changes to this edition This new edition of Thkmg Sides represents I con-
siderable revision to this book. Twenty-five of the 38 selections and 11 of
the 19 issues are new. Thus, as we rush toward the twenty-tirst century, this
heavily revised book will help us understand the implication of I changing
set of economic issues that were not part of our world just a few years ago.
The new issues are Should Cii
Is It Time to Abolish the Minimum -h Be
Increased Just by Using Mart Inputs and bnjn
Social Security Program S

Index Overstate Changes in t'>. \>r a

Constitutional Amendment to B -erve
 .

ii/ PREFACE

the Cause of Poor Macroeconomic Performance? (Issue 12); 7s the Nonaccelerating

Inflation Rate of Unemployment a Useful Guide for Macroeconomic Policy? (Issue
13);Would Adopting Wisconsin's Welfare Reforms End Welfare As We Know It?
(Issue 14); Does Free TradeMake the Poor, Poorer? (Issue 16); and Has the North
American Free Trade Agreement Been a Success? (Issue 19). For two of the issues,
we have retained the topic from the seventh edition but have replaced one
or both of the selections in order to bring the debate up to date or to focus
more clearly on the controversy: Is*sue 1 on profits and Issue 6 on managed
competition for the health care system.
As with all of the previous editions, the issues in the eighth edition can be
used in any sequence. Although the general organization of the book loosely
parallels the sequence of topics found in a standard introductory economics
textbook, you can pick and choose which issues to read first, since they are
designed to stand alone. Note that we have retained the modification to Part
3 introduced in the seventh edition. That part, "Trie World Around Us/'
allows us to more fully represent the host of problems our society faces in
this ever-changing world we live in.

A word to the instructor An Instructor's Manual With Test Questions (multiple-

choice and essay) is available through the publisher. A general guidebook,
Using Taking Sides in the Classroom, which discusses methods and techniques
for integrating the pro/con approach into any classroom setting, is also avail-
able. An online version of Using Taking Sides in the Classroom and a correspon-
dence service for Taking Sides adopters can be found at www dushkin com/
. .

usingtakingsides/ For students, we offer a field guide to analyzing ar-

.

gumentative essays, Analyzing Controversy: An Introductory Guide, with exer-

cises and techniques to help them to decipher genuine controversies. Tak-
ing Sides: Clashing Views on Controversial Economic Issues is only one title
in the Taking Sides series. If you are interested in seeing the table of con-
tents for any of the other titles, please visit the Taking Sides Web site at
http: //www. dushkin. com/ takings ides/

Acknowledgments We have received many helpful comments and sugges-

tionsfrom our friends and readers across the United States and Canada. As
always, their suggestions were very welcome and have markedly enhanced
the quality of this edition of Taking Sides. If as you read this book you are
reminded of an essay that could be included in a future edition, we hope that
you will drop us a note. We very much appreciate your interest and help, and
we are always pleased to hear from you.
Our special thanks go to those who responded with suggestions for the
eighth edition:

Samuel Bostaph Joan G. Buccino

University of Dallas Florida Southern College
 PREFACE /iii

Mary Bumgarner Anatasios Papathanasis

Kennesaw State University Central Connecticut State
University
Thomas Curry
Morningside College Cy A. Peebles
Towson State University
John Whitney Evans
College of St. Scholastica Kolleen J. Rask
College of the Holy Cross
Douglas C. Gordon
Arapahoe Community Aldo Rugai
College St. Xavier University

James Hornsten Robert Sobel

Lake Forest College Hofstra University
Connie Humphreys Hubert Spraberry
Edison Community College Howard Payne University
Brian J. McKenna Deborah Thorsen
St. Xavier University Palm Beach Community
R. Morris College
J.

Broward Community College John Trebnik

South Marian College
Harold Moses Carolyn Tut tie
Daytona Beach Community Lake Forest College
College-Main
Janice Yee
Charles J. Mullin Wartburg College
Ohio State
University-Columbus

Joe Mullin
Columbus State Community
College

We also offer our very special thanks to Robert M Ball. Charles Cravpo, and
Sylvester J. Schieber, who wrote i ivciallv for this edition of Viking
Sides. We deeply appreciate their time and patience, M\d, most importantly,
admire their dedication to increasing the economic understanding of a new
generation of students.
We are also indebted to David H. Dean, our editorial adviser, and list

manager of the Taking Sides program at Pushkin this

edition of the book. He provided excellent counsel .md gave US much-no

support as we approached our publication deadlines, [hose who iufl
most in the preparation oi this manuscript were those who had to read
Swartz's tortured handwriting: our typists Cheryl Reed and Sherry Rekhold
Finally we owe much to our graduate assistants here at the I'm
iv / PREFACE

Notre Dame: Joseph A. Stevano and Matthew C. Weagle. They were always
able to maintain a smile even when our requests to run to the library were
outrageous.
To all those mentioned above, we owe a huge debt, many thanks, and none
of the blame for any shortcomings that remain in this edition of Taking Sides.

Thomas R. Swartz
University of Notre Dame
Frank J. Bonello
University of Notre Dame
CONTENTS IN BRIEF

PARTI MICROECONOMIC ISSUES 1

Issue 1. Are Profits the Only Business of Business? 2
Issue 2. Should We Encourage the Private Ownership of Guns? 20
Issue 3. Should Cities Subsidize Sports and Sports Venues? 38
Issue 4. Is It Time to Abolish the Minimum Wage? 52
Issue 5. Are Rent Controls the Cause of America's Homelessness? 76
Issue 6. Is Managed Competition the Cure for Our Ailing Health Care
System? 96
Issue 7. Are More Prisons and Prison Beds the Answer to America's
Rising Crime Rate? 114

PART 2 MACROECONOMIC ISSUES 141

Issue 8. Can Economic Growth Be Increased Just by Using More Inputs
and Improving Efficiency? 142
Issue 9. Is Our Current Social Security Program Securely Anchored? 160
Issue 10. Does the Consumer Price Index Overstate Changes in the Cost of
Living? 190
Issue 11. Is There a Need for a Constitutional Amendment to Balance the
Budget? 206
Issue 12. Is the Federal Reserve the Cause of Poor Macroeconomic
- Performance? 218
Issue 13. Is the Nonaccelerating Inflation Rate of Unemployment a Useful
Guide for Macroeconomic Policy ! 2.^2

Issue 14. Would Adopting Wisconsin's Welfare Reforms End Welfare As

We Know It? 250

PART 3 THE WORLD AROUND US 279

Issue 15. Should the United States Protect 1

Foreign Competition? 280

Issue 16. Does Free Trade Make the Poor. 1

2M
Issue 17. Does Global Wanning Require Immediate Government
Action? 312
Issue 18. Should Pollution Be Put to the Maria 13 \

Issue 19. Has the North American Rtee bade Agreement Been i

Suco
CONTENTS
Preface i

Introduction: Economics and Economists: The Basis for Controversy xii

PARTI MICROECONOMIC ISSUES 1

ISSUE 1. Are Profits the Only Business of Business? 2

YES: Milton Friedman, from "The Social Responsibility of Business
Is to Increase Its Profits," The New York Times Magazine 4
NO: Robert Almeder, from "Morality in the Marketplace," in
Milton Snoeyenbos, Robert Almeder, and James Humber, eds.,
Business Ethics, rev. ed. 10

Free-market economist Milton Friedman contends that the sole responsibility

of business is to increase profits. Philosopher Robert Almeder maintains that
capitalism must act in socially responsible ways.

ISSUE 2. Should We Encourage the Private Ownership of Guns? 20

YES: Daniel D. Polsby, from "The False Promise of Gun Control,"
The Atlantic Monthly 22
NO: Arthur L. Kellermann et al., from "Gun Ownership as a Risk
Factor for Homicide in the Home," The New England Journal of Medicine 30

Law professor Daniel D. Polsby alleges that gun-control laws, not guns, in-
crease violence. Physician Arthur L. Kellermann and his colleagues argue
that gun ownership increases an individual's risk of being murdered.

ISSUE 3. Should Cities Subsidize Sports and Sports Venues? 38

YES: Thomas V. Chema, from "When Professional Sports Justify the
Subsidy: A Reply to Robert Baade," The Journal of Urban Affairs 40
NO: Robert A. Baade, from "Stadium Subsidies Make Little
Economic Sense for Cities: A Rejoinder," The Journal of Urban Affairs 44

Attorney Thomas V. Chema claims that a sports venue has both direct and
indirect returns to invested dollars. Urban sports facilities consultant Robert
A. Baade argues that sports venues bring poor economic returns.

VI
 CONTENTS /vii

ISSUE 4. Is It Time to Abolish the Minimum Wage? 52

YES: Thomas Rustici, from "A Public Choice View of the Minimum
Wage/' Cato Journal 54

NO: Charles Craypo, from "In Defense of Minimum Wages/' An

Original Essay Written for This Volume 65

Orthodox neoclassical economist Thomas Rustici asserts that the minimum

wage unemployment among least-skilled workers. Labor economist
creates
Charles Craypo argues that a high minimum wage is good for the economy.

ISSUE 5. Are Rent Controls the Cause of America's

Homelessness? 76
YES: William Tucker, from "How Housing Regulations Cause
Homelessness," The Public Interest 78
NO: Richard P. Appelbaumfrom "Scapegoating Rent
et al.,
Control: Masking the Causes of Homelessness/' Journal of the
American Planning Association 87

Journalist William Tucker suggests that there is a substantial correlation be-

tween rent controls and homelessness. Sociologist Richard P. Appelbaum and
his research associates submit that Tucker's statistical analysis is flawed.

ISSUE 6. IsManaged Competition the Cure for Our Ailing

Health Care System? 96
YES: Paul M. Ellwood Jr. and George D. Lundberg, from "Managed
Care: A Work in Progress/' Journal of the American Medical Association 98

NO: John H. McArthur and Francis D. Moore, from "The Two

Cultures and the Health Care Revolution: Commerce and
Professionalism in Medical Care," Journal of the American Mi
Association 106

Physician Paul M. Ellwood Jr. and George D. Lundberg, an editor, argue

that we cannot return to fee-for-service medicine. Harvard Business School
professors John H. McArthur and Francis D, Moore warn that managed care
will ensure primarily the profitability oi the corporation

ISSUE 7. Are More Prisons and PritOIl Beds the Answer to

America's Rising Crime Rate? 1 14

YES: Edwin W. Zedlewski, horn "When I lave We Punished

Enough?" Public AdnunisL 116
viii/ CONTENTS

NO: David F. Greenberg, from "The Cost-Benefit Analysis of

Imprisonment/' Social Justice 127

Economist Edwin W. Zedlewski argues that investment in more prisons is

wise social policy. Economist David F. Greenberg contends that the benefits
of more prisons are overestimated.

PART 2 MACROECONOMIC ISSUES 141

ISSUE 8. Can Economic Growth Be Increased Just by Using

More Inputs and Improving Efficiency? 142
YES: Council of Economic Advisers, from Economic Report of the
President 1997 144
NO: Felix G. Rohatyn, from "Recipe for Growth/' Wall Street Journal 152

The Clinton administration's Council of Economic Advisers believes in stim-

ulating economic growth by increasing physical capital and improving ef-
ficiency. Felix G. Rohatyn, a financial expert, argues that an increase in the
growth rate does not require the redistribution of wealth.

ISSUE 9. Is Our Current Social Security Program Securely

Anchored? 160
YES: Robert M. Ball, from "Keeping the Social Security Promise,"
An Original Essay Written for This Volume 162
NO: Sylvester J. Schieber, from "Social Security: Avoiding the
Downstream Catastrophe," An Original Essay Written for This Volume 173
Robert M. Ball, former commissioner of Social Security, believes that Social
Security is in good shape financially. Sylvester J. Schieber, a business execu-
tive, sees a serious Social Security funding problem.

ISSUE 10. Does the Consumer Price Index Overstate Changes in

the Cost of Living? 190
YES: Michael J. Boskin et al., from "The CPI Commission: Findings
and Recommendations," American Economic Review 192
NO: Dean Baker, from "The Inflated Case Against the CPI," The
American Prospect 198

MichaelJ. Boskin and members of the Advisory Commission to Study the

Consumer Price Index state that changes in the Consumer Price Index over-
 1

CONTENTS / ix

state changes in the cost of living. Dean Baker, an economist, argues that it is

impossible to determine the direction of the Consumer Price Index.

ISSUE 11. Is There a Need for a Constitutional Amendment to

Balance the Budget? 206
YES: Martin A. Regalia, from "Should the Senate Pass a Balanced
Budget Amendment to the U.S. Constitution? Pro/' Congressional
Digest 208
NO: Robert Rubin, from "Should the Senate Pass a Balanced Budget
Amendment to the U.S. Constitution? Con," Congressional Digest 213

Martin A. Regalia, an economist, argues in favor of a constitutional amend-

ment to balance the budget. Robert Rubin, secretary of the treasury in the
Clinton administration, contends that an amendment would eliminate the
government's ability to respond effectively to economic problems.

ISSUE 12. Federal Reserve the Cause of Poor

Is the
Macroeconomic Performance? 218
YES: Lester Thurow, from "The Crusade That's Killing Prosperity,"
Vie American Prospect 220
NO: Matthew Miller, from "Grow Up," Vie New Republic 227

Lester Thurow, an economics professor at Massachusetts Institute of Tech-

nology, states that two major macroeconomic problems are due to Federal
Reserve policies. Matthew Miller, senior editor for t: .public, argues

that raising aggregate demand will lead to systemic inflation.

ISSUE 13. Is the Nonaccelerating Inflation Rate of Unemployment

a Useful Guide for Macroeconomic Pblil 232
YES: Joseph Stiglitz, from " Reflections on the Natural K.

Hypothesis," Journal of Economic Fr 234

NO: James K. Galbraith, from "The Surrender of Econoiv.

The American Prospect 24

Joseph Stiglitz, chairman of the Clinton administration'sCouncilot Economic

Advisers, contends that the nonaccelerating inflation rMc of unemployment
(NAIRU) is a useful guide for maaoeconomk policy fames k GaJbraith,
professor of economics at tK :\otk\. NAIRU to
a useless guide.
x/ CONTENTS

ISSUE 14. Would Adopting Wisconsin's Welfare Reforms End

Welfare As We Know It? 250
YES: Robert Rector, from "Wisconsin's Welfare Miracle/' Policy
Review 252
NO: Michael Wiseman, from "Welfare Reform in the United States:
A Background Paper," Housing Policy Debate 262

Heritage Foundation senior policy analyst Robert Rector claims that Wiscon-
sin has won more than half the battle against welfare dependence. University
of Wisconsin economist Michael Wiseman concludes that the governor of
Wisconsin has not found the key to welfare savings.

PART 3 THE WORLD AROUND US 279

ISSUE 15. Should the United States Protect Domestic Industries

from Foreign Competition? 280
YES: Robert Kuttner, from "The Free Trade Fallacy," The New Republic 282
NO: Michael Kinsley, from "Keep Free Trade Free," The New Republic 289

Columnist Robert Kuttner argues that "comparative advantage" is deter-

mined by government action, not by free markets. Social critic Michael Kins-
ley claims that protectionism weakens the economy.

ISSUE 16. Does Free Trade Make the Poor, Poorer? 294
YES: William Greider, from "Global Warning: Curbing the Free
Trade Freefall," The Nation 296
NO: Gary Burtless, from "Worsening American Income Inequality:
Is World Trade to Blame?" The Brookings Review 304

Columnist and social critic William Greider warns that blind acceptance of
"free-market doctrine" must inevitably lead to inequality. Gary Burtless, a
senior fellow at the Brookings Institution, states that although the wages of
less-skilled workers have plunged, this shift is not confined to the traded-
goods sector.

ISSUE 17. Does Global Warming Require Immediate

Government Action? 312
YES: Cynthia Pollock Shea, from "Protecting Life on Earth: Steps to
Save the Ozone Layer," Worldwatch Paper 87 314
 CONTENTS / xi

NO: Lester B. Lave, from "The Greenhouse Effect: What

Government Actions Are Needed?" journal of Policy Analysis and
Management 324

Cynthia Pollock Shea, a senior researcher with the Worldwatch Institute,

argues that immediate action must be taken to halt emissions of chemicals
that deplete the ozone. Professor of economics Lester B. Lave warns that
drastic solutions could be harmful or costly.

ISSUE 18. Should Pollution Be Put to the Market Test? 334

YES: Alan S. Blinder, from Hard Heads, Soft Hearts 336
NO: David Moberg, from "Environment and Markets: A Critique of
Tree Market' Claims/' Dissent 345

Alan S. Blinder, a member of the Board of Governors of the Federal Reserve

System, maintains that market energy can solve America's environmental

problems. Social critic David Moberg argues that public policy and direct
government intervention have positive effects on the environment.

ISSUE 19. Has the North American Free Trade Agreement Been a
Success? 356
YES: Paul Krugman, from "How Is NAFTA Doing?" Vie New
Democrat 358

NO: Sarah Anderson, John Cavanagh, and David Ranney, from

"NAFTA: Trinational Fiasco," Vie Nation 363

Paul Krugman, professor of economics at Stanford University, claims that the

North American Free Trade Agreement (NAFTA) has boon a Sarahs

Anderson and John Cavanagh, both from the Institute for Policy Studios,
and David Ranney, professor of urban planning at the University oi 111::
Chicago, argue that NAFTA is not in the best inten
and the United States.

Contributors 370

Index 374
INTRODUCTION
Economics and Economists:
The Basis for Controversy

Thomas R. Swartz
Frank J. Bonello

I think that Capitalism, wisely managed, can probably be more efficient for
attaining economic ends than any alternative system yet in sight, but that in
itself it is in many ways extremely objectionable.

Lord John Maynard Keynes, Tlte End of Laissez-Faire (1926)

Although more than 70 years have passed since Lord Keynes (1883-1946)
penned these lines, many economists still struggle with the basic dilemma he
outlined. The paradox rests in the fact that a free-market system is extremely
efficient. It is purported to produce more at a lower cost than any other
economic system. But in producing this wide array of low-cost goods and
services, problems arise. These problems —
most notably a lack of economic
—
equity and economic stability concern some economists.
If the problems raised and analyzed in this book were merely the product

of intellectual gymnastics undertaken by egg-headed economists, we could

sit back and enjoy these confrontations as theoretical exercises. The essays

contained in this book, however, touch each and every one of us in tangible
ways. Some focus upon macroeconomic topics, such as balancing the bud-
get and the Federal Reserve's monetary policy. Another set of issues deals
with microeconomic topics. We refer to these issues as micro problems not
because they are small problems, but because they deal with small economic
units,such as households, firms, or individual industries. A third set of is-
sues deals with matters that do not fall neatly into the macroeconomic or
microeconomic classifications. This set includes three issues relating to the
international aspects of economic activity and two involving pollution.
The range of issues and disagreements raises a fundamental question: Why
do economists disagree? One explanation is suggested by Lord Keynes's 1926
remark. How various economists will react to the strengths and weaknesses
found in an economic system will depend upon how they view the relative
importance of efficiency, equity, and stability. These are central terms, and we
will define them in detail in the following pages. For now the important point
is that some economists may view efficiency as overriding. In other cases,

the same economists may be willing to sacrifice the efficiency generated by

the market in order to ensure increased economic equity and /or increased
economic stability.

XII
 Swartz and Bonello / xiii

Given the extent of conflict, controversy, and diversity, it may appear that
economists rarely, if ever, agree on any economic issue. We would be most
misleading if we left the reader with this impression. Economists rarely chal-
lenge the internal logic of the theoretical models that have been developed
and articulated by their colleagues. Rather, they will challenge either the va-
assumptions used in these models or the value of the ends these
lidity of the
models seek to achieve. The challenges typically focus upon such issues as
the assumption of functioning, competitive markets, and the desirability of
perpetuating the existing distribution of income. In this case, those who sup-
port and those who challenge the operation of the market agree on a large
number of issues. But they disagree most assuredly on a few issues that have
dramatic implications.
This same phenomenon of agreeing more often than disagreeing is also true
in the area of economic policy. In this area, where the public is most acutely
aware of differences among economists, these differences are not generally
over the kinds of changes that will be brought about by a particular policy.
The differences more typically concern the timing of the change, the specific
characteristics of the policy, and the size of the resulting effect or effects.

ECONOMISTS: WHAT DO THEY REPRESENT?

Newspaper, magazine, and TV commentators all use handy labels to de-
scribe certain members What do the headlines
of the economics profession.
mean when they refer to the Chicago School, the Kevnesians, the institutional
economists, or the radical economists? What do these individuals stand for?
Since we too use our own labels throughout this book, we feel obliged to iden-
tify the principal groups orcamps in our profession. el us warn you thatI

this can be a misleading venture. Some economists— perhaps most of them

— defy classification. They drift from one camp to another, selecting a gem
of wisdom here and another there. These are practical men and women who
believe that no one camp has all the answers to all the economic problems
confronting society.
Recognizing this limitation, four major groups oi economists can be iden-
These groups are differentiated on the basis ot two bask criteria: how
tified.

they view efficiency relative to equity and stability; and what Significance
they attach to imperfectly competitive market struct Bring
various views on these criteria, it i> essentia] to understand the meaning ot
certain terms to be used in this description.
Efficiency, equity, and stability n^pre-ent goals tor an economic system.
An economy is efficient when it produces th. and services that
people want without wasting quity in I an economic sense
has several dimensions. It means that income ^nd wealth are distributed
according to accepted principles ot fairness, that those who .ire unable to
for themselves receive adequate care. And that mainstream economic acth its-
is open to all persons. Stability is \ to* ed as
t! ind
xiv / ECONOMICS AND ECONOMISTS: THE BASIS FOR CONTROVERSY

downs in business activity, in prices, and in employment. In other words,

marked by steady
stability is increases in output, little inflation, and low

unemployment.
When the term market structures is used, it refers to the number of buyers
and sellers in the market and the amount of control they exercise over price.
At one extreme is a perfectly competitive market where there are so many
buyers and sellers that no one has any ability to influence market price. One
seller or buyer obviously could have great control over price. This extreme
market structure, which we call pure monopoly, and other market structures
that result in some control over price are grouped under the broad label of
imperfectly competitive markets. With these terms in mind, we can begin to
examine the various schools of economic thought.

Free-Market Economists
One of the most visible groups of economists and perhaps the easiest group
to identify and classify is the free-market economists. These economists believe
that the market, operating freely without interferences from government or
labor unions, will generate the greatest amount of well-being for the greatest
number of people.
Economic efficiency is one of the priorities for free-market economists.
In their well-developed models, consumer sovereignty —
consumer demand
for —
goods and services guides the system by directly influencing market
prices. The distribution of economic resources caused by these market prices
not only results in the production of an array of goods and services that
are demanded by consumers, but this production is undertaken in the most
cost-effective fashion. The free-market economists claim that, at any point,
some individuals must earn incomes that are substantially greater than those
of other individuals. They contend that these higher incomes are a reward
for greater efficiency or productivity and that this reward-induced efficiency
will result in rapid economic growth that will benefit all persons in the so-
ciety. They might also admit that a system driven by these freely operating

markets will be subject to occasional bouts of instability (slow growth, infla-

tion, and unemployment). They maintain, however, that government action
to eliminate or reduce this periodic instability will only make matters worse.
Consequently, government, according to the free-market economist, should
play a minor role in the economic affairs of society.
Although the models of free-market economists are dependent upon func-
markets in the real world does
tioning, competitive markets, the lack of such
not seriously jeopardize their position. First, they assert that large-size firms
are necessary to achieve low per-unit costs; that is, a single large firm may
be able to produce a given level of output with fewer scarce resources than a
largenumber of small firms. Second, they suggest that the benefits associated
with the free operation of markets are so great compared to government inter-
vention that even a second-best solution of imperfectly competitive markets
still yields benefits far in excess of government intervention.
 Swartz and Bonello / xv

These advocates of the free market have been given various labels over
time. The oldest and most persistent label is classical economists. This is because
the classical economists of the eighteenth century, particularly Adam Smith,
were the first to point out the virtues of the market. In T)\e Wealth of Nations
(1776), Smith captured the essence of the system with the following words:

Every individual endeavors to employ his capital so that its produce may be of
greatest value. He generally neither intends to promote the public interest nor
knows how much he is promoting He intends only his own security, only his
it.

own gain. And he is in this led by an invisible hand to promote an end which was
no part of his intention. By pursuing his own interest he frequently promotes
that of society more effectively than when he really intends to promote it.

Liberal Economists
Another significant group of economists in the United States can be classified
as liberal economists. Liberal here refers to the willingness to intervene in the
free operation of the market. These economists share with the free-market
economists a great respect for the market. The liberal economist, however,
does not believe that the explicit and implicit costs of a freely operating mar-
ket should or can be ignored. Rather, the liberal maintains that the costs of an
uncontrolled marketplace are often bome by those in society who are least
capable of bearing them: the poor, the elderly, and the infirm. Additionally, lib-
eral economists maintain that the freely operating market sometimes results
in economic instability and the resultant bouts of inflation, unemployment,
and slow or negative growth.
Consider for a moment the differences between free-market economists
and liberal economists at the microeconomic level. Liberal economists take
exception to the free market on two grounds. First, these economists find a
basic problem with fairness in the marketplace. Since the market is driven
by the forces of consumer spending, there are those who through no fault of
their own (they maybe aged, young, infirm, or physically or mentally handi-
capped) may not have the wherewithal to participate in the economic system.
Second, the unfettered marketplace does not and cannot handle spillover ef-
fects or what are known as externalities. These are the third-pa: that

may occur as a result of some action. Will a firm willingly compensate it>
1
neighbors for the pollutants it pours into the nearbv lake Will a truck driver
willingly drive at the speed limit and in the process reduce the highway
accident rate? Liberal economists think not. These economist tore

willing to have the government intervene in these and other, similar cases.

The economists' role in macroeconomics fe

liberal Uly pptfl
Ever since the failure of free-market economics during the Cireat not I

the 1930s, Keynesianism (still another label tor liberal economics)hafl be,
widely known. In his 1935 book, The General Theory
and Money, Lord John Mavnard Keynes laid the bask groundwork \^\ this
school of thought. Keynes argued that the tUStOI operating market
-

economies was marked by periods ol recurring recessions, sometii

xvi / ECONOMICS AND ECONOMISTS: THE BASIS FOR CONTROVERSY

deep recessions, which we call depressions. He maintained that government

intervention through its fiscal —government tax and spending power
policy
—could eliminate, or at least soften these sharp reductions in economic activ-
ity and as a result move the economy along a more stable growth path. Thus
for the Keynesians, or liberal economists, one of the extremely objectionable
aspects of a free-market economy is its inherent instability.
Liberal economists are also far more concerned about the existence of im-
perfections in the marketplace than are their free-market counterparts. They
reject thenotion that imperfect competition is an acceptable substitute for
competitive markets. They may agree that the imperfectly competitive firms
can achieve some savings because of their large size and efficiency, but they
assert that since there is little or no competition the firms are not forced to
pass these cost savings on to consumers. Thus liberal economists, who in
some circles are labeled antitrusters, are willing to intervene in the market in
two ways: They are prepared to allow some monopolies, such as public util-
ities, to exist, but they contend that these must be regulated by government;

or they maintain that there is no justification for monopolies, and they are
prepared to invoke the powers of antitrust legislation to break up existing
monopolies and/or prevent the formation of new ones.

Mainstream Critics and Radical Reform Economists

There are two other groups of economists we must identify One group can be
called mainstream critics. Included in this group are individuals like Thorstein
Veblen (1857-1929), with his critique of conspicuous consumption, and John
Kenneth Galbraith (b. 1908), with his views on industrial structure. One rea-
sonably cohesive subgroup of mainstream critics are the post-Keynesians.
They are post-Keynesians because they believe that as the principal eco-
nomic institutions have changed over time, they have remained closer to the
spirit of Keynes than have the liberal economists. As some have suggested,
the key aspect of Keynes as far as the post-Keynesians are concerned is his
assertion that "expectations of the future are not necessarily certain." On a
more practical level post-Keynesians assert, among other things, that the pro-
ductivity of the economic system is not significantly affected by changes in
income distribution, that the system can still be efficient without competitive
markets, that conventional fiscal policies cannot control inflation, and that
"incomes policies" are the means to an effective and equitable answer to the
inflationary dilemma. This characterization of post-Keynesianism is drawn
from Alfred S. Eichner's introduction in A Guide to Post-Keynesian Economics
(M. E. Sharpe, 1978).
The fourth and last group can be called the radical reform economists. Many
in thisgroup trace their ideas back to the nineteenth-century philosopher-
economist Karl Marx and his most impressive work, the three volumes of
Das Kapital. As with the other three groups of economists, there are sub-
groups of radical reform economists. One subgroup, which may be labeled
contemporary Marxists, is best represented by those who have published
 Swartz and Bonello / xvii

their research results over the years in the Review of Radical Political Eco-
nomics. These economists examine issues that have been largely ignored by
mainstream economists, for example, war, sexism, racism, imperialism, and
civil rights. In their analyses of these issues they borrow from and refine the
work of Marx. In the process, they emphasize the role of class in shaping
society and the role of the economy in determining class structures. More-
over, they see a need to encourage explicitly the development of some form
of democratic socialism, for only then will the greatest good for the greatest
number be ensured.
In concluding this section, we must warn you to use these labels with
extreme care. Our categories are not hard and fast. There is much grayness
around the edges and little that is black and white in these classifications.
This does not mean, however, that they have no value. It is important to
understand the philosophical background of the individual authors. This
background does indeed color or shade their work.

SUMMARY
It is is no shortage of economic problems that demand solu-
clear that there
[Link] the same time there is no shortage of proposed solutions. In fact,
the problem is often one of oversupply. The nineteen issues included in this
volume will acquaint you or, more accurately, reacquaint you with some of
these problems. And, of course, there are at least two proposed solutions for
each of the problems. Here we hope to provide new insights regarding the
alternatives available and the differences and similarities of these alternative
remedies.
If this introduction has served its purpose, you will be able to identify

common elements in the proposed solutions to the different problems. For

example, you will be able to identify the reliance on the forces of the market
advocated by free-market economists as the remedy for several economic
ills. This introduction should also help you understand why there are at

least two proposed solutions for every economic problem; each group of
economists tends to interpret a problem from its own philosophical position
and to advance a solution that is grounded in that philosophical framework.
Our intention, of course, is not to connect persons to one philosophic y
tion or another. We hope instead to generate discussion and promote under-
standing. To do this, each of us must see not only a proposed solution, we
must also be aware of the foundation that supports that solution. With greater
understanding, meaningful progress in addressing economic problems can
be achieved.
 .

On the Internet . .

The Dismal Scientist

Provides free economic data, analysis, and forecasts on
[Link]
a variety of topics.
[Link] disma I. com/

The Economist
The Web edition of the Economist is available free to sub-
scribers of the print edition or for an annual fee to those
who wish to subscribe online. A selection of articles is
available free to those who want to dip into the journal.
[Link]

Electronic Policy Network

Timely information and ideas about national policy on eco-
nomics and politics, welfare and families, education, civic par-
and health policy in the form of a virtual magazine.
ticipation,
[Link]

Resources for Economists on the Internet

This resource of the WWW
Virtual Library on Economics
is an excellent starting place for any research in econom-

ics by academic and practicing economists and anyone

interested in economics. Has many Web links.
h ttp://econ wpa wustl. edu/econFA Q/EconFAQ. h tml
.

Statistical Resources on the Web/Economics

Here is an excellent source of statistics collated from fed-
eral bureaus, economic indicators —both historical and
current, the Federal Reserve Board, economic sources,
federal statistical tables, a consumer price inflator/defla-
tor, and many links to other sources.
[Link]
.html

WebEc —WWW Resources in Economics

A most complete virtual library of economics facts, fig-
ures, and thoughts.
[Link] [Link]/[Link]
 PART 1
Microeconomic Issues

Our lives are profoundly affected by economic decisions made at tlie

microeconomic level. Some important decisions are those regarding profit

motives of businesses, city subsidies for sports venues, tlie minimum wage,
the health care industry, rent controls, and more prison space.

Are Profits the Only Business of Business?

Should We Encourage the Private Ownership of Guns?

Should Cities Subsidize Sports and Sports Venues?

Is It Time to Abolish the Minimum Wage?

Are Rent Controls the Cause of America's Homelessness?

Is Managed Competition the Cure for Our Ailing Health Care

Industry?

Are More Prisons and Prison Beds the Answer to America's

Rising Crime Rate?
ISSUE 1

Are Profits the Only Business

of Business?

YES: Milton Friedman, from "The Social Responsibility of Business Is to

Increase Its Profits/' The New York Times Magazine (September 13, 1970)

NO: Robert Almeder, from "Morality in the Marketplace/' in Milton Snoeyen-

bos, Robert Almeder, and James Humber, eds., Business Ethics, rev. ed. (Pro-
metheus Press, 1998)

ISSUE SUMMARY
YES: Free-market economist Milton Friedman contends that the sole respon-
sibility of business is to increase its profits.

NO: Philosopher Robert Almeder maintains that if capitalism is to survive,

it must act in socially responsible ways that go beyond profit making.

—
Every economic society whether it is a traditional society in Central Africa,
a fossilized planned economy such as Cuba's, or a wealthy capitalist society
such as those found in North America, Western Europe, or the Pacific Rim
— must address the basic economic problem of resource allocation. These
societies must determine what goods and services they can and will produce,
how these goods and services will be produced, and/or whom these goods and
services will be produced.
The what, how, and for whom questions must be answered because of the
problem of scarcity Even if a given society were indescribably rich, it would
still confront the problem of scarcity —in the case of a rich society, "relative
scarcity." It might have all needs to produce all the goods
the resources it

and services it would ever want, but it could not produce all these things
simultaneously. Thus, even a very rich society must set priorities and produce
first those goods and services with the highest priority and postpone the

production of those goods and services with lower priorities. If time is of the
essence, this society would determine how these goods and services should
be produced. And since this wealthy society cannot produce all it wants
instantly, it must also determine for whom the first bundle of goods and
services will be produced.
Few, if any, economic societies are indescribably rich. On the other hand,
there are many examples of economic societies that face grinding deprivation
daily. In these societies and in all the societies that fall between poverty
 I

and great affluence, the what, hozv, and for whom questions are immediately
apparent. Somehow these questions must be answered.
In some societies, such as the Amish communities of North America, the
answers to these questions are found in tradition: Sons and daughters follow
in their parents' footsteps. Younger generations produce what older gener-
ations produced before them. The methods of production the horsedrawn —
plow, the hand-held scythe, the use of natural fertilizers remain unchanged; —
thus, the how question is answered in the same way that the/or whom question
is answered —
by following historic patterns. In other societies, such as self-
sustaining religious communities, there is a different pattern of responses to
these questions. In these communities, the "elder" of the community deter-
mines what will be produced, how it will be produced, and/or whom
be it will
produced. If there is a well-defined hierarchical system, it is similar to one of
the former stereotypical command economies of Eastern Europe.
Although elements of tradition and command are found in the industrial-
ized societies of Western Europe, North America, and Japan, the basic answers
to the three questions of resource allocation in these countries are determined
by profit. In these economic societies, what will be produced is determined by
what will yield the greatest profit. Consumers, in their search for maximum
satisfaction, will bid for thosegoods and services that they want most. This
consumer action drives the prices of these goods and services up, which, in
turn, increases producers' profits. The higher profits attract new firms into the
industry and encourage existing firms to increase their output. Thus, profits
are the mechanism that ensures that consumers get what they want. Simi-
larly, the profit-seeking behavior of business firms determines how the goods
and services that consumers want will be produced. Since firms attempt to
maximize their profits, they select those means of production that are eco-
nomically most efficient. Lastly, the for zvhom question is also linked to profits.
Wherever there is a shortage of goods and services, profits will bo high- In
the producers' attempts to increase their output, they must attract factOl
production (land, labor, and capital) away from other economic acti\
This bidding increases factor prices or factor incomes and ensures that these
factors will be able to buy goods and services in the open marketp!
Both Milton Friedman and Robert Almocier recognize the merits of a profit-
driven economic system. They do not quarrel over the importance of pn
But they do quarrel over whether or not business tirms ha\ e obligations be-
yond making profits. Friedman holds that the only responsibility ot busil
is to make profits and that anyone who maintains otherwise King
pure and unadulterated socialism." Almeder. w ho 1- ^ (early not a "sodfl

contends that business must act in socially responsibl t

capitalism is

to survive."
 Milton Friedman
YES

THE SOCIAL RESPONSIBILITY OF

BUSINESS IS TO INCREASE ITS PROFITS

When I hear businessmen speak eloquently about the "social responsibilities

of business in a free-enterprise system/' I am reminded of the wonderful
line about the Frenchman who discovered at the age of 70 that he had been
speaking prose all his life. The businessmen believe that they are defending
free enterprise when they declaim that business is not concerned "merely"
with profit but also with promoting desirable "social ends; that business
has a social conscience" and takes seriously its responsibilities for providing
employment, eliminating discrimination, avoiding pollution and whatever
else may be the catchwords of the contemporary crop of reformers. In fact they
are— or would be if they or anyone else took them seriously preaching pure —
and unadulterated socialism. Businessmen who talk this way are unwitting
puppets of the intellectual forces that have been undermining the basis of a
free society these past decades.
The discussions of the "social responsibilities of business" are notable for
their analytical looseness and lack of rigor. What does it mean to say that
"business" has responsibilities? Only people can have responsibilities. cor- A
poration is an artificial person and in this sense may have artificial responsi-
but "business" as a whole cannot be said to have responsibilities, even
bilities,

in this vague sense. The

first step toward clarity in examining the doctrine

of the social responsibility of business is to ask precisely what it implies for

whom.
Presumably, the individuals who are to be responsible are businessmen,
which means individual proprietors or corporate executives. Most of the
discussion of social responsibility is directed at corporations, so in what
follows I shall mostly neglect the individual proprietor and speak of corporate
executives.
In a free-enterprise, private-property system, a corporate executive is an
employee of the owners of the business. He has direct responsibility to his
employers. That responsibility is to conduct the business in accordance with
which generally will be to make as much money as possible
their desires,
while conforming to the basic rules of the society, both those embodied in

From Milton Friedman, "The Social Responsibility of Business Is to Increase Its Profits," The
New York Times Magazine (September 13, 1970). Copyright 1970 by The New York Times Co.
©
Reprinted by permission.
 5

YES Milton Friedman/

law and those embodied in ethical What does it mean to say that the cor-
custom. Of course, in some cases his porate executive has a "social responsi-
employers may have a different objective. bility" in his capacity as businessman?
A group of persons might establish a If this statement is not pure rhetoric, it

corporation for an eleemosynary purpose must mean that he is to act in some way
— for example, a hospital or a school. The that is not in the interest of his employ-

manager of such a corporation will not [Link] example, that he is to refrain from
have money profit as his objective but the increasing the price of the product in or-
rendering of certain services. der to contribute to the social objective of
preventing inflation, even though a price
In either case, the key point is that, in
his capacity as a corporate executive, the
increase would be in the best interests of
manager is the agent of the individuals
the corporation. Or that he is to make ex-
penditures on reducing pollution beyond
who own the corporation or establish
the amount that is in the best interests of
the eleemosynary institution, and his
the corporation or that is required by law
primary responsibility is to them.
in order to contribute to the social ob-
Needless to say, this does not mean that jective of improving the environment. Or
it is easy to judge how well he is per-
that, at the expense of corporate profits,
forming his task. But at least the crite- he is to hire "hard-core" unemployed in-
rion of performance is straightforward, stead of better-qualified available work-
and the persons among whom a volun- men to contribute to the social objective
tary contractual arrangement exists are of reducing poverty.
clearly defined. In each of these cases, the corporate
Of course, the corporate executive is executive would be spending someone
own right. As a per-
also a person in his else's money for a general social interest.
son, he may have many other responsibil- Insofar as his actions in accord with his
ities that he recognizes or assumes volun- "social responsibility" reduce returns to
» tarily — to his family, his conscience, his stockholders, he is spending their money.
feelings of charity, his church, his clubs, Insofar as his actions raise the price to
his city, his country. He may feel impelled customers, heis spending the customers'

by these responsibilities to devote part of money. Insofar as h lower the

his income to causes he regards as wor- wages of some employees, he is spending
thy, to refuse to work for particular corpo- their money.

rations, even to leave his job, for example, The stockholders or the customers or
to join his country's armed forces. It we the employees could separa:
wish, we may refer tosome of these re- their own money on the particular

sponsibilities as "social responsibility action it t lied to do so. The

But in these respects he is acting a executive i> exercising a distinct "social

principal, not an agent; he is spending rather thm serving as

his own money or time or energy, not the .m agent ot H older* or the

money of his employers or the time or en- he only if

ergy he has contracted to devote to their spends the monev in adifl v than

purposes. If these are "social responsibil- they would have iptnfl it.
ities/' they are the social responsibilities But if he does thi>, he is in .

of individuals, not of business. imposing taxes, on the one band

 —

6 / 1. ARE PROFITS THE ONLY BUSINESS OF BUSINESS?

deciding how the tax proceeds shall be intolerable that such civil servants
spent, on the other. insofar as their actions in the name of
This process raises political questions social responsibility are real and not just
on two levels: principle and conse- —
window-dressing should be selected as
quences. On the level of political prin- they are now. If they are to be civil
ciple, theimposition of taxes and the servants, then they must be selected
expenditure of tax proceeds are govern- through a political process. If they are to
mental functions. We have established impose taxes and make expenditures to
elaborate constitutional, parliamentary foster "social" objectives, then political
and judicial provisions to control these machinery must be set up to guide the
functions, to assure that taxes are im- assessment of taxes and to determine
posed so far as possible in accordance through a political process the objectives
with the preferences and desires of the to be served.
public — after all, "taxation without rep- This is the basic reason why the doc-
resentation" was one of the battle cries trine of "social responsibility" involves
of the American Revolution. We have a the acceptance of the socialist view that
system of checks and balances to sepa- mechanisms, not market mecha-
political
rate the legislative function of imposing nisms, are the appropriate way to deter-
taxes and enacting expenditures from the mine the allocation of scarce resources to
executive function of collecting taxes and alternative uses.
administering expenditure programs and On the grounds of consequences, can
from the judicial function of mediating the corporate executive in fact discharge
disputes and interpreting the law. his alleged "social responsibilities"? On
Here the businessman — self-selected the one hand, suppose he could get
7
or appointed directly or indirectly by away with spending the stockholders or
—
stockholders is to be simultaneously customers' or employees' money. How
legislator, executiveand jurist. He is to is he to know how to spend it? He is
decide whom to tax by how much and told that he must contribute to fighting
for what purpose, and he is to spend the inflation. How is he to know what action
—
proceeds all this guided only by general of his will contribute to that end? He
exhortations from on high to restrain is presumably an expert in running his

inflation, improve the environment, fight —

company in producing a product or
poverty and so on and on. selling it or financing it. But nothing
The whole justification for permitting about his selection makes him an expert
the corporate executive to be selected on inflation. Will his holding down the
by the stockholders is that the executive price of his product reduce inflationary
is an agent serving the interests of his pres- sure? Or,by leaving more spending
principal. This justification disappears power hands of his customers,
in the
when the corporate executive imposes simply divert it elsewhere? Or, by forcing
taxes and spends the proceeds for him to because of the
produce less
"social" purposes. He becomes in effect lower simply contribute to
price, will it

a public employee, a civil servant, shortages? Even if he could answer these

even though he remains in name an questions, how much cost is he justified in
employee of a private enterprise. On imposing on his stockholders, customers
grounds of political principle, it is and employees for this social purpose?
 7I

YES Milton Friedman/

What is the appropriate share and what determine expenditures for such "social"
is the appropriate share of others? purposes as controlling pollution or
And, whether he wants to or not, training the hard-core unemployed, but
can he get away with spending his that theproblems are too urgent to wait
stockholders', customers' or employees' on the slow course of political processes,
money? Will not the stockholders fire that the exercise of social responsibility
him? (Either the present ones or those by businessmen is a quicker and surer
who take over when his actions in way to solve pressing current problems.
the name of social responsibility have Aside from the question of fact —
reduced the corporation's profits and the share Adam Smith's skepticism about
price of its stock.) His customers and the benefits that can be expected from
his employees can desert him for other "those who affected to trade for the
producers and employers less scrupulous public good" —
this argument must be
in exercising their social responsibilities. rejected on grounds of principle. What
This facet of "social responsibility" it amounts to is an assertion that those

doctrine is brought into sharp relief when who favor the taxes and expenditures
the doctrine is used to justify wage re- in question have failed to persuade a
straint by trade unions. The conflict of in- majority of their fellow citizens to be
terest is naked and clear when union offi- of like mind and that they are seeking
cials are asked to subordinate the interest to attain by undemocratic procedures
of their members to some more general what they cannot attain by democratic
social purpose. If the union officials try to procedures. In a free society, it is hard
enforce wage restraint, the consequence for "good" people do "good," but that
to
is likely to be wildcat strikes, rank-and- is a small price to pay for making it hard

file revolts and the emergence of strong for "evil" people to do "evil," especially
competitors for their jobs. We thus have since one man's good is another's evil.
the ironic phenomenon that union lead- I ha\ oncentrated on
ers —at least in the U.S. —
have objected to the special case of the corporate exec-
Government interference with the mar- utive, except only for the brief digres-

ket far more consistently and coura- sionon trade unions. But precisely the
geously than have business leaders. same argument applies to the newer phe-
The difficulty of exercising "social re- nomenon oi calling upon sUvkhoL:
sponsibility" illustrates, of course, the require corporations to exercise social re-
great virtue of private competitive enter- sponsibility (the recent G v

prise — it forces people to be responsible example). In BIOS! ot thi what

for their own actions and makes it dif- is involved is some stockhold-
in effect

ficult for them to "exploit" other people ers trying to get other sUvkholoY:

for either selfish or unselfish pur; customers or employees) to contribute

They can do good —but only at their own against their will to
expense. voredbv tl

Many a reader who has followed igain imp

the argument this far may be
tempted ding the pi

to remonstrate that it is all well and situation ot th<

good to speak of government's having

the responsibility to impose taxe turns of hi
8/ 1. ARE PROFITS THE ONLY BUSINESS OF BUSINESS?

to exercise his "social responsibility/' he that are entirely justified in its own self-
is spending his own money, not someone interest.
else's. If he wishes to spend his money would be inconsistent of me to
It

on such purposes, that is his right, and call on corporate executives to refrain
I cannot see that there is any objection from this hypocritical window-dressing
to his doing so. In the process, he, too, because it harms the foundations of a
may impose costs on employees and cus- free society. That would be to call on
tomers. However, because he is far less them to exercise a "social responsibility"!
likely than a large corporation or union to If our institutions, and the attitudes of

have monopolistic power, any such side the public make it in their self-interest
effects will tend to be minor. to cloak their actions in this way, I

Of course, in practice the doctrine of

cannot summon much indignation to

social responsibility is frequently a cloak

denounce them. At the same time, I can
express admiration for those individual
for actions that are justified on other
proprietors or owners of closely held
grounds rather than a reason for those
corporations or stockholders of more
actions.
broadly held corporations who disdain
To illustrate, it may well be in the long- such tactics as approaching fraud.
run interest of a corporation that is a Whether blameworthy or not, the use
major employer in a small community to of the cloak of social responsibility, and
devote resources to providing amenities the nonsense spoken in its name by in-
to that community or to improving its
fluential and prestigious businessmen,
government. That may make it easier does clearly harm the foundations of a
to attract desirable employees, it may
free society I have been impressed time
reduce the wage bill or lessen losses
and again by the schizophrenic charac-
from pilferage and sabotage or have other ter of many businessmen. They are ca-
worthwhile effects. Or it may be that, pable of being extremely far-sighted and
given the laws about the deductibility
clear-headed in matters that are inter-
of corporate charitable contributions,
They
nal to their businesses. are incredi-
the stockholders can contribute more bly short-sighted and muddle-headed in
to charities they favor by having the matters that are outside their businesses
corporation make the gift than by doing but affect the possible survival of busi-
itthemselves, since they can in that
ness in general. This short-sightedness is
way contribute an amount that would strikingly exemplified in the calls from
otherwise have been paid as corporate
many businessmen for wage and price
taxes.
guidelines or controls or incomes poli-
In each of these —and many similar cies. There is nothing that could do more
— cases, there is a strong temptation to in a brief period to destroy a market sys-
rationalize these actions as an exercise tem and replace it by a centrally con-
of "social responsibility." In the present trolled system than effective governmen-
climate of opinion, with its widespread tal control of prices and wages.
aversion to "capitalism," "profits," the The short-sightedness is also exempli-
"soulless corporation" and so on, this is fied in speeches by businessmen on social
one way for a corporation to generate responsibility. This may gain them kudos
goodwill as a by-product of expenditures in the short run. But it helps to strengthen
 9

YES Milton Friedman/

the already too prevalent view that the and a say in what is to be done, but if

pursuit of profits wicked and immoral

is he is overruled, he must conform. It is

and must be curbed and controlled by ex- appropriate for some to require others
ternal forces. Once this view is adopted, to contribute to a general social purpose
the external forces that curb the market whether they wish to or not.
will not be the social consciences, how- Unfortunately, unanimity is not always
ever highly developed, of the pontificat- feasible. There are some respects in which
ing executives; it will be the iron fist of conformity appears unavoidable, so I do
Government bureaucrats. Here, as with not seehow one can avoid the use of the
price and wage controls, businessmen political mechanism altogether.
seem to me to reveal a suicidal impulse. But the doctrine of "social responsi-
The political principle that underlies bility" taken seriously would extend the
the market mechanism is unanimity. scope of the political mechanism to every
In an ideal free market resting on human activity. It does not differ in phi-
private property, no individual can coerce losophy from the most explicitly collec-
any other, all cooperation is voluntary, tivist doctrine. It differs only by profess-
all parties to such cooperation benefit ing to believe that collectivist ends can be
or they need not participate. There attained without collectivist means. That
are no "social" values, no "social" is why, in my book "Capitalism and Free-

responsibilities in any sense other than dom," I have called it a "fundamentally

the shared values and responsibilities subversive doctrine" in a free society, and
of individuals. Society is a collection of have said that in such a society, "there is
individuals and of the various groups one and only one social responsibility of
they voluntarily form. —
business to use its resources and engage
The political principle that underlies in activities designed to increase its prof-
the political mechanism is conformity. its so long as it stays within the rules of

The individual must serve a more the game, which is to say, engages in open
—
general social interest whether that be and free competition without deception
determined by a church or a dictator or a or fraud."
majority. The individual may have a vote
 Robert Almeder
NO

MORALITY IN THE MARKETPLACE:

REFLECTIONS ON THE FRIEDMAN
DOCTRINE

INTRODUCTION
In seeking to create a climate more favorable for corporate activity, Interna-
tional Telephone and Telegraph allegedly contributed large sums of money to
"destabilize" the duly elected government of Chile. Even though advised by
the scientific community that the practice is lethal, major chemical companies
reportedly continue to dump large amounts of carcinogens and mutagens into
the water supply of various areas and, at the same time, lobby strongly to
prevent legislation against such practices. General Motors Corporation, other
automobile manufacturers, and Firestone Tire and Rubber Corporation have
frequently defended themselves against the charge that they knowingly and
willingly marketed a product that, owing to defective design, had been reli-
ably predicted to kill a certain percentage of its users and, moreover, refused
to recall promptly the product even when government agencies documented
the large incidence of death as a result of the defective product. Finally,
people often say that numerous advertising companies happily accept, and
earnestly solicit, accounts to advertise cigarettes knowing full well that as a
direct result of their advertising activities a certain number of people will die
considerably prematurely and painfully. Most recently, of course, American
Tobacco Companies have been charged with knowingly marketing a very
addictive product known to kill untold numbers in slow, painful and costly
deaths while the price of the stock of these companies has made fortunes
for the shareholders. We need not concern ourselves with whether these and
other similar charges are true because our primary concern here is with what
might count as a justification for such corporate conduct were it to occur.
There can be no question that such corporate behavior sometimes occurs and
is frequently legal, or at least not illegal. The question is whether corporate

behavior should be constrained by nonlegal or moral considerations. If so, to

what extent and how could it be done? As things presently stand, it seems

From Robert Almeder, "Morality in the Marketplace: Reflections on the Friedman Doctrine."
Copyright © 1997 by Robert Almeder. Revised and expanded from "Morality in the
Marketplace/' in Milton Snoeyenbos, Robert Almeder and James Humber, eds., Business Ethics,
rev. ed. (Prometheus Press, 1992). Reprinted by permission of Robert Almeder.

10
 NO Robert Almeder/ 11

to be a dogma of contemporary capi- inherent to the competition process. This,

talism rapidly emerging throughout the they say, is what has made capitalist
world that the sole responsibility of busi- societies the envy of the world while
ness is to make as much money as is ideological socialisms sooner of later fail
legally possible. But the interesting ques- miserably to meet deep human needs.
tion is whether this view is rationally de- Smith's view, that there is an invisible
fensible. hand, as it were, directing an economy
Sometimes, although not very fre- governed solely by the profit motive to
quently, corporate executives will admit the greatest good for society in the long
to the sort of behavior depicted above run, 1
dominant motivation and
is still the
and then proceed proximately to justify justification for those who would want
such behavior in the name of their re- an economy unregulated by any moral
sponsibility to the shareholders or own- concern that would, or could, tend to
ers (if the shareholders are not the own- decrease profits for some alleged social or
ers) to make as much profit as is legally moral good.
possible. Thereafter, less proximately and Milton Friedman, for example, has
more generally, they will proceed to urge frequently asserted that the sole moral
the more general utilitarian point that responsibility of business is to make
the increase in profit engendered by such as much profit as is legally possible;
corporate behavior begets such an un- and by that he means to assert that
questionable overall good for society that attempts to regulate or restrain the
the behavior in question is morally ac- pursuit of profit accordance with in
ceptable if not quite praiseworthy. More what some people believe to be socially
specifically, the justification in question desirable ends are in fact subversive of
can, and usually does, take two forms. the common good because the greatest
The first and most common form of good for the greatest number is achieved
justification consists in urging that, as by an economy maximally competitive
long as one's corporate behavior is not and unregulated by moral rules in its
illegal,the behavior will be morally pursuit of profit. So, on Friedman's
2

acceptable because the sole purpose of view, the grea test good
being in business is to make a profit; achieved by corporations acting legally,

and the rules of the marketplace are but with no further regard for what mav
somewhat different from those in other be morally desirable; and this \
places and must be followed if one is to the paradox that, EH bu>mc>>, the gn
make a profit. Moreover, proponents of good tor society can be achieved onlv
thisview hasten to add that, as Adam by acting without regard tor morality,

Smith has claimed, the greatest good for at lea>t in moral rules are not
society in the long run is achieved not reflected in the legal code. Moreover,
by corporations seeking to act mo rails', adoption ot this position constitutes
or with a sense of social responsibility a conscious commitment to the
fairly

in their pursuit of profit, but rather by view that while one's personal lite mas-
each corporation seeking to maximize its well need moral governance beyond
own profit, unregulated in that endea\ OX the law, when pursuing profit it is

except by the laws of supply and demand iry that i orate behavior
along with whatever other law be unregulated by any moral concern
12 / 1. ARE PROFITS THE ONLY BUSINESS OF BUSINESS?

other than that of making as much not too clear what would count for
it is

money as is legally possible; curiously doing it. In short, business corporations

enough, it is only in this way that could argue (as Friedman has done) 4 that
society achieves the greatest good. So corporate actions in behalf of society's
viewed, it is not difficult to see how a interests would require of corporations
corporate executive could sincerely and an ability to clearly determine and rank
consistently adopt rigorous standards of in noncontroversial ways the major needs
morality in his or her personal life and of society; and it would not appear that
yet feel quite comfortable in abandoning this could be done successfully.
those standards in the pursuit of profit. Perhaps another, and somewhat easier,
Albert Carr, for example, likens the way of formulating this second argument
conduct of business to that of playing consists in urging that because moralists
poker. 3 As Carr would have it, moral and philosophers generally fail to agree
busybodies who insist on corporations on what are the proper moral rules (if
acting morally might do just as well any), as well as on whether we should
to censure a good bluffer in poker for be moral, it would be imprudent to
being deceitful. Society, of course, lacking sacrifice a clear profit for a dubious or
a perspective such as Friedman's and controversial moral gain. To authorize
Carr's is only too willing to view such such a sacrifice would be to abandon a
behavior as strongly hypocritical and clear responsibility for one that is unclear
fostered by an unwholesome avarice. or questionable.
The second way of justifying, or If there are any other basic ways of
defending, corporate practices that may justifying the sort of corporate behavior
appear morally questionable consists noted at the outset, I cannot imagine what
in urging that even if corporations they might be. So, let us examine these
were to take seriously the idea of two modes of justification. In doing this,
limiting profits because of a desire I hope to show that neither argument

to be moral or more responsible to is sound and, moreover, that corporate

social needs, then corporations would be behavior of the sort in question is clearly
involved in the unwholesome business immoral if anything is immoral and if —
of selecting and implementing moral nothing is immoral, then such corporate
values that may not be shared by a behavior is clearly contrary to the long-
large number of people. Besides, there is term interest of a corporation. In the end,
the overwhelming question of whether we will reflect on ways to prevent such
there can be any non-questionable moral behavior, and on what is philosophically
values or non-controversial list of social implied by corporate willingness to act in
priorities for corporations to adopt. After clearly immoral ways.
all, if ethical relativism is true, or if ethical
nihilism is true (and philosophers can be
II. THE "INVISIBLE HAND"
counted upon to argue agressively for
both positions), then it would be fairly argument is that the
Essentially, the first
silly of corporations to limit profits for greatest good for the greatest number will
what may be a quite dubious reason, be, and can only be, achieved by corpo-
namely, for being moral, when there are rations acting legally but unregulated by
no clear grounds for doing it, and when any moral concern in the pursuit of profit.
 NO Robert Almeder/ 13

As we saw earlier, the evidence for this ar- of those implications of this rule below
gument rests on a fairly classical and un- before drawing a conclusion.
questioning acceptance of Adam Smith's The second argument cited above as-
view that society achieves a greater good serts that even if we were to grant, for
when each person is allowed to pur- the sake of argument, that corporations
sue her or his own self-interested ends have social responsibilities beyond that of
than when each person's pursuit of self- making as much money as is legally pos-
interested ends is regulated in some way would be
sible for the shareholders, there
or another by moral rules or concern. But no noncontroversial way for corporations
I know of no evidence Smith ever offered to discover just what these responsibili-
for this latter claim, although it seems ties are in the order of their importance.
clear that those who adopt it generally do Owing to the fact that even distinguished
so out of respect for the perceived good moral philosophers predictably disagree
that has emerged for various modem so- on what one's moral responsibilities are,
cieties as a direct result of the free enter- if any, it would seem irresponsible to limit
prise system and its ability to raise the profits to satisfy dubious moral responsi-
overall standard of living of all those un- bilities.

der it. For one thing, this argument unduly

However, there is nothing inevitable exaggerates our potential for moral
about the greatest good occurring in an disagreement. Admittedly, there might
unregulated economy. Indeed, we have well be important disagreements among
good inductive evidence from the age of corporations (just as there could be
the Robber Barons that unless the profit among philosophers) as to a priority
motive is regulated in various ways (by ranking of major social needs; but that
statute or otherwise) untold social evil does not mean that most of us could
can, and will, occur because of the nat- not, or would not, agree that certain
ural tendency of the system to place things ought not be done in the name
ever-increasing sums of money in ever- of profit even when there is no law
decreasing numbers of hands as a re- prohibiting such acts. Doubtless, there
sult of the nature of competition unreg- will always be a tew who would do most
ulated. If all this is so, then so much the anything tor a profit; but that is hardly a
worse for all philosophical attempts to good argument in tavor of their having
what would appear to be morally
justify the moral right to do so rather than a
questionable corporate behavior on the good argument showing that ::

grounds that corporate behavior, unreg- to be moral. In sum, it is ditticult to

ulated by moral concern, is necessarily or see how this second argument favoring
even probably productive of the greatest corporate moral nihilism i> am better
good for the greatest number. Moreover, than the general argument tor ethical
a rule utilitarian would not be very hard nihilism based on the variability of ethical
pressed to show the many unsavory im- judgments or practices; mu\ apart
plications to society as a whole if society the tact that it tacitly prvsupposos that
were to take seriously a rule to the effect morahtv is a matter ot what wo all :

that, ifone acts legally, it is morally per- would, or should, accept the atgument
missible to do whatever one wants to do is maximally counttrintu shall .

to achieve a profit. We shall discuss some aggesting that we

14 / 1. ARE PROFITS THE ONLY BUSINESS OF BUSINESS?

cannot generally agree that corporations person's cannot be taken from him
life

have certain clear social responsibilities or her without a good reason. If our

to avoid certain practices. Accordingly, I utilitarian cannot provide a convincing

would now argue that if anything
like to justification for his claim that a greater
is immoral, a certain kind of corporate good is served by killing an innocent
behavior is quite immoral although it person in order to raise the standard of
may not be illegal. living for a large number of poor people,
then hard to see how he can have the
it is

good reason that he needs to deprive an

III. MURDER FOR PROFIT innocent person of his or her life. Now,
Without caring to enter into the reasons it seems clear that there will be anything

for the belief, assume we all believe

I but unanimity in the moral community
that wrong to kill an innocent
it is on the question of whether there is a
human being for no other reason than greater good achieved in raising the
that doing so would be more financially standard of living by killing an innocent
rewarding for the killer than if he were baby than in leaving the standard of
to earn his livelihood in some other living alone and not killing an innocent
way. Nor, I assume, should our moral baby. Moreover, even if everybody were
feeling on this matter change depending to agree that the greater good is achieved
on the amount of money involved. Killing by the killing of the innocent baby, how
an innocent baby for fifteen million could that be shown to be true? How
dollars would not seem to be any less does one compare the moral value of a
objectionable than killing it for twenty human life with the moral value of raising
cents. It is possible, however, that a self- the standard of living by the taking of
professing utilitarian might be tempted that life? Indeed, the more one thinks
to argue that the killing of an innocent about it, the more difficult it is to see just
baby for fifteen million dollars would what would count as objective evidence
not be objectionable if the money were for the claim that the greater good is

to be given to the poor; under these achieved by the killing of the innocent
circumstances, greater good would be baby. Accordingly, I can see nothing that
achieved by the killing of the innocent would justify the utilitarian who mightbe
baby. But, I submit, if anybody were to tempted to argue that if the sum is large
argue in this fashion, his argument would enough, and if the sum were to be used
be quite deficient because he has not for raising the standard of living for an
established what he needs to establish indefinite number poor people, then
of
to make his argument sound. What he it would be morally acceptable to kill an

needs is a clear, convincing argument innocent person for money.

that raising the standard of living of an These reflections should not be taken
indefinite number of poor persons by the to imply, however, that no utilitarian
killing of an innocent person is a greater argument could justify the killing of an
good for all those affected by the act than innocent person for money. After all, if
if the standard of living were not raised the sum were large enough to save the
by the killing of an innocent person. This lives of a large number of people who
is needed because part of what we mean would surely die if the innocent baby
by having a basic right to life is that a were not killed, then one would as a
 NO Robert Almeder/ 15

rule be justified in killing the innocent to "destabilize" a foreign government,

baby for the sum in question. But this selling cigarette* while knowing that they
situation obviously quite different from
is are highly addictive killers of innocent
the situation in which one would attempt people, advertising cigarettes, knowingly
to justify the killing of an innocent person marketing children's clothing having a
in order to raise the standard of living for known cancer-causing agent, and refus-
an indefinite number of poor people. It ing to recall (for fear of financial loss)
makes sense one innocent person
to kill goods known to be sufficiently defective
in order to save, say twenty innocent to directly maim or kill a certain percent-
persons; but it makes no sense at all age of their unsuspecting users because
to kill one innocent person to raise the of the defect. On this latter item, we are
standard of living of an indefinite number all familiar, for example, with convinc-
of people. In the latter case, but not in the ingly documented charges that certain
former, a comparison is made between prominent automobile and tire manufac-
things that are incomparable. turers will knowingly market equipment
Given these considerations, it is re- sufficiently defective to increase the like-
markable and somewhat perplexing that lihood of death as a direct result of the
certain corporations should seek to de- defect, and yet refuse to recall the prod-
fend practices that are in fact instances of uct because the cost of recalling and re-
killing innocent persons for profit. Take, pairing would have a greater adverse im-
for example, the corporate practice of pact on profit than if the product were
dumping known carcinogens into rivers. not recalled and the company paid the
On Milton Friedman's view, we should projected number of predictably success-
not regulate or prevent such companies ful suits. Of course, if the projected cost

from dumping their effluents into the en- of the predictably successful suits were
vironment. Rather we should, if we like, to outweigh the cost of recall and repair,
tax thecompany after the effluents are in then the product would be recalled and
the water and then have the tax money repaired, but not otherwise.
used to clean up the environment. 5 For In cases of this sort, the companies
Friedman, and others, the fact that so involved may admit to having certain
many people will die as a result of this marketing problems or a design problem,
practice seems to be just part of the cost and they may even admit to having made
of doing business and making a profit. a mistake; but, interestingly enough, they
If there is any moral difference between do not view themselves as immoral or as
such corporate practices and murdering murderers for keeping their product in
innocent human beings for money, it is the market place when thev know people
hard to see what it is. It is even more ing from it, people who would not
difficult to see how anyone could justify die it thedefa erected.

the practice and see it as no more than The important point is not whether
a business practice not to be regulated m red these practices have occurred in
by moral concern. And there are a host oi now; then
the past, or occur even
other corporate activities that arc morally be no doubt that such have
|

equivalent to deliberate killing of inno- OCCUned and continue to occur. Rather

cent persons for money. Such practices the point is that when companies i

number among them contributing funda such w . must

16 / 1. ARE PROFITS THE ONLY BUSINESS OF BUSINESS?

either not know what they do is murder riously injure innocent persons affected
(i.e., an innocent
unjustifiable killing of by those policies. Moreover, we have said
person), or knowing that it is murder, nothing about wage discrimination, sex-
seek to justify it in terms of profit. And I ism, discrimination in hiring, price fix-
have been arguing that it is difficult to see ing, price gouging, questionable but not
how any corporate manager could fail to unlawful competition, or other similar
amount to murder
see that these policies practices that some will think businesses
for money, although there may be no civil should avoid by virtue of responsibility
statute against such corporate behavior. to society. My main concern has been to
then where such policies exist, we
If so, show that because we all agree that mur-
can only assume that they are designed der for money is generally wrong, and
and implemented by corporate managers since there no discernible difference be-
is

who either see nothing wrong with tween that and certain corporate policies
murder for money (which is implausible) that are not in fact illegal, then these cor-
or recognize that what they do is wrong porate practices are clearly immoral (that
but simply refuse to act morally because is, they ought not to be done) and inca-

it is more financially rewarding to act pable of being morally justified by appeal

immorally to the Friedman doctrine since that doc-
Of course, it is possible that corpo- trine does not admit of adequate eviden-
rate executives would not recognize such tial support. In itself, it seems sad that

acts as murder. They may, after all, view this argument needs to be made and, if it
murder as a legal concept involving one were not for what appears to be a fairly
non-corporate person or persons deliber- strongcommitment within the business
ately killing another non-corporate per- community to the Friedman doctrine in
son or persons and prosecutable only the name of the unquestionable success
under existing criminal statute. If so, it of the free enterprise system, the argu-
is somewhat understandable how corpo- ment would not need to be stated.
rate executives might fail, at least psycho- The fact that such practices do exist
logically, to see such corporate policies — designed and implemented by corpo-
as murder rather than as, say, calculated rate managers who, for all intents and
risks, tradeoffs, or design errors. Still, for purposes appear to be upright members
all that, the logic of the situation seems —
of the moral community only heightens
clear enough. the need for effective social prevention.
Presumably, of course, any company will-
ing to put human lives into the profit and
IV. CONCLUSION loss column is not likely to respond to
In addition to the fact that the only two moral censure. Accordingly, I submit that
plausible arguments favoring the Fried- perhaps the most effective way to deal
man doctrine are unsatisfactory, a strong with the problem of preventing such cor-
case can be made for the claim that cor- porate behavior would consist in struc-
porations do have a clear and noncontro- turing legislation such that senior corpo-
versial moral responsibility not to design rate managers who knowingly concur in
or implement, for reasons of profit, poli- practices of the sort listed above can ef-
cies that they know, or have good rea- fectively be tried, at their own expense,
son to believe, will kill or otherwise se- for murder, rather than censured and
 NO Robert Almeder/ 17

fined a sum to be paid out of corporate had permitted the car "to remain on In-
profits. This may seem a somewhat ex- diana highways knowing full well its de-
treme or unrealistic proposal. However, fects." The fact that the Ford Motor com-
it seems more unrealistic to think that ag- pany was ultimately found innocent of
gressively competitive corporations will the charges by the jury is incidental to the
respond towhat is morally necessary if point that the increasing number of states
failure to do so could be very or even min- that allow corporations to fall under the

imally profitable. In short, unless we take criminal code an example of social reg-
is

strong and appropriate steps to prevent ulation that could have been avoided had
such practices, society will be reinforc- corporations and corporate managers not
ing a destructive mode of behavior that followed so ardently the Friedman doc-
is maximally disrespectful of human life, trine.
just as society will be reinforcing a value In the long run, of course, corporate
system that so emphasizes monetary gain and individual willingness to do what
as a standard of human success that mur- is clearly immoral for the sake of
der for profit could be a corporate policy monetary gain is a patent commitment
if the penalty for being caught at it were of a certain view about the nature of
not too dear. human happiness and success, a view
Fortunately, a number of states in that needs to be placed in the balance
America have enacted legislation that with Aristotle's reasoned argument and
makes corporations subject to the crim- reflections to the effect that money and
inalcode of that state. This practice be- all that it brings is a means
to an end,
gan to emerge quite strongly after the and not the end in itself that
sort of
famous Pinto case in which an Indiana will justify acting immorally to attain
superior court judge refused to dismiss it. What that beautiful end is and why

a homicide indictment against the Ford being moral allows us to achieve it,
Motor Company. The company was in- may well be the most rewarding and
dicted on charges of reckless homicide profitable subject a human being can
stemming from a 1978 accident involv- think about. Properly understood and
ing a 1973 Pinto in which three girls died placed in perspective; Aristotle's view
when the car burst into flames after being on the nature and attainment of human
slammed in the rear. This was the first happiness could go a long way toward
case in which Ford, or any other auto- alleviating the temptation to kill for
mobile manufacturer, had been charged money.
with a criminal offense. The indictment In the meantime, any ardent supporter

went forward because the state of In- of the capital ten will want
diana adopted in 1977 a criminal code to see the system thrive and flourish;
provision permitting corporations to be ,md this it cannot do if it invites

charged with criminal acts. At the time, and denUU mment angulation
incidentally, twenty-two other states had in the name oi the public inten

similar codes. At any rate, the judge, in Re- logical commitment to what
fusing to set aside the indictment, agreed I ha\« i above .>.
Jman
with the prosecutor's argument that the counterproductive >\nd not in
charge was based not on the Pinto de- anyone's long-range interest because it is
sign fault, but rather on the tact thai most likely to beget an asing i
18 / 1. ARE PROFITS THE ONLY BUSINESS OF BUSINESS?

regulatory climate. The only way to good. Unfortunately, taking the long-
avoid such encroaching regulation is run view is difficult for everyone. After
to find ways to move the business all, for each of us, tomorrow may not

community into the long-term view of come. But living for today only does not
what is in its interest, and effect ways seem to make much sense either, if that
of both determining and responding to deprives us of any reasonable and happy
social needs before society moves to tomorrow. Living for the future may not
regulate business to that end. To so be the healthiest thing to do; but do it
move the business community is to ask we must, if we have good reason to think
business to regulate its own modes of that we will have a future. The trick is to
competition in ways that may seem very provide for the future without living in
difficult to achieve. Indeed, if what I it, and that just requires being moral. 6

have been suggesting is correct, the only

This paper is a revised and expanded version
kind of enduring capitalism is humane
of "Morality in the Marketplace," which
capitalism, one that is at least as socially
appears in Business Ethics (revised edition)
responsible as society needs. By the same
eds. Milton Snoeyenbos, Robert Almeder and
token, contrary to what
sometimesis
James Humber (Buffalo, NX: Prometheus
felt in the business community, the
Press, 1992.) 82-90, and, as such, it is a
Friedman doctrine, ardently adopted for
revised and expanded version of an earlier
the dubious reasons generally given,
piece "The Ethics of Profit: Reflections on
will most likely undermine capitalism
Corporate Responsibility," which originally
and motivate an economic socialism by
appeared in Business and Society (Winter
assuring an erosive regulatory climate
1980, 7-15).
in a society that expects the business
community to be socially responsible in
ways that go beyond just making legal NOTES
profits.
1. Adam Smith, The Wealth of Nations, ed. Edwin
In sum, being socially responsible Canaan (New York: Modern Library, 1937), p. 423.
in ways that go beyond legal profit 2. See Milton Friedman, "The Social Responsi-
making is by no means a dubious bility of Business Is to Increase Its Profits," in The
New York Times Magazine (September 13, 1970), pp.
luxury for the capitalist in today's world.
33, 122-126 and "Milton Friedman Responds," in
It is a necessity if capitalism is to Business and Society Review no. 1 (Spring 1972), p.
survive at all; and, presumably, we 5ff.

3. Albert Z. Carr, "Is Business Bluffing Ethical?"

shall all profit with the survival of a
Harvard Business Review (January-February 1968).
vibrant capitalism. If anything, then, 4. Milton Friedman in "Milton Friedman Re-
rigid adherence to the Friedman doctrine sponds," in Business and Society Review no. 1 (Spring
is not only philosophically unjustified, 1972), p. 10.
5. Ibid
and unjustifiable, it is also unprofitable
6. I would like to thank J. Humber and M.
in the long run, and therefore, downright Snoeyenbos for their comments and criticisms of
subversive of the long-term common an earlier draft.
POSTSCRIPT
Are Profits the Only Business
of Business?

Friedman dismisses the pleas of those who argue for socially responsible
business action on the grounds that these individuals do not understand the
role of the corporate executive in modem society. Friedman points out that
the executives are responsible to the corporate owners, and if the corporate
executives take a "socially responsible" action that reduces the return on
the owners' investment, they have spent the owners' money. This, Friedman
maintains, violates the very foundation of the American political-economic
system: individual freedom. If the corporate executives wish to take socially
responsible actions, they should use their own money; they should not pre-
vent the owners from spending their money on wha I al actions they
might wish to support.
Almeder argues that some corporate behavior is immoral and that defense
of this immoral behavior imposes great costs on society. He likens corpo-
rate acts such as advertising cigarettes, marketing automobiles that cannot
sustain moderate rear-end collisions, and contributing funds to destabilize
foreign governments to murdering innocent children tor profit. He argues
that society must not condone this behavior, but instead, through federal and
state legislation, it must continue to impose regulations upon businesses until

businesses begin to regulate themselves.

Perhaps no single topic is more fundamental to microeconomics than is
the issue of [Link] pages have been written in defense ot profits; see,
for example, Milton and Rose Friedman's Free to Choose: A Personal Statement
(Harcourt Brace Jovanovich, 1980). A classic n Frank H. Knight's
I

Risk, Uncertainty, and Profits (Kell) 21). Friedrkh A. Hayek, the author
I

of many journal articles and books, is a guru for many current tree markl
There are a number of other books and articles, however, that are hi
critical of the Friedman-Knight-Havek position, including Christopher D.
Stone's WJiere the Law Etuis: Social Control .rper and

Row, 1975). Others who challenge the legitimacy oi the notion that ma: I

are morally free zones include Thomas Mulligan,*' Critique oi A I

man's Essay 'The Social Responsibility ol Business b to Inc tease Its .

Journal of Business Ethics (1986); tenid i M

Hausmaiv Are Markets Morally
Free Zones?" Philosophy and PiMi d Andrew Henley,

"Economic Orthodoxy and the Free Market System A Christian C nth.

International Journal of Social \
(vol. 14, no. L<
ISSUE 2
Should We Encourage the Private
Ownership of Guns?
YES: Daniel D. Polsby, from "The False Promise of Gun Control/' Vie Atlantic
Monthly (March 1994)
NO: Arthur L. Kellermann et al., from "Gun Ownership as a Risk Factor
for Homicide in the Home/' Tlie New England journal of Medicine (October 7,

1993)

ISSUE SUMMARY
YES: Law professor Daniel D. Polsby alleges that guns do not increase crime
rates or violence in the streets but that the "proliferation of gun-control laws
almost certainly does."
NO: Trie research of emergency room physician Arthur L. Kellermann and
his colleagues suggests that gun ownership increases an individual's risk of
being murdered rather than providing that person with self-protection.

In 1992 crimes committed with handguns increased by almost 50 percent over

the previous five-year annual average. In that year, handguns were used in
931,000 violent crimes. It may be because of such as these that
statistics
—
the Brady Bill federal legislation requiring a five-day waiting period and
a background check for individuals wishing to purchase guns was passed —
by Congress in November 1993 after numerous attempts to pass gun-control
legislation were defeated by the powerful pro-gun lobby during the previous
seven years.
The pro-gun interests in the United States are well articulated by the Na-
tional Rifle Association (NRA) and its members. This organization boasts a
membership in excess of 3.3 million, and it claimed liquid assets of more
than $90 million in 1990. Throughout its existence, the NRA has effectively
blocked nearly every attempt at governmental control over private owner-
ship of guns. Traditionally, the NRA and others have defended their position
on the grounds that legislation in this area would violate the "right to bear
arms," which they allege is protected by the Second Amendment to the Con-
stitution.
However, in recent years public opinion has increasingly turned against
thegun lobby. Also, society has begun to question whether or not the Second
Amendment is applicable to private gun ownership. The amendment in full
states: "A well regulated Militia, being necessary to the security of a free

20
State, the right of people to keep and bear Arms, shall not be infringed."
Many argue that the NRA's constitutional argument is rendered invalid by
the reference to a "well regulated Militia." Most maintain that
legal scholars
the Supreme Court's 1939 decision in United States v. stands as the
Miller still

appropriate interpretation of the Second Amendment. Here the Court ruled

that the intent of the amendment was to ensure a collective right having "some
reasonable relationship to the preservation or efficiency of a well-regulated
militia/' The Court did not rule that individuals have a right to keep and bear
arms. Indeed, lower courts have turned to the Miller decision to uphold, not
down gun-control legislation.
strike
The most recent Supreme Court ruling in this area came in 1980, when the
Court reaffirmed that attempts to control the use of guns through legislative
action "do not trench upon any constitutionally protected liberties." It is
noteworthy that both Warren E. Burger, the chief justice at that time, and
the current chief justice William H. Rehnquist, both conservatives, joined the
majority of the Court in this interpretation.
If there is no constitutional prohibition against gun control, what are the
costs and ownership of handguns? The NRA has long
benefits of private
argued that handguns are necessary for self-protection. The NRA's new ad-
vertising slogan, "Refuse to Be a Victim," is directed toward getting that
message across to women, who as a group have traditionally been more
opposed to gun ownership than men. The arguments of those opposed to
gun control go far beyond this, however. This becomes clear in the essay by
Daniel D. Polsby, which follows. Polsby raises fundamental economic ques-
tions about the demand for guns, the sources of the supply of guns, and the
elastic characteristics of both supply and demand.
In large measure, the purpose of Polsby's selection is to respond to the
medical community, which has challenged the NRA's contention that guns are
an important means of self-protection. In this regard, Arthur L Kellermann
and his associates argue that guns are more likely to result in injury to a
member of a gun-owning household than they are to protect the household
from intruders.

:i
 Daniel D. Polsby
YES

THE FALSE PROMISE OF GUN CONTROL

During the 1960s and 1970s the robbery rate in the United States increased
sixfold, and the murder rate doubled; the rate of handgun ownership nearly
doubled in that period as well. Handguns and criminal violence grew to-
gether apace, and national opinion leaders did not fall to remark on the
coincidence.
Ithas become a bipartisan article of faith that more handguns cause more
violence. Such was the unequivocal conclusion of the National Commission
on the Causes and Prevention of Violence in 1969, and such is now the
editorial opinion of virtually every influential newspaper and magazine,
from The Washington Post to The Economist to the Chicago Tribune. Members of
the House and Senate who have not dared to confront the gun lobby concede
the connection privately. Even if the National Rifle Association [NRA] can
produce blizzards of angry calls and letters to the Capitol virtually overnight,
House members one by one have been going public, often after some new
firearms atrocity at a fast-food restaurant or the like. And last November they
passed the Brady bill.
Alas, however well accepted, the conventional wisdom about guns and
violence is mistaken. Guns don't increase national rates of crime and violence
— but the continued proliferation of gun-control laws almost certainly does.
Current rates of crime and violence are a bit below the peaks of the late
1970s, but because of a slight oncoming bulge in the at-risk population of
males aged fifteen to thirty-four, the crime rate will soon worsen. The rising
generation of criminals will have no more difficulty than their elders did in
obtaining the tools of their trade. Growing violence will lead to calls for laws
still more severe. Each fresh round of legislation will be followed by renewed

frustration.
Gun-control laws don't work. What is worse, they act perversely. While
legitimate users of firearms encounter intense regulation, scrutiny, and bu-
reaucratic control, illicit markets easily adapt to whatever difficulties a free
society throws in their way. Also, efforts to curtail the supply of firearms in-
flict collateral damage on freedom and privacy interests that have long been
considered central to American public life. Thanks to the seemingly never-

From Daniel D. Polsby, "The False Promise of Gun Control," The Atlantic Monthly (March 1994).
Copyright © 1994 by Daniel D. Polsby. Reprinted by permission.

22
 YES Daniel [Link]/ 23

ending war on drugs and long experience to secure the tranquillity and good order
attempting to suppress prostitution and of the community. But most people are
pornography, we know a great deal about not dedicated antiquitarians, and would
how illicit markets function and how not be impressed by the argument "I ad-
costly to the public attempts to control mit that my behavior is very dangerous
them can be. It is essential that we make to public safety, but the Second Amend-
use of this experience in coming to grips ment says I have a right to do it anyway."
with gun control. That would be a case for repealing the
The thousands of gun-control laws in Second Amendment, not respecting it.
the United States are of two general types.
The older kind sought to regulate how,
where, and by whom firearms could be
FIGHTING THE DEMAND CURVE
carried. More recent laws have sought Everyone knows that possessing a hand-
to make it more costly to buy, sell, gun makes it easier to intimidate, wound,
or use firearms (or certain classes of or someone. But the implication of
kill

firearms, such as assault rifles, Saturday- this point for social policyhas not been
night specials, and so on) by imposing so well understood. It is easy to count
fees, special taxes, or surtaxes on them. the bodies of those who have been killed
The Brady bill is of both types: it has or wounded with guns, but not easy to
a background-check provision, and its count the people who have avoided harm
five-day waiting period amounts to a because they had access to weapons.
"time tax" on acquiring handguns. All Think about uniformed police officers,
such laws can be called scarcity-inducing, who cam handguns in plain view not in
r

because they seek to raise the cost of order to kill people but simply to daunt
buying firearms, as figured in terms of potential attackers. And it works. Crimi-
money, time, nuisance, or stigmatization. nals generally do not single out police of-
Despite the mounting number of ficers for opportunistic attack. Though of-
scarcity-inducing laws, no one is very ficerscan expect to draw their guns from
satisfied with them. Hobbyists want time to time, few even in big-city depart-
to get rid of them, and gun-control ments will actually tire I shot (except in
proponents don't think they go nearly target practice) in the course of a year.
far enough. Everyone seems to agree that This observation points to an important
gun-control laws have some effect on the truth: people who are armed make com-
distribution of firearms. But it has not paratively unattractive victims. A crim-
been the dramatic and measurable effect inal might not know it any one civil-
their proponents desired. ian is armed, but it it b Miown
Opponents of gun control have tradi- that | large nun dians do carry I

tionally wrapped their arguments in the : iminal.s will become warier.

Second Amendment to the Constitution. Winch wt'ap | IR the right

Indeed, most modem scholarship affirms kinds can I
.1 onlv after consid-
that so far as the drafters o( the Bill of ering two related qu what
Rights were concerned the right to bear i> the n civilian pos-
arms was to be enjoyed by everyone not
just a militia, and that one of the principal uiol
justifications for an armed populace u M laws |
24 / 2. SHOULD WE ENCOURAGE THE PRIVATE OWNERSHIP OF GUNS?

recent scholarship raises serious ques- ing to pay more for a weapon than most
tions about the "weapons increase vio- other people would. Professors, politi-
lence" hypothesis. The second question is cians,and newspaper editors are, as a
emphasized here, because it is routinely group, at very low risk of being involved
overlooked and often mocked when no- in such transactions, and they thus sys-
ticed; yet it is crucial. Rational gun control tematically underrate the value of defen-
requires understanding not only the rela- sive handguns. (Correlative, perhaps, is

tionship between weapons and violence their uncritical readiness to accept stud-
but also the relationship between laws ies that debunk the utility of firearms for
and people's behavior. Some things are self-defense.) The class of people we wish
very hard to accomplish with laws. The to deprive of guns, then, is the very class
purpose of a law and its likely effects are with the most inelastic demand for them
not always the same thing. Many statutes — —
criminals whereas the people most
are notorious for the way in which their likely to comply with gun-control laws
unintended effects have swamped their don't value guns in the first place.
intended ones.
In order to predict who will comply
with gun-control laws, we should re-
DO GUNS DRIVE UP CRIME RATES?
member thatguns are economic goods Which premise is true —that guns in-
that are traded in markets. Consumers' crease crime or that the fear of crime
interest in them varies. For religious, causes people to obtain guns? Most of
moral, aesthetic, or practical reasons, the country's major newspapers appar-
some people would refuse to buy fire- ently take this problem to have been
arms at any price. Other people willingly solved by an article published by Arthur
pay very high prices for them. Kellermann and several associates in the
Handguns, so often the subject of October 7, 1993, New England Journal of
gun-control laws, are desirable for one Medicine. Kellermann is an emergency-
—
purpose to allow a person tactically room physician who has published a
to dominate a hostile transaction with number of influential papers that he be-
another person. The value of a weapon to lieves discredit the thesis that private
a given person is a function of two factors: ownership of firearms is a useful means

how much he or she wants to dominate of self-protection. (An indication of his

a confrontation if one occurs, and how wide influence is that within two months
likely it is that he or she will actually be the study received almost 100 mentions
in a situation calling for a gun. in publications and broadcast transcripts
Dominating a transaction simply indexed in the Nexis data base.) For
means getting what one wants without this study Kellermann and his associates
being hurt. Where people differ is in how identified fifteen behavioral and fifteen
likely it is that they will be involved in environmental variables that applied to
a situation in which a gun will be valu- a 388-member set of homicide victims,
able. Someone who intends to engage in found a "matching" control group of
—
a transaction involving a gun a crimi- 388 nonhomicide victims, and then as-
nal, for example —
is obviously in the best certained how the two groups differed
possible position to predict that likeli- in gun ownership. In interviews Keller-
hood. Criminals should therefore be will- mann made clear his belief that owning
 :

YES Daniel [Link]/ 25

a handgun markedly increases a person's study as soon as it appeared, but none

risk of being murdered. saw fit to discuss the study's limitations.
But the study does not prove that point A few, in order to introduce a hint of
at all. Indeed, as Kellermann explicitly balance, mentioned that the NRA, or
conceded in the text of the article, the some member of its staff, disagreed with
causal arrow may very well point in the study. But readers had no way of
the other direction: the threat of being knowing that Kellermann himself had
killed may make people more likely to registered a disclaimer in his text. "It
arm [Link] people at risk of is possible," he conceded, "that reverse
being killed, especially people involved causation accounted for some of the
in the drug trade or other illegal ventures, association we
observed between gun
might well rationally buy a gun as a ownership and homicide." Indeed, the
precaution, and be willing to pay a price point is stronger than that: "reverse
driven up by gun-control laws. Crime, causation" may account for most of the
after all, is a dangerous business. Peter association between gun ownership and
Reuter and Mark Kleiman, drug-policy homicide. Kellermann's data simply do
researchers, calculated in 1987 that the not allow one to draw any conclusion.
average crack dealer's risk of being killed If firearms increased violence and
was far greater than his risk of being sent crime, then rates of spousal homicide
to prison. (Their data cannot, however, would have skyrocketed, because the
support the implication that ownership stock of privately owned handguns has
of a firearm causes or exacerbates the risk increased rapidly since the mid-1960s.
of being killed.) But according to an authoritative study
Defending the validity of his work, of spousal homicide in the American
Kellermann has emphasized that the link Journal of Public Health, by James Mercy
between lung cancer and smoking was and Linda Saltzman, rates of spousal
initially established by studies method- homicide in the years 1976 to 19,^

ologically no different from his. Gary If firearms increased violence and crime,
Kleck, a criminology professor at Florida the crime rate should have increased
State University, has pointed out the flaw throughout the 19S0s, while the national
in thiscomparison. No one ever thought stock of privately handguns
that lung cancer causes smoking, so when increased by moa
than a million units in
1

the association between the two was es- every year of the decade. It did not. Nor
tablished the direction of the causal arrow- should the rate and crime
was not in doubt. Kleck wrote that it is m Sw lt/erland. New Zealand, and
asthough Kellermann, trying to di» be as low as they are. thm the number
how diabetics differ from other people, of firearm- iUan household is

found that they are much more likely comparable to that in thi

to possess insulin than nondiabetks Conversely, gun-control .md i

concluded that insulin is a risk factor tor South AfriCI should be jflflfYfh of i

diabetes. instead ot having murder rates more than

The New York Times, the / twice tl high ifl those [in the I

Times, Vie Washington Post, The I 1 The determinants ot crime and

Globe,and the Chicago Tribune all law-ahidm Dtiptax

prominent coverage to Ke Hermann's matters, uhkh arc not fully understood

26 / 2. SHOULD WE ENCOURAGE THE PRIVATE OWNERSHIP OF GUNS?

and certainly not explicable in terms demand among various types of con-
of a country's laws. But gun-control sumers, after the laws are enacted crim-
enthusiasts, who have made capital out inals should be better armed, compared
of the low murder rate in England, with noncriminals, than they were before.
which is largely disarmed, simply ignore Of course, plenty of noncriminals will re-
the counterexamples that don't fit their main armed. But even if many noncrimi-
theory. nals will pay as high a price as criminals
If firearms increased violence and will to obtain firearms, a larger number
crime, Florida's murder rate should not will not.
have been falling since the introduction, Criminals will thus still take the same
seven years ago, of a law that makes gamble they already take in assaulting
it easier for ordinary citizens to get a victim who might or might not be
permits to carry concealed handguns. armed. But they may appreciate that
Yet the murder rate has remained the the laws have given them a freer field,
same or fallen every year since the —
and that crime still pays pays even bet-
law was enacted, and it is now lower ter, in fact, than before. What will hap-

than the national murder rate (which pen to the rate of violence?Only a rel-
has been rising). As of last November atively few gun-mediated transactions
183,561 permits had been issued, and — currently, five percent of armed rob-
only seventeen of the permits had been beries committed with firearms result —
revoked because the holder was involved in someone's actually being shot (the
in a firearms offense. It would be statistics are not broken down into en-
precipitate to claim that the new law counters between armed assailants and
has "caused" the murder rate to subside. unarmed victims, and encounters in
Yet here is a situation that doesn't fit which both parties are armed). It seems
the hypothesis that weapons increase reasonable to fear that if the number of
violence. such transactions were to increase be-
If increased violence and
firearms cause criminals thought they faced fewer
crime, programs of induced scarcity deterrents, there would be a correspond-
would suppress violence and crime. But ing increase in shootings. Conversely, if

— —
another anomaly they don't. Why gun-mediated transactions declined — if

not? A theorem, which we could call criminals initiated fewer of them because
the futility theorem, explains why gun- they feared encountering an armed vic-
control laws must either be ineffectual or tim or an armed good Samaritan the —
in the long term actually provoke more number of shootings would go down.
violence and crime. Any theorem de- The magnitude of these effects is, admit-
pends on both observable fact and as- tedly, uncertain. Yet hard to doubt
it is

sumption. An assumption that can be the general tendency of a change in the

made with confidence is that the higher law that imposes legal burdens on buy-
the number of victims a criminal as- ing guns. The futility theorem suggests
sumes to be armed, the higher will be that gun-control laws, if effective at all,

the risk — the price—of assaulting them. would unfavorably affect the rate of vio-
By definition, gun-control laws should lent crime.
make weapons scarcer and thus more ex- The futility theorem provides a lens
pensive. By our prior reasoning about through which to see much of the
 ——
YES Daniel [Link]/ 27

[Link] is undeniable that gun-control Are there empirical studies that can
—
laws work to an extent. Consider, for serve to help us choose between the
example, California's background-check futility theorem and the hypothesis that
law, which in the past two years has guns increase violence? Unfortunately,
prevented about 12,000 people with a no: the best studies of the effects of gun-
criminal record or a history of mental control laws are quite inconclusive. Our
illness or drug abuse from buying statistical tools are too weak to allow us
handguns. In the same period Illinois's to identify an effect clearly enough to
background-check law prevented the persuade an open-minded skeptic. But it
delivery of firearms to more than 2,000 is precisely when we are dealing with

people. Surely some of these people undetectable statistical effects that we

simply turned to an illegal market, but have to be certain we are using the best
just as surely not all of them did. The models available of human behavior
laws of large numbers allow us to say
that among the foiled thousands, some
ADMINISTERING PROHIBITION
potential killers were prevented from
getting a gun. We do not know whether Assume for the sake of argument that
the number is large or small, but it is to a reasonable degree of criminological
implausible to think it is zero. And, as certainty, guns are every bit the public-
gun-control proponents are inclined to health hazard they are said to be. It
."
say, "If only one life is saved . . follows, and many journalists and a few
public officials have already said, that
The hypothesis that firearms increase we ought to treat guns the same way
violence does predict that if we can
slow we do smallpox viruses or other critical
down the diffusion of guns, there will be vectors of morbidity and mortality
less violence; one life, or more, will be namely, them from potential
isolate

saved. But the futility theorem asks that hosts and destroy them as speedily as
we look not simply at the gross number of possible. Clearly, firearms have at least
bad actors prevented from getting guns one characteristic that distinguishes them
but at the effect the law has on all the from smallpox vinw v wants to

people who want to buy a gun. Suppose keep smallpox viruses m the nightStand
we succeed in piling tax burdens on the drawer. Amazingly enough, gun-control
acquisition of firearms. We can safely literature seems never to have explored

assume that a number of people who the problem of getting weapons away
might use guns to kill will be sufficiently from people who very much w ant to keep
discouraged not to buy them. But we them in the nightStand draw
cannot assume this about people who Our existing gun-control lav
feel that they must have guns in order uniformly permissive, and. Indeed, m
to survive financially and physically A certain places are tOUgh even bv interna-

few lives might indeed be saved. But the tional gtandwrdff Advocacy groups sel-

overall rate of violent crime might not dom stress the considerable differ*
go down at all. And if guns are owned anion. in jurisd* id me-
predominantly by people who have good dia reports regularly assert that tin

reason to think they will use them, the .

any-
rate might even go up. in the country. Ihil il not the
 —
28 / 2. SHOULD WE ENCOURAGE THE PRIVATE OWNERSHIP OF GUNS?

case. For example, handgun restrictions sacrifices of privacy and convenience,

in Chicago and the District of Columbia and the costs of paying guards, have been
are much less flexible than the ones in thought worth the (perceived) gain in se-
the United Kingdom. Several hundred curity. No doubt it would be possible,
thousand British subjects may legally buy though it would probably not be easy,
and possess sidearms, and anyone who to make weapons-free zones of shopping
joins a target-shooting club is eligible to centers, department stores, movie the-
do But in Chicago and the District of
so. aters, ball parks. But it is not obvious how
Columbia, excepting peace officers and one would cordon off the whole of an
the like, only grandfathered registrants open society.
may legally possess handguns. Of course, Voluntary programs have been inef-
tens or hundreds of thousands of peo- fectual. From time to time community-
—
ple in both those cities nobody can be action groups or police departments have
—
sure how many do in fact possess them sponsored "turn in your gun" days,
illegally. which are nearly always disappointing.
Although there is, undoubtedly, ille- Sometimes the government offers to buy
gal handgun ownership in the United guns at some price. This approach has
Kingdom, especially in Northern Ireland been endorsed by Senator Chafee and
(where considerations of personal secu- the Los Angeles Times. Jonathan Alter, of
rity and public safety are decidedly un- Neiusiveek, has suggested a variation on
like those elsewhere in the British Isles), this theme: youngsters could exchange
it is probable that Americans and Britons their guns for a handshake with Michael
differ in their disposition to obey gun- Jordan or some other sports hero. If the
control laws: there is reputed to be a price offered exceeds that at which a gun
marked national disparity in compliance can be bought on the street, one can ex-
behavior. This difference, if it exists, may pect to see plans of this kind yield some
have something to do with the com- sort of harvest —
as indeed they have. But
paratively marginal value of firearms to it is implausible that these schemes will

British consumers. Even before it had actually result in a less-dangerous popu-

strict firearms regulation, Britain had lation. Government programs to buy up
very low rates of crimes involving guns; surplus cheese cause more cheese to be
British criminals, unlike their American produced without affecting the availabil-
counterparts, prefer burglary (a crime of ity of cheese to people who want to buy
stealth) to robbery (a crime of intimida- it. So it is with guns
tion). to the problem of crime
The solution
Unless people are prepared to sur- improving the chances of young
lies in
render their guns voluntarily, how can men. Easier said than done, to be sure.
the U.S. government confiscate an ap- No one has yet proposed a convincing
preciable fraction of our country's nearly program for checking all the dislocating
200 million privately owned firearms? forces that government assistance can set
We know that it is possible to set up in motion. One relatively straightforward
weapons-free zones in certain locations change would be reform of the educa-
—commercial and many court-
airports tional system. Nothing guarantees pru-
houses and, lately, some troubled big-city dent behavior like a sense of the future,
high schools and housing projects. The and with average skills in reading, writ-
 YES Daniel [Link]/ 29

ing, and math, young people can realis- people have little or nothing to lose by
tically look forward to constructive em- spending their li vt-s in crime, dispositions
ployment and the straight life that steady to violence will perbi>t.
work makes possible.
But firearms are nowhere near the This is what makes the case for the
root of the problem of violence. As long right to bear arms, not the Second
as people come in unlike sizes, shapes, Amendment. It is foolish to let anything
ages,and temperaments, as long as they ride on hopes for effective gun control.
diverge in their taste for risk and their As long as crime pays as well as it does,
willingness and capacity to prey on other we will have plenty of it, and honest folk
people or to defend themselves from must choose between being victims and
predation, and above all as long as some defending themselves.
 —

NO Arthur L. Kellermann et al.

GUN OWNERSHIP AS A RISK FACTOR

FOR HOMICIDE IN THE HOME
Homicide claims the lives of approximately 24,000 Americans each year,
making it the 11th leading cause of death among all age groups, the 2nd
leading cause of death among all people 15 to 24 years old, and the leading
cause of death among male African Americans 15 to 34 years old. Homicide
rates declined in the United States during the early 1980s but rebounded
thereafter. One category of homicide that is particularly threatening to our
sense of safety is homicide in the home.
Unfortunately, the influence of individual and household characteristics
on the risk of homicide in the home is poorly understood. Illicit-drug use,
alcoholism, and domestic violence are widely believed to increase the risk
of homicide, but the relative importance of these factors is unknown. Fre-
quently cited options to improve home security include the installation of
electronic security systems, burglar bars, and reinforced security doors. The
effectiveness of these protectivemeasures is unclear, however.
Many people also keep firearms (particularly handguns) in the home for
personal protection. One recent survey determined that handgun owners are
twice as likely as owners of long guns to report "protection from crime"
as their single most important reason for keeping a gun in the home. It
is possible, however, that the risks of keeping a firearm in the home may

outweigh the potential benefits.

To clarify these issues, we conducted a population-based case-control
study to determine the strength of the association between a variety of po-
tential risk factors and the incidence of homicide in the home

RESULTS

Study Population
There were 1860 homicides in the three counties [from which samples were
taken] during the study period. Four hundred forty-four (23.9 percent) took
place in the home of the victim. After we excluded the younger victim in

From Arthur L. Kellermann et al., "Gun Ownership as a Risk Factor for Homicide in the Home,"
The New England Journal of Medicine, vol. 329, no. 15 (October 7, 1993), pp. 1084-1091. Copyright
© 1993 by The Massachusetts Medical Society. All rights reserved. References omitted.

30
 —
NO Arthur L. Kellermann et iL / 31

19 double deaths, 2 homicides that were member, or some other person known to
not reported to project staff, and 3 late the victim.
changes to a death certificate, 420 cases Attempted resistance was reported in
(94.6 percent) were available for study. 184 cases (43.8 percent). In 21 of these
(5.0 percent) the victim unsuccessfully
Reports on the Scene attempted to use a gun in self-defense. In
Most of the homicides occurred inside the 56.2 percent of the casesno specific signs
victim's home. Eleven percent occurred of resistancewere noted. Fifteen victims
outside the home but within the imme- (3.6 percent) were killed under legally
diate property lines. Two hundred sixty- excusable circumstances. Four were shot
five victims (63.1 percent) were men; 36.9 by police acting in the line of duty. The
percent were women. A majority of the rest were killed by another member of
homicides (50.9 percent) occurred in the the household or a private citizen acting
context of a quarrel or a romantic triangle. in self-defense.
An additional 4.5 percent of the victims
were killed by a family member or an in-
Comparability of Case Subjects
timate acquaintance as part of a murder-
and Controls
suicide. Thirty-two homicides (7.6 per- ... Interviews with a matching control*
cent) were related to drug dealing, and 92 were obtained for 99.7 percent of the case
homicides (21.9 percent) occurred during interviews, yielding 388 matched pairs.
the commission of another felony, such as
Three hundred fifty-seven pairs were
a robbery, rape, or burglary. No motive matched for all three variables, 27 for two
other than homicide could be established variables, and 4 for a single variable (sex).
in 56 cases (13.3 percent). The demographic characteristics of the
The great majority of the victims (76.7 victims and controls were similar, except
percent) were killed by a relative or that the case subjects were more likely to
someone known to them. Homicides by have rented their homes (70.4 percent vs.
a stranger accounted for only 15 cases 47.3 percent) and to have lived alone (26.8
(3.6 percent). The identity of the offender percent vs. 11.9 percent)
could not be established in 73 cases (17.4
percent). The remaining cases involved
Univariate Analysis
other offenders or police acting in the line
Alcohol was moa comnu 1
imed
of duty.
by one or more members of the house-
Two hundred nine victims (49.8 per-
hold hi by me::
oi
cent) died from gunshot wounds. A knife
oi the hous .'.cohol
or some other sharp instrument was used
was also more commonly consumed by
to kill 111 victims (26.4 percent). The re-
the case subjects themselves than by their
maining victims were either bludgeoned
matched control i re re-
(11.7 percent), strangled (6.4 percent), or
ported to have mai
killed by other means (5.7 percent).
lism (such as
conelal
Evidence of forced entry was noted much more
ble at work due to drinking)
in 59 cases (14.0 percent). Eighteen oJ
these involved an unidentified intruder;
IGonbota win matched with tht cm -

six involved strangers. Two involved the

police. The rest involved a spouse* family
32 / 2. SHOULD WE ENCOURAGE THE PRIVATE OWNERSHIP OF GUNS?

often than matched controls. Illicit-drug Multivariate Analysis

use (by the case subject or another house- Six variables were retained in our fi-

hold member) was also reported more nal conditional logistic-regression model:
commonly by case households than con- home rented, case subject or control lived
trol households. alone, any household member ever hit or
Previous episodes of violence were hurt in a fight in the home, any house-
reported more frequently by members of hold member ever arrested, any house-
case households. When asked if anyone hold member used illicit drugs, and one
in the household had ever been hit or or more guns kept in the home. Each of
hurt in a fight in the home, 31.8 percent these variables was strongly and inde-
of the proxies [who were interviewed pendently associated with an increased
as representatives of] the case subjects risk of homicide in the home. No home-
answered affirmatively, as compared security measures retained significance
with only 5.7 percent of controls. Physical in the final model. After matching for
fights in the home while household four characteristics and controlling for
members were drinking and fighting the effects of five more, we found that the
severe enough to cause injuries were presence of one or more firearms in the
reported much more commonly by case home was strongly associated with an in-
proxiesthan controls. One or more creased risk of homicide in the home
members of the case households were Stratified analyses with our final re-
also more likely to have been arrested gression model revealed that the link be-
or to have been involved in a physical tween guns and homicide in the home
fight outside the home than members of was present among women as well as
control households. men, blacks as well as whites, and
Similar percentages of case and con- younger as well as older people. Re-
trol households reported using deadbolt stricting the analysis to pairs with data
locks, window bars, or metal security from case proxies who lived in the home
doors. The case subjects were slightly less of the victim demonstrated an even
likely than the controls to have lived in a stronger association than that noted for
home with a burglar alarm, but they were the group overall. Gun ownership was
slightly more have controlled se-
likely to most strongly associated with homicide
curity [Link] identical percent- at the hands of a family member or in-
ages of case and control households re- timate acquaintance Guns were not
ported owning a dog. significantly linked to an increased risk
One or more guns were reportedly of homicide by acquaintances, uniden-
kept in 45.4 percent of the homes of tified intruders, or strangers. We found
the case subjects, as compared with 35.8 no evidence of a protective benefit from
percent of the homes of the control gun ownership in any subgroup, includ-
subjects —Shotguns and rifles were kept ing one restricted to cases of homicide
by similar percentages of households, but that followed forced entry into the home
the case households were significantly and another restricted to cases in which
more likely to have a handgun Case resistance was attempted. Not surpris-
households were also more likely than ingly, the linkbetween gun ownership
control households to contain a gun that and homicide was due entirely to a strong
was kept loaded or unlocked. association between gun ownership and
 — — —
NO Arthur L. Kellennann et aL / 33

homicide by firearms. Homicide by other Although our case definition excluded

means was not significantly linked to the the rare instances in which a nonresident
presence or absence of a gun in the home. intruder was killed by a homeowner, our
Living in a household where someone methodology was capable of demonstrat-
had previously been hit or hurt in a fight ing significant protective effects of gun
in the home was also strongly and in- ownership as readily as any evidence of
dependently associated with homicide, increased risk
even after we controlled for the effects Four limitations warrant comment.
of gun ownership and the other four vari- our study was restricted to homi-
First,
ables in our final model— Previous fam- cides occurring in the home of the victim.
ily violence was linked to an increased The dynamics of homicides occurring in
risk of homicide among men as well as other locations (such as bars, retail es-
women, blacks as well as whites, and tablishments, or the street) may be quite
younger as well as older people. Virtu- different. Second, our research was con-
ally all of this increased risk was due ducted in three urban counties that lack
to a marked association between prior a substantial percentage of Hispanic cit-
domestic violence and homicide at the izens. Our results may therefore not be
hands of a family member or intimate ac- generalizable to more rural communities
quaintance or to Hispanic households. Third, it is

possible that reverse causation accounted

for some of the association we observed
DISCUSSION between gun ownership and homicide
Although firearms are often kept in i.e., in a limited numbers of cases, peo-

homes for personal protection, this study ple may have acquired a gun in response
shows that the practice is counterpro- to a specific threat. If the source of that
ductive. Our data indicate that keeping threat subsequently caused the homicide,
a gun in the home is independently as- the link between guns in the home and
sociated with an increase in the risk of homicide may be due at least in part to
homicide in the home. The use of illicit the failure of these weapons to provide
drugs and a history of physical fights in adequate protection from the assailants.
the home are also important risk factors. Finally, we cannot exclude the possibility

Efforts to increase home security have that the association we observed is due to

largely focused on preventing unwanted a third, unidentified factor. I:

entry, but the greatest threat to the lives pie, people who keep guns in
their homes

of household members appears to come are more psychologically prone to vio-

from within. lence than people who do not, this could
We restricted our study to homicides explain the link between gun ownership
that occurred in the home of the victim, and homicide in the home. Alt:
because these events can be most plau- camined several behavioral mark-
sibly linked to specific individual and .\nd aggression and in-

household characteristics. If, tor exam- cluded two in our final log ossion
ple, the ready availability of a gun in- model aiding" of
creases the risk of homicide, this ettect rtfa difficult to control tor "Psy-

should be most noticeable in the immedi- chological autopsies" have been u

ate environment where the gun i> kept. control tor |

es be-
34 / 2. SHOULD WE ENCOURAGE THE PRIVATE OWNERSHIP OF GUNS?

tween adolescent victims of suicide and gone" most and "having someone break
inpatient controls with psychiatric disor- intoyour home while you are at home"
ders, but we did not believe this approach 4th on a list of 16 crimes. Although
was practical for a study of homicide vic- homicide is the most serious of crimes,
tims and neighborhood controls. At any it occurs far less frequently than other
rate, a link between gun ownership and types of household crime. Measures that
any psychological tendency toward vio- make a home more difficult to enter
lence or victimization would have to' be are probably more effective against these
extremely strong to account for an ad- crimes.
justed odds ratio of 2.7. Despite the widely held belief that
Given the univariate association we ob- guns are effective for protection, our
served between alcohol and violence, it results suggest that they actually pose
may seem odd that no alcohol-related a substantial threat to members of the
variables were included in our final mul- household. People who keep guns in
tivariate model. Although consumption their homes appear to be at greater risk
of alcoholic beverages and the behavioral of homicide in the home than people
correlates of alcoholism were strongly as- who do not. Most of this risk is due to
sociated with homicide, they were also a substantially greater risk of homicide at
related to other variables included in our the hands of a family member or intimate
final model. Forcing the variable "case acquaintance. We did not find evidence
subject or control drinks" into our model of a protective effect of keeping a gun in
did not substantially alter the adjusted the home, even in the small subgroup of
odds ratios for the other variables. Fur- cases that involved forced entry.
thermore, the adjusted odds ratio for Saltzman and colleagues recently
this variable was not significantly greater found that assaults by family members
thanl. or other intimate acquaintances with a
Large amounts of money are spent gun are far more likely to end in death
each year on home-security systems, than those that involve knives or other
locks, and other measures intended to weapons. A gun kept in the home is far
improve home security. Unfortunately, more likely to be involved in the death
our results suggest that these efforts of a member of the household than it
have little effect on the risk of homicide is to be used to kill in self-defense. Co-
in the home. This finding should come hort and interrupted time-series studies
as no surprise, since most homicides have demonstrated a strong link between
in the home involve disputes between availability of guns and community rates
family members, intimate acquaintances, of homicide. Our study confirms this
friends, or others who have ready association at the level of individual
access to the home. It is important to households.
realize, however, that these data offer no Previous case-control research has
insight into the effectiveness of home- demonstrated a strong association be-
security measures against other house- tween the ownership of firearms and
hold crimes such as burglarv robbery, suicide in the home. Also, unintentional
or sexual assault. In a 1983 poll, Seattle shooting deaths can occur when children
homeowners feared "having someone play with loaded guns they have found
break into your home while you are at home. In the light of these observations
 NO Arthur I.. Kellermann et al. / 35

and our present findings, people should gest that the risk of homicide is markedly
be strongly discouraged from keeping increased in h< n re a person has
guns in their homes. previously been hit or hurt in a fam-
The observed association between bat- ily fight. At the very least, this obser-
tering and homicide is also important. In vation should prompt physicians, social
contrast to the money spent on firearms workers, law-enforcement officers, and
and home security, little has been done the courts to work harder to identify and
to improve society's capacity to respond protect victims of battering and other
to the problem of domestic violence. In forms of family violence. Early identifica-
the absence of effective intervention, bat- tion and effective intervention may pre-
tering tends to increase in frequency and vent a later homicide.
severity over time. Our data strongly sug-
POSTSCRIPT
Should We Encourage the Private
Ownership of Guns?
The whether or not the firearms industry should go unreg-
real issue here is
ulated. Advocates of regulation note that many consumer goods that appear
to be far less dangerous than handguns are regulated. If everyday items such
as children's toys, over-the-counter drugs, and small kitchen appliances are
regulated, why are handguns left unregulated? Surely, more individuals are
maimed and killed each year by handguns than by many of the goods that
society now regulates.
The NRA would be quick to point out that regulation of the gun industry is
not the answer. Indeed, they might argue that the answer is to deregulate all
consumer goods. This is the position taken by Jacob Sullivan, the managing
editor of Reason. In a recent article in National Review (February 7, 1994), Sulli-
van takes great care to show how such as the Brady Bill
ineffective regulation
will be. Waiting periods and background checks, he argues,
will not stop the
Colin Fergusons of the world. (Ferguson shot 23 people, fatally wounding 6
of them, on a New York train running from Manhattan to Hicksville on the
Long Island Railroad.) Ironically, according to Sullivan, these gun regulations
would not have even stopped John Hinckley, who attempted to assassinate
President Ronald Reagan and seriously wounded and permanently hand-
icapped Reagan's press secretary James Brady, for whom the Brady Bill is
named.
Polsby and other spokespersons for the NRA's position assert that gun
control would disarm the law-abiding citizenry and leave the "bad guys"
with a monopoly on guns. Kellermann and others within and outside of the
medical field, however, find that the cost paid for gun ownership is too high:
There are too many accidental shootings; there are too many successful gun-
related suicides; and there are too many friends and family members shot in
the heat of passion. For Kellermann, guns are too efficient in killing people.
There has been much written about the firearms industry and gun con-
trol, particularly after Congress passed the Brady 1993. For
Bill in November
background, see Jonathan Alter, "How
America's Meanest Lobby Ran Out
of Ammo," Newsweek (May 16, 1994); Frank Lalli, "The Cost of One Bullet:
$2 Million," Money (February 1994); and Owen Ullmann and Douglas Har-
brecht, "Talk About a Loaded Issue," Business Week (March 14, 1994). For a
good discussion on the limitations of gun control, see David B. Kopel, "Hold
Your Fire: Gun Control Won't Stop Rising Violence," Policy Review (Winter
1993). And to hear from another member of the medical community, read
the editorial by Jerome P. Kassirer entitled "Guns in the Household," which

36
appeared in the October 7, 1993, issue of Tlie New England journal of Medicine
along with the Kellermann article.
Finally, we should call your attention to the latest struggle by tru
to gain the support of women. In magazines such as Women and Guns (pub-
lished by the Second Amendment Foundation) and in an ad campaign enti-
tled "Refuse to Be a Victim/' which has appeared in women's journals such
as Woman's Day and Redbook, the NRA has urged women to "declare j
independence from the tragic fear that has become the shameful plague of
our times." For a discussion of this campaign, see Sally Chew, "The NRA
Goes Courting/' Lear's (January 1994).

J7
ISSUE 3
Should Cities Subsidize Sports and
Sports Venues?

YES: Thomas V. Chema, from "When Professional Sports Justify the Subsidy:
A Reply to Robert Baade," The Journal of Urban Affairs (vol. 18, no. 1, 1996)
NO: Robert A. Baade, from "Stadium Subsidies Make Little Economic Sense
for Cities: A Rejoinder/' The Journal of Urban Affairs (vol. 18, no. 1, 1996)
ISSUE SUMMARY
YES: Attorney and economic development expert Thomas V. Chema claims
that a sports venue has both direct and indirect returns to invested dollars.

NO: Economics professor and urban sports facilities consultant Robert A.

Baade argues that although one might justify a sports subsidy on the basis
of "image" or "enhanced quality of life," one cannot justify spending limited
development dollars on the economic returns that come from sports venues.

The cities Green Bay, Wisconsin, Cooperstown, New York,

of Vail, Colorado,
Indianapolis, Indiana, and by a common
Louisville, Kentucky, are all united
denominator. Each boasts a well-known sports venue or sporting event. South
Bend, Indiana, may be known to most people as the home of the Fighting
Irish football team of Notre Dame, but only our family and a few friends
know, or for that matter care, that Bonello and Swartz live there too!
Is there an economic value to the city of South Bend that is totally separate
and apart from the dollars spent by 90,000 college football fans who will
search for the 80,000 tickets that are available six times each fall semester? In
broader terms, is there an economic value for the "city fathers and mothers"
associated with your ability to correctly connect ski lifts, a football team, a
baseball hall of fame, an auto race, and a horse race with their respective
cities? This is the essence of the debate found in this issue. Robert A. Baade
argues that too few individuals utilize sports facilities to make them worthy
candidates for public investment. Thomas V. Chema disagrees, particularly
if the venues are strategically placed within the urban community.

We should first examine the impact of a few sports venues. Perhaps no sin-
gle sports arena has had a longer, more lasting effect on its urban surroundings
than the Coliseum in Rome. This marvelous, two-thousand-year-old struc-
ture was home to some of the most gruesome "sports" events in Western
history. In spite of its crumbling walls and hundreds of years of physical ne-
glect, it still attracts thousands of daily visitors. In fact, this long-abandoned

38
structure still anchors the economic development of the southeast corner of
modern Rome.
Alternatively, consider the impact of the America's Cup challenge match
to western Australia. The America's Cup is awarded to the winner of a
worldwide sailing competition. Until 1986, the competition was always held
off the New England coast, since the U.S. team had never lost this international
competition. Their first loss came at the hands of the Australians who then

had the right to host the challenge match in Fremantle, western Australia. This
small, nineteenth-century port city had fallen into serious economic decline
prior to the America's Cup challenge match. Although the Australians lost
their treasured "Cup" in 1986, they gained much in return. When the sleek
racing ships sailed out of the mouth of the Swan River Bay on their return
home, they left behind a transformed city awash with cappuccino shops,
boutiques, restaurants, microbreweries, and pricey loft condos.
What part of Fremantle's rehabilitation is two or
the direct result of the
threedozen challenge teams that had to be housed and wined and dined in
the two years leading up to the races? What part can be traced to the posi-
tive externalities or spillover effects associated with the presence of wealthy
sailing teams and the hangers-on who could afford to go halfway around the
world to see a sporting event?
Thomas V. Chema attributes large portions of economic development to
the presence of sports teams. On the other side, Robert A. Baade contends
that it is necessary to carefully measure the dollar costs of sports enterprises
to ensure that they do not result in the diversion of leisure dollars to absentee
team owners and players.

39
 Thomas V. Chema
YES

WHEN PROFESSIONAL SPORTS

JUSTIFY THE SUBSIDY:
A REPLY TO ROBERT BAADE
Since virtually the dawn of recorded history the public has been digging into
its collective pockets to subsidize the construction of sports venues. Granted,
thishas not always been a voluntary effort, but then the niceties of democracy
were often lost on pharaohs, kings, emperors, and other potentates. The
rationale for the public subsidy has varied over time and geography but,
with relatively few exceptions, sports have consistently been subsidized.
Robert A. Baade has made a decade long career (or perhaps crusade) argu-
ing against the subsidy. In his most recent paper, "Professional Sports as Cata-
lysts for Metropolitan Economic Development/' he purports to demonstrate,
using two economic modeling formulae, that subsidy cannot be justified on
the basis of economic development and job growth.
For a host of reasons, I disagree with the ultimate conclusion reached
by Professor Baade that "cities should be wary of committing substantial
portions of their capital budgets to building stadiums." Before cataloging
areas of disagreement, let's accept that it is true that professional sports and
sport venues are not a panacea for all urban problems. In fact, like Professor
Baade, I believe that they are not necessarily even development tools. Their
value as catalysts for economic development (job growth and the creation of
wealth) depends upon where they are located and how they are integrated
into a metropolitan area's growth strategy.
Cities of the future will be important and successful if they can create a
critical mass of opportunities for people to socialize within their borders.
Several millennia ago, Plato and Aristotle characterized human beings as
social creatures. We want to come together, to interact.
For the past 500 years much of that interaction has taken place in cities as
people did business and engaged in commerce. Today, with the information
superhighway and advanced communications, we tend to be much more
isolated in business transactions. Thus, we continually look for other ways
to generate human contact and interaction. Cities which understand that

From Thomas V. Chema, "When Professional Sports Justify the Subsidy: A Reply to Robert
Baade," The Journal of Urban Affairs, vol. 18, no. 1 (1996), pp. 19-22. Copyright © 1996 by JAI
Press, Inc. Reprinted by permission of JAI Press, Inc., Greenwich, CT, and London, England.

40
 .

YES Thomas V. Chema / 41

cultural activities, recreations, sports and for the first time in 30 years, that down-
plain old socializing not only bring town has much to offer. They are coming
people together, but form a solid base even when there are no sporting 81
for economic growth, will be the cities
Such success dramatizes the flaw
which prosper. Cleveland, Baltimore,
in Professor Baade's past and current
Indianapolis, and Minneapolis are cities
analyses and conclusions. Baade has re-
which recognize that sports venues and
searched essentially nonurban facilities
events can fit into an overall vision for
which were not intended to be economic
strategic growth. They have integrated
development tools. The multiuse stadi-
the facilities into the urban fabric and
ums that proliferated in the late 60s and
they are successful.
early 70s were specifically designed to be
The key venues being a cata-
to sports
apart from the city. The design character-
lyst for economic development is locating
istics give the impression more of a fort
them in an urban setting and integrating
than a marketplace. Moreover, during the
them into the existing city infrastructure.
period surveyed most new venues were
It is the spin-off development generated
located in suburban or rural locations.
by two million or more people visiting
The relatively few urban venues might as
a specific area of a city during a concen-
well have been in suburbs because they
trated time frame which is critical. The
were separated from their host city by a
return on the public investment in a ball-
moat of surface parking. These facilities
park or arena, in dollar and cents terms
became and continue to be isolated at-
as opposed to the intangible entertain-
tractions. People drive to them, park on
ment value comes not from the facility
surface lots, enjoy the events in the build-
itself, but from the jobs created in new
ing,and then go home. This is not bad,
restaurants, taverns, retail, hotels, etc.,
but it does not generate economic de-
that spring up on the periphery of the
velopment spin-off. Contrary to Pi
sports venue.
sor Baade's conclusion, however, it is not
In Cleveland, for example, since the
the sport activity, but the context which
opening of Jacob Field, 20 new restau-
is key.
rants employing nearly 900 people have
opened within two blocks of second base. With the exception of Arlington, Texas,
There are two new retail establishments the post-1990 ballparks are in urb...
on Prospect Avenue where there had tings. They connect with the hosl

been none since World War II. There are and give people an Opport unity
six projects to convert vacant upper sto- money in that hi tl en that
ries of office and commercial buildings to tunity. people accept it and thecitv bene-
market rate apartments and condomini- fits. Drawing conch: at the eco-

ums and the Gateway facility is only two nomic development <m the last

years old. .tion of 9\

This development is materializing be- able at best. Certainlv. then' is no merit in

cause 5,000,000 visitors are coming to extrapolating from the ti ers of

games and entertainment and they are Pittsburgh Cincinnati, Philadelphia

spending their money outside the walls and drawing oonduaiora as to the public
of the sportsvenues before and alter the return from investment in tod
events. Moreover, they are disco, den yards and Id.
42 / 3. SHOULD CITIES SUBSIDIZE SPORTS AND SPORTS VENUES?

Moreover, the economic model pro- velopment posited in the study. What is
posed by Dr. Baade intuitively raises sev- the value in measuring the metropolitan
eral questions. First, emphasis is placed growth vis-a-vis other cities? Moreover,
on the assumption that most of the money it seems clear that the fully loaded cost

generated by a stadium is "quickly dis- of a stadium cannot be recovered from

bursed beyond the stadium's environs/' the stadium revenue alone. Indeed, that
That may well be, but is that not equally is why a subsidy is needed. The return on

true of a steel mill or auto plant? What is the subsidy investment must be judged
the point here, surely not that a business not only on the revenue potential of the
enterprise to be a growth generator must facility (and players) but on the spin-off
reinvest the income in the immediate sur- as well. Of course, the subsidy is not
roundings? made only because an economic return
Second, the fact that the current gen- on investment is expected, but also be-
eration of public assembly facilities is a cause of the entertainment value of the
self-contained series of profit centers does sports activity or venue. This is not an ex-
not mean that spin-off development will clusive analysis nor is the sale to the pub-
not occur. Given the correct location and lic of the subsidy ever exclusively based

avoiding surrounding the venue with a on the expected economic development

sea of surface parking, entertainment re- return on investment.
lated enterprises will spring up and flour- Fifth, what is the rationale for mea-
ish in the shadow of the stadiums. Wit- suring capital investment and sports
ness Cleveland and Denver. Even in the revenue receipts on a per capita ba-
dead times these businesses can survive sis? I strongly suspect that any other
once the public becomes familiar with entertainment-related industry would
them. Indeed in the modern facility there provide similar results to that which Pro-
will be less true dead time because the fessor Baade shows in his paper. In fact,
facility will strive to maximize its useful- if type of analysis were applied to
this
ness,drawing people to its restaurants, investments in steel mills,computer fac-
team shops, etc., even when there is no tories, supermarkets, or most other in-
event. dustries, the relative results would make
TTiird, the analysis totally ignores the stadium investments look pretty good.
fiscal impact sporting events and rev- Contrary to the implication, using Pro-
enues have on the host public jurisdic- fessor Baade's Chicago example, the in-
tion. Assuming the implausible circum- vestment of $150 million in a stadium
stance where no sports-related revenues which equates to approximately $54.00
stay in the metropolis from a private sec- per capita is returned in less than three
tor perspective, there still would be the years based on $22.00 per capita in sports
impact of tax revenues left behind. Vir- franchise revenue. A three year payback
tually every host city has a wage or in- on investment is generally viewed favor-
come tax, a sales tax, and /or admissions ably in the private sector. Such a return
tax. Triis reality, multimillions of dollars, on a public sector investment that should
seems to be ignored by the models pro- last at lest 40 years ought to be viewed
posed by Professor Baade. very positively.
Fourth, it is difficult to accept the Sixth, the low wage, seasonal job argu-
rather narrow definition of economic de- ment which is typically made by oppo-
 YES Thomas V. Chema / 43

nents of sports investments is,

facility contribution to the economy of that
frankly, [Link] community, but city?...
particularly major urban centers, need to Finally, it is not clear what jobs are
have a diverse mixture of job types in counted as having been created by
their economy Not everyone is a rocket professional sports in the Baade an
scientist. Not everyone could become one Clearly the team and the stadium direct
even if there were such jobs available, employees, even including all <

which clearly there are not. Some mem- related staff, constitute a small number.
bers or potential members of the labor Most of the jobs created are not going to
forceneed jobs as ushers, ticket takers, show up in SIC 794. This model is t I

vendors, etc. These jobs are neither de- little utility.

meaning to their holders nor do they It is appropriate for the public to

cause a city to gain "a comparative ad- review its investment in a sports venue
vantage is unskilled and seasonal labor." as an investment in public infrastructure.
This type of reasoning is the product of Like a road, bridge, or water line, the
effete snobbery. return on the investment comes indirectly
Seventh, how does one measure the op- as well as directly. A proper analysis
portunity cost involved in public subsi- includes a review of the entertainment
dies of sports? I have yet to see or hear value of the facility and the spin-off value
of a single instance where the alternative created by the facility. Similarly, a road
to building a new
stadium, for example, is by transportation utility and
justified
was something other than doing nothing. the development that it opens on its
At least since 1989, there have been no periphery.
proposals of schools v. stadiums or jails Just as not every road is equal in
v. arenas! The real issue here is collective itseconomic impact, not every stadium
public investment or individual private will generate development that justifies
expenditures. Economically, this is true a public subsidy. However, when a city
of every public investment and sport is establishes a development strategy that
no exception. includes sports as part of a critical mass
Eighth, is it really appropriate to of attractions designed to lun^ people into
measure the economic contribution of the urban core, then a <port team or venue
an industry based on the growth of the can and will provide significant economic
host city rather than on the industry's value to tru
NO Robert A. Baade

STADIUM SUBSIDIES MAKE LITTLE

ECONOMIC SENSE FOR CITIES:
A REJOINDER

The thoughtful critiques of my research authored by Messrs. Chema and

Rosentraub indicate significant agreement among us about the economic im-
pact that professional sports teams and stadiums have on local and regional
economies. The areas of alleged disagreement can be broadly characterized
as either technical (those monetary benefits and costs that are generally rec-
ognized and quantified) or qualitative. Some of the technical issues can be ad-
dressed, perhaps resolved, through a clarification of the methods I employed
and their outcomes. Other questions can be resolved only with additional
data which will enable evaluation of the urban stadiums constructed after
1990. The purpose of this rejoinder is to help advance the stadium debate by
commenting on issues raised by Mr. Chema and Dr. Rosentraub.
Before elaborating on specifics relating to these issues, several matters de-
serve comment. First, I do not have preconceived notions on whether cities,
taken individually or collectively, should subsidize the construction of sports
facilities. The persistent and ubiquitous use of an economic/investment ra-

tionale for public stadium subsidies, however, compels an evaluation of the

economic contribution of commercial sport to metropolitan economies. Sta-
dium subsidies represent a classic public finance issue involving both equity
and efficiency questions. My research sounds a cautionary note for gov-
ernments contemplating subsidies on economic grounds. Specifically, cities
should reconsider how the stadium is integrated into the urban economy
and /or reconsider using the promise of economic gain as a means of selling
the subsidy to a skeptical public.
On a personal note, my research about the economic impact of professional
sports teams and stadiums has been inspired by my interest in public finance
issues and my lifelong experience with sports. In large part my choice to teach

From Robert A. Baade, "Stadium Subsidies Make Little Economic Sense for Cities, A Rejoinder,"
The Journal of Urban Affairs, vol. 18, no. 1 (1996), pp. 33-37. Copyright © 1996 by JAI Press, Inc.
Reprinted by permission of JAI Press, Inc., Greenwich, CT, and London, England.

44
 NO Robert A. Baade/45

at a liberal arts college was conditioned sports can be evaluated. In retrospect it

by my affection both academics

for would appear that prospective economic
and sport. Lake Forest College gave impact studies in general have failed
me an opportunity to coach as well as to capture all the significant inflows
teach. I raise this point in response to and outflows that are essential for
Mr. Chema's reference to my "decade a ballpark estimate of the economic
long career (or perhaps crusade) arguing contribution of professional sports. On
against the subsidy." While he may have the other hand, retrospective anal
mistakenly inferred from my work that limited by data availability.
I dislike sports, to the contrary, I have In reacting to specific areas of con-
valued sports as a participant, coach, cern, Mr. Chema notes the importance of
educator, and fan. stadium context. In referring to stadium
Given my experience, I may be in a location he observed: "Their value as cat-
better position than some to evaluate the alysts for economic development de- . . .

intangibles so often used in discussing pends upon where they are located and
and defending sports. The second point how they are integrated into a metropoli-
I wish to make is that I have not dis- tan area's growth strategy." In noting
cussed intangibles in my work except to the success of urban sports facilities con-
recognize their potential importance. Be- structed after 1990, he alleged a flaw in
cause proponents of subsidies rational- my research. "Such success dramatizes
ize their position first and foremost on the flaw in Professor Baade's past and
economic grounds, it is logical to eval- current analyses and conclusions." In re-
uate first the merits of these arguments. sponse to this allegation I would refer
My work focuses exclusively on the eco- him to Baade and Dye (1988, p\
nomic dimension. If we can resolve the where we wrote:
issue as it relates to economics, then it
If an urban stadium is being planned, the
may be necessary to move the stadium
plan should be expanded to incorpo-
subsidy debate to the psychological arena development... A stadium
rate ancillary
where intangibles are properly the focus. is not usually enough oi a significant
Third, I have chosen to do retrospective development to anchor an an
stadium analysis because I recognize that omy alone. Rather, in considering the re-
identifying and accurately measuring all an urban neighborhood,
vitalization of

the dollar inflows and outflows to an a number potential economic an-

of

area's economy that are induced by chors should be developed simultane-

ously Commercial ventures require
commercial sport is a daunting task.
traffic The stadium can provide infu-
Stadium economic impact studios arc
sions of people, but residential develop 1

prospective in nature and are heavily

ment incorporated with commercial de-
dependent on the assumptions about velopment will ensure a balanced, non-
the financial inflows and outflows to
lOnal clientele tor burineM in th«.
an area's economy as the conseqw dium neighborhood
of professional sports activities. On a

practical level, approach has boon

my I have emphaa Hum context in
to provide a filter through which the public presentations and in my wotfc with
promises of increased economic growth stadium planners and architects. Cam-
for municipalities through professional den Yards and the triplex
46 / 3. SHOULD CITIES SUBSIDIZE SPORTS AND SPORTS VENUES?

in Cleveland represent important exper- Mr. Chema opines that "the fact that the
iments relating to stadium context. Re- current generation of public assembly fa-
search by a number of social scientists, in- cilities is a self-contained series of profit
cluding my own, has identified a stadium centers does not mean that spin-off devel-
and team novelty effect. All else equal, a opment will not occur." Given the correct
stadium and team will attract greater in- developmental context, that may be true,
terest in the first few years of their, ex- but many stadiums are being designed
istence. So while there is reason to be with the team's bottom line in mind, of-
encouraged by some aspects of the eco- ten to the detriment of the local econ-
nomic performance of Camden Yards and omy When a stadium is moved across the
Gateway (not all the financial news from street (Chicago's Comiskey Park comes
Gateway is good), I am sure that Mr. to mind) in the absence of a broader de-
Chema recognizes that sound statistical velopment plan to explicitly include the
analysis of these two projects requires neighborhood, many of the economic ac-
more than a few observations of eco- tivities are revenues appropriated by lo-
nomic outcomes. As previously noted, cal entrepreneurs are appropriated by the
retrospective analysis is limited by data stadium operatives seeking to maximize
availability. their share of stadium-induced revenues.
Furthermore, in evaluating the sta- In focusing on Cleveland and Camden
dium's economic contribution, a model Yards, Mr. Chema concentrates on the ex-
must be constructed that is capable of ceptions rather than the rule in stadium
separating the stadium from other parts planning. The reality is that most sta-
of the development. An integrated de- dium deals are signed at the midnight
velopment complicates the task for the hour by legislators opting to do what is

scholar seeking to determine the sta- necessary to retain a team rather than
dium's economic contribution separate formulating a plan that integrates the
from other elements of the plan. stadium and team into a broader devel-
Mr. Chema's emphasis on context ig- opment package. One could blame leg-
nores at least one important contex- myopic stadium legis-
islators alone for
tual point. Many of the stadiums that lation, but these outcomes are inspired
are currently planned or under con- at least as much by the structure of pro-
struction replace stadiums that have fessional sports leagues which serve their
been deemed economically obsolete by own economic interest by maintaining an
a team. Boston, Cincinnati, Milwaukee, excess demand for teams. St. Petersburg,
Minneapolis, New York, and Seattle cur- Nashville, and Charlotte do not serve the
rently are in the throes of debates about economic interests of Chicago, Houston,
new stadiums for Major League base- and Milwaukee.
ball (MLB). Cincinnati, Minneapolis, and Mr. Chema raised other issues that are
Seattle have facilities that are 25 years more technical in nature. He alleges that
old or less. The dome in Minneapolis is my "analysis totally ignores the fiscal
13 years old. This shorter stadium shelf impact sporting events and revenues
life has important economic implications. have on the host public jurisdiction."
One concern is how the new generation of Tax revenues are derived. If the tax
facilities born out of economic imperative base expands, tax revenues increase.
will affect the neighborhood's economy. Professional sports generate additional
 NO [Link]/47

tax revenues to the extent that they little in an absolute sense to a metropoli-
expand the local economy. If sport is tan economy. At present modeling the
construed as part of the entertainment economies of each city that hosts pro-
industry, as no less an authority than fessional sport is not possible and so an
Bud Selig, MLB's current commissioner, alternative technique must be devised
contends, commercial sport from the to assess the actual contribution of pro-
perspective of the global economy is fessional sport relative to theeconomic
arguably a zero-sum game. If all the promise articulated by boosters. Further-
fans supporting a professional sports more, an economist would be remiss if
team within a city are residents of that the question of opportunity cost was ig-

city, that team will serve to realign nored. Public officials must evaluate the
economy activity within the city rather stadium not only on its own merit but rel-
than expanding its tax base. Because taxes ative to alternative uses of those funds.
are derived, tax revenues do not change Both issues are considered at length in
in such a situation. Does it matter much my paper. An argument can be made
to the city whether it derives its revenues that in the municipal auction for profes-
from sports entertainment or recreation sional sports franchises, like the auction
provided by the local theater? for free agent players, the winning bid
If we drew an imaginary circle from likely exceeds the team's marginal rev-
economic ground zero, the point at enue product. It is likely that the greater
which the stadium activity occurs, the the excess demand for professional sports
larger the circle the smaller the net teams, the greater the difference between
change in economic activity. This reality the team's marginal revenue product and
should help focus the debate about the price the host city pays.
stadium subsidies for various levels of Mr. Chema uses the figures I provided
government. For example, the State of on per capita stadium investments and
Kentucky on purely economic grounds returns to argue that stadiums provide
may not want to use its general funds a good return on investment. The per
to build a stadium for Louisville unless capita returns were notcomputed for in-
it can be demonstrated that either fans dividual sports, but were calculated for
will pour across the Indiana, Ohio, West commercial sports in general. For indi-
Virginia, and Tennessee borders or that vidual cities, I have calculated returns
Louisville is in need of urban renewal, on taxpayer equity on the order ot
a public goods argument that could for an individual sport and those calcu-

justify an infusion of state funds. If the lations were based on figures ptO\

stadium replaces leisure and recreational from the economic impact studies { \

spending in Danville with spending in sidy supporters. In football and basi

Louisville, Danville may want to argue the trend is decidedly auav from multi-
against the use of state funds for a purpose facilities, a trend that is dr:
stadium in Louisville. economic imperatives (individual teams
Mr. Chema raised the question "what want exclusive control of itadtam rev-
isthe value in measuring the metropoli- enues). By the year Z00(\ it is not unrea-
tan growth vis-a-vis other ci tie- sonable to predict that baseball and
Professor Rosentraub has indicated in ball will no longer il facility

his critique, commercial sport contributes in the Unih

48 / 3. SHOULD CITIES SUBSIDIZE SPORTS AND SPORTS VENUES?

With regard to Mr. Chema's claim that is certainly affected by the presence
"at least since 1989, there have been no of professional franchises. Professional
proposals of schools v. stadiums", I was sports serve as a focal point for group
identification. Sports contests are a part
puzzled by the use of the word proposals.
With all due respect, I would encourage of civic culture. There may well be a
willingness of voters to pay taxes to
Mr. Chema to listen to the tapes of the
subsidize this kind of activity just like
1995 Cincinnati City Council debates on
there is for parks and museums.
the use of public funds for new stadiums
for the NFL Bengals and the MLB Reds.
Professor Rosentraub, in particular, has
Mr. Chemaunderstandably found of-
articulated the less visible ways in which
fensive the use of the low wage job cre-
a large public project translates into a
ation argument in conjunction with op-
more vibrant economy. Without repeat-
position to stadium subsidies. Most of us
ing his words, I echo his sentiments.
recognize the need for all types of em-
ployment. Rather than construing this ar- An after-the-fact audit includes the
gument as the product of "effete snob- economic impact of these laudable in-
bery," I would ask him to recognize that tangibles and, even then, commercial
some of us are trying to explain why sport does not emerge as a statistically
sport might not contribute in absolute significant contributor to metropolitan
dollar terms as much as subsidy propo- economies. Dr. Rosentraub has empha-
nents suggest. My work should not be sized the fact that the professional sports
construed as a recipe for job creation, but industry is too small to significantly in-
rather as an explanation for why stadium fluence a large metropolitan economy. I

subsidies may not have provided the pro- would only add that it is not only its small
jected economic boost. size which renders commercial sport rel-

As noted earlier, I argued that a retro- atively unimportant. It is a fact that sports
spective approach to assessing the eco- spectating is but one leisure option avail-
nomic contribution of a stadium or team able to the residents of a large diverse
is necessary, give the complex manner in
metropolis. Money spent on sports spec-
which dollar inflows and outflows may tating is financed by reduced spending
be affected. An after-the-fact audit of how in other recreational venues and that fact

a change in the professional sports in- contributes to the consistently statisti-

dustry influences a metropolitan econ- cally insignificant results for professional

omy tacitly includes both direct and in- sports my research has yielded using a
direct effects. Indirect changes include an variety of models.
altered city psyche or vision or a height-
This fundamental principle is fortified
ened spirit of cooperation. All these in-
by the fact that the primary beneficia-
direct changes may, indeed, alter the eco-
ries of public stadium largesse are owners
nomic landscape. On page 274 of my 1988
and players and fans for whom commer-
article cited previously, I noted (Baade & cial sportsproduce substantial consumer
Dye, 1988, p. 274):
surplus. For owners and players, particu-

the most significant contribution of larly those who reside outside the city ex-
sports is be in the area
likely to tending the subsidy, there may be adverse
of intangibles. The image of a city economic effects from diverting leisure
 NO [Link]/49

dollars from locally owned entertainment subsidy is a political expedient, perhaps

centers to absentee owners and players. necessity, but it is inconsonant with the
In the final analysis I can only repeat statistical evidence.
what I have said so often. If cities
subsidize commercial sports in the quest
for an improved image or to enhance
the quality of life for its citizens, then REFERENCES
taxpayers should be allowed to decide
Baade, R. A., & Dye, R. F. (1988). Sports stadiums
the stadium subsidy issue on these bases. and area development: a critical review. Economic
Using economics as a justification for the Development Quarterly, 2, 265-275.
POSTSCRIPT
Should Cities Subsidize Sports and
Sports Venues?

You probably have been directly or indirectly affected by a sports facility

sometime in your life. For many of us this means being part of the crowd that
shoulders its way into a baseball park or a basketball arena to watch a favorite
team play For others this means being trapped in a traffic jam as thousands
of cars rush home at the end of a football game or the end of a day at the
races. Are these modern-day coliseums that dominate the cityscape worth the
millions of dollars that taxpayers are asked to pay? Would the community
be better advised to spend these dollars attracting industry that supports
high-paying jobs or by stabilizing neighborhoods that are in distress?
Chema advocates attracting professional sports teams to a city by offering
them substantial subsidies. He argues that Baade has biased his results by
focusing his analysis on suburban facilities, which are surrounded by "a moat
of surface parking." Chema details benefits such as spin-off development, a
whole range of and relative rates of return in
taxes, entertainment value,
other industries. Baade contends that communities should be wary of the
many promises made by prospective professional sports franchises. city A
should not be intimidated by the team's threat to leave for another that is
willing to build a new, more costly facility. Baade argues that most of the
dollars generatedby these sports teams are earned by absentee team owners
and players and that most of the new employment associated with operating
these facilities are at the minimum wage level.
A surprising amount has been written on this topic. In part this can be traced
few conservative journals have been persuaded by Baade's
to the fact that a
two essays by Raymond J. Keating: "We Wuz
position. For example, look for
Robbed! The Subsidized Stadium Scam/' Policy Review (March/April 1977)
and "Pitching Socialism: Government-Financed Stadiums Invariably Enrich
Owners at Public Expense," National Review (April 22, 1996). There is plenty
written on the other side as well. See Curt Smith, "Comeback: The Triumphant
Return of Old-Style Ball Parks Show That Tradition Can Be Popular," The
American Enterprise (March/April 1997), or, on a related topic, Joanna Cagau
and Neil de Mause, "Buy the Bums Out," In These Times (December 9, 1996).
Finally, there are many articles that examine the economic impact of the
Summer Olympics in Atlanta, Georgia. See for example, Matthew Cooper,
"Welcome to the Olympic Village," New Republic (July 15 and 22, 1996).

50
ISSUE 4
Time
Is It to Abolish the Minimum
Wage?
YES: Thomas Rustici, from "A Public Choice View of the Minimum Wage/'
Cato Journal (Spring /Summer 1985)

NO: Charles Craypo, from "In Defense of Minimum Wages/' An Original

Essay Written for This Volume (1997)

ISSUE SUMMARY
YES: Orthodox neoclassical economist Thomas Rustici asserts that the effects
of the minimum wage are clear: it creates unemployment among the least-
skilled workers.

NO: Labor economist Charles Craypo argues that a high minimum wage is

good for workers, employers, and consumers alike, and hence it is good for
the economy as a whole.

In the midst of the Great Depression, Congress passed the Fair Labor Stan-
dards Act (FLSA) of 1938. In one bold stroke, it established a minimum wage
rate of $.25 an hour, placed controls on the use of child labor, designated 44
hours as the normal workweek, and mandated that time and a half be paid
to anyone working longer than the normal workweek. Fifty years later the
debates concerning child labor, length of the workweek, and overtime pay
have long subsided, but the debate over the minimum wage rages on.
The immediate and continued concern over the minimum wage component
of the FLSA should surprise few people. Although $.25 an hour is a paltry sum
compared to today's wage rates, in 1938 it was a princely reward for work
It must be remembered that jobs were hard to come by and unemployment

rates at times reached as high as 25 percent of the workforce. When work was
found, any wage seemed acceptable to those who roamed the streets with no
"safety net" to protect their families. Indeed, consider the fact that $.25 an
hour was 40.3 percent of the average manufacturing wage rate for 1938.
Little wonder, then, that the business community in the 1930s was up in
arms. Business leaders argued that if wages went up, prices would rise. This
would choke off the little demand for goods and services that existed m the
marketplace, and the demand for workers would be sure to fall. The end
result would be a return to the depths of the Depression where there was
little orno hope of employment for the very people who were supposed to
benefit from the Fair Labor Standards Act

52
 This dire forecast was demonstrated by simple supply and demand anal-
ysis. First, as modem-day introductory textbooks in economics invariably
show, unemployment occurs when a minimum wage greater than the equi-
librium wage is mandated by law. This simplistic analysis, which assumes
competitive conditions in both the product and factor markets, is predicated
upon the assumptions that as wages are pushed above the equilibrium level,
the quantity of labor demanded will fall and this quantity of labor supplied
will increase. The result is that this wage rigidity prevents the market from
clearing. The end result is an excess in the quantity of labor supplied relative
to the quantity of labor demanded.
The question that should be addressed in this debate is whether or not a
simple supply and demand analysis is capable of adequately predicting what
happens in real-world labor markets when a minimum wage is introduced
or an existing minimum wage is raised. The significance of this is not based
on idle curiosity. The minimum wage has been increased numerous times
since its introduction in 1938. Most recently, effective September 1, 1997,
legislation establishing the current minimum wage of $5.15 was signed into
law by President Clinton.
Did this minimum wage increase, and other increases before it, do irrepara-
bleharm to those who are least able to defend themselves in the labor market,
the marginal worker? That is, if a minimum wage of S5.15 is imposed, what

happens to all those marginal workers whose value to the firm is something
less than $5.15? Are these workers fired? Do firms simply absorb this cost
increase in the form of reduced corporate profits? What happens to produc-
tivity?
This is the crux of the debate between Thomas Rustici and Charles Craypo.
Rustici argues that the answer is obvious for all to see: there will be
m the quantity of labor supplied relative to the quantity demanded. In lay
terms, there will be unemployment. Craypo rejects thi>

He recommends judging the minimum wage on the intent of the original

legislation: increased aggregate demand and elimination of predator) i.

market practices

S3
 . .

Thomas Rustici
YES

A PUBLIC CHOICE VIEW OF

THE MINIMUM WAGE

Why, when the economist gives advice to his society, is he so often cooly ignored?
He never ceases to preach free trade . . and protectionism is growing in the
United States. He deplores the perverse effects of minimum wage laws, and the
legal minimum is regularly raised each 3 to 5 years. He brands usury laws as a
medieval superstition, but no state hurries to repeal its laws.

—George Stigler

INTRODUCTION
Much of public policy is allegedly based on the implications of economic the-
ory. However, economic analysis of government policy is often disregarded
for political reasons. The minimum wage law is one such example. Every
politician openly deplores the spectacle of double-digit teenage unemploy-
ment pervading modern society. But, when economists claim that scientific
proof, a priori and empirical, dictates that minimum wage laws cause such a
regretful outcome, their statements generally fall on deaf congressional ears.
Economists too often assume that policymakers are interested in obtaining all
the existing economic knowledge before deciding on a specific policy course.
This view of the policy-formation process, however, is naive. In framing eco-
nomic policy politicians will pay some attention to economists' advice, but
such advice always will be rejected when it conflicts with the political reality
of winning votes.

ECONOMIC EFFECTS OF THE MINIMUM WAGE

Economic analysis has demonstrated few things as clearly as the effects of the
minimum wage law. It is well known that the minimum wage creates unem-
ployment among the least skilled workers by raising wage rates above free
market levels. Eight major effects of the minimum wage can be discussed: un-
employment effects, employment effects in uncovered sectors of the economy,

From Thomas Rustici, "A Public Choice View of the Minimum Wage," Cato Journal, vol. 5, no. 1
(Spring/Summer 1985). Copyright © 1985 by Cato Journal Reprinted by permission.

54
 :

YES Thomas Rustici / 55

reduction in nonwage benefits, labor tion and Labor Secretary Frances Perkins
substitution effects, capital substitution the green light to reestablish the federal
effects, racial discrimination in hiring minimum wage, which was achieved on
practices, human development,
capital 25 June 1938 when President Roc
and distortion of the market process signed into law the Fair Labor Standards
with respect to comparative advantage. Act (FLSA).
Although the minimum wage has other The FSLA included legislation affect-
effects, such as a reduction in hours of ing work-age requirements, the length
employment, these eight effects are the of the workweek, pay rates for overtime
most significant ones for this paper. work, as well as the national minimum
wage provision. The law established min-
Unemployment Effects imum wage rates of 25 cents per hour
The first federal minimum wage laws the first year, 30 cents per hour for the
were established under the provisions next six years, and 40 cents per hour after
of the National Recovery Administration seven years. The penalty for noncompli-
(NRA). The National Industrial Recovery ance was severe: violators faced a $10,000
Act, which became law on 16 June fine, six months imprisonment, or both.

1933, established industrial minimum In addition, an aggrieved employee could

wages Over 90
for 515 classes of labor. sue his employer for twice the difference
percent of the minimum wages were set between the statutory wage rate and his
at between 30 and 40 cents per hour. 1
actual pay. 4
Early empirical evidence attests to the With the passage of the FLSA, it be-
unemployment effects of the minimum came inevitablethat major dislocations
wage. Using the estimates of C. F. Roos, would result in labor markets, primar-
who was the director of research at the ily those for low-skilled and low-wage
NRA, Benjamin Anderson states: "Roos workers. Although the act affected oc-
estimates that, by reason of the minimum cupations covering only one-fifth of the
wage provisions of the codes, about labor force, 5 leaving a large uncovered
500,000 Negro workers were on relief in sector to minimize the disemployment
1934. Roos adds that a minimum wage effects, the minimum wage was still ex-
definitely causes the displacement of the tremely counterproductive. The Labor
young, inexperienced worker and the old Department admitted that the new min-
worker." 2 imum wage had a disemployment ef-

On 27 May 1935 the Supreme Court de- fect, and one historian sympathetic to
clared the NRA unconstitutional, bury- the minimum wage ed to con-
ing theminimum wage codes with it. cede that "[t]he Department of Lab
The minimum wage law reappeared at timated that the 25-cents-an-hour mini-
a later date, however, with the support mum \. ^0,000 to 50,000
of the Supreme Court. In what became About 90% of
the precedent for the constitutionality of in southern industries such as bag

future minimum wage legislation, the pecan shelling, and fa vmming." 6

Court upheld the Washington State min- ndeistate
imum wage law on 29 March 1937 in the actual magnitude ot th«

West Coast Hotel z\ Parrish.* This Since only 300,000 work.

laration gave the Roosevelt administra- .so as a result ot the minimum
 .

56 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

wage/ estimates of 30,000-50,000 lost much more hardship from the minimum
jobs reveal that 10-13 percent of those wage law. According to Anderson:
covered by the law lost their jobs. But it
It was thought by many that, in the
is highly dubious that only 30,000-50,000
first year, the provision would not
low- wage earners lost their jobs in the
affect many industries outside the South,
entire country; that many unemployed though the framers of the law apparently
could have been found in the state of forgot about Puerto Rico, and very grave
Texas alone, where labor authorities saw came in that island
disturbances
devastation wrought via the minimum Immense unemployment resulted there
wage on the pecan trade. The New through sheer inability of important
York Times reported the following on 24 industries to pay the 25 cents an hour. 9
October 1938:
Simon Rottenberg likewise points out the
Information received today by State tragic position in which Puerto Rico was
labor authorities indicated that more placed by the enactment of the minimum
than 40,000 employees of the pecan nut wage:
shelling plants in Texas would be thrown
out of work tomorrow by the closing When the Congress established a mini-

down of that industry, due to the new mum wage of 25 cents per hour in 1938,
Wages and Hours Law. In San Antonio, the average hourly wage in the U.S. was
sixty plants, employing ten thousand 62.7 cents. mandatory
... It resulted in a

men and women, mostly Mexicans, will increase for only some 300,000 workers

close — Plant owners assert that they out of a labor force of more than 54 mil-
lion. InPuerto Rico, in contrast the
cannot remain in business and pay the . . .

minimum wage of 25 cents an hour with new minimum far exceeded the
Federal
prevailing average hourly wage of the
a maximum working week of forty-four
hours. Many garment factories in Texas major portion of Puerto Rican workers. If
will also close. 8 a continuing serious attempt at enforce-
ment . . . had been made, it would have
meant economic chaos
literal for the is-
It can reasonably be deduced that even
land's economy. 10 . .

if the Texas estimates had been wildly

inaccurate, the national unemployment After two years of economic disruption
effect would still have exceeded the in Puerto Rico, Congress amended the
Department of Labor's estimates. minimum wage provisions. 11 The mini-
The greatest damage, however, did not mum wage was reduced to 12.5 cents per
come in Texas or in any other south- hour, but it was too late for many indus-
ern state, but in Puerto Rico. Since a triesand for thousands of low-wage earn-
minimum wage law has its greatest un- ers employed by them, who suddenly

employment effect on low-wage earners, found unemployment the price they had
and since larger proportions of work- to pay for the minimum wage.

ers in poor regions such as Puerto Rico In sum, the tragedy of the minimum
tend to be at the lower end of the wage wage laws during the NRA and the FLSA
scale, Puerto Rico was disproportionately was not just textbook-theorizing by aca-
hard-hit. Subject to the same national 25- demic economists, but real-world disas-
cents-per-hour rate as workers on the ter for the thousands who became the
mainland, Puerto Rican workers suffered victims of the law. But these destruc-
 YES Thomas Rustici / 57

tive effects have not caused the law to of (1) the disemployed workers who
be repealed; to the contrary, it has been lose their jobs and unemployment
suffer
expanded in coverage and increased in during the transition to employment in
amount. the uncovered sector, and (2) everyone
.Evidence for the unemployment ef-
. . in the uncovered sector, as their wage
fects of the minimum wage continues rate falls due to the influx of unemployed
to mount. Many empirical studies since workers from the covered sector. While
the early 1950s —from early research by increasing the incomes of some low-wage
Marshall Colberg and Yale Brozen to earners, increasing the minimum wage
more recent work by Jacob Mincer and tends to make the lowest wage earners
—
James Ragan have validated the predic- in theuncovered sector even poorer than
tions of economic theory regarding the they otherwise would have been.
unemployment effects of the minimum Yale Brozen has found that the un-
wage law. In virtually every case it was covered household sector served to ab-
found that the net employment effects sorb the minimum wage-induced dis-
and labor-force participation rates were employed in the past. 12 But the "safety
negatively related to changes in the min- valve" of the uncovered portion of
imum wage. In the face of 50 years of evi- the economy is rapidly vanishing with
dence, the question is no longer if the min- the continual elimination of various
imum wage law creates unemployment, exemptions. 13 Because of this trend we
but how much current or future increases can expect to see the level of structural
in the minimum wage will adversely af- unemployment increase with escalation
fect the labor market. of the minimum wage. 14

Employment in Uncovered Sectors Nonwage Benefits

The labor market can be divided into two Wage rates are not the only costs asso-
sectors: that covered by the minimum ciated with the employment oi workers
wage law, and that not covered. In a by firms. The effective labor cost a firm
partially covered market, the effects of the incurs is usually a package of pecuniar)'
minimum wage are somewhat disguised. and nonpecuniarv benefits. As such,
Increasing disemploys workers in
it tends Richard McKl I

the covered sector, prompting them to employers can be -

Respond
search for work in the uncovered sector to minimum wage law by cutting
if they are trainable and mobile. This buck or eliminating altogether t:
then drives down the wage rate in the fringe benefits tnd con,!
uncovered sector, making it lower than it like the eomp. that increaae

otherwise would have been. Since perfect the supply of labor but which do

knowledge and not obs<

flexibility is By
reducing such non-monev b<
in real-world labor markets, substantial
employ iv. - his
unemployment can occur during the
laboi in what they other*
transition period. •

Employees in the covered sector who the v.

do not lose their jobs get a

increase through the higher minimum it one takes the \ iew thai
wage. But this comes only at the expense : nonpecu-
58 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

Table 1

Value of the Minimum Wage, 1955-1995

Minimum Wage as
Value of the Value of the a Percent of the
Minimum Wage, Minimum Wage, Average Private
Year Nominal Dollars 1995 Dollars! Nonsupervisory Wage
1955 $0.75 $3.94 43.9%
1956 '
1.00 5.16 55.6
1957 1.00 5.01 52.9
1958 1.00 4.87 51.3
1959 1.00 4.84 49.5
1960 1.00 4.75 47.8
1961 1.15 5.41 53.7
1962 1.15 5.36 51.8
1963 1.25 5.74 54.8
1964 1.25 5.67 53.0
1965 1.25 5.59 50.8
1966 1.25 5.43 48.8
1967 1.40 5.90 52.2
1968 1.60 6.49 56.1
1969 1.60 6.21 52.6
1970 1.60 5.92 49.5
1971 1.60 5.67 46.4
1972 1.60 5.51 43.2
1973 1.60 5.18 40.6
1974 2.00 5.89 47.2
1975 2.10 5.71 46.4
1976 2.30 5.92 47.3
1977 2.30 5.56 43.8
1978 2.65 6.00 46.6
1979 2.90 5.99 47.1
1980 3.10 5.76 46.5
1981 3.35 5.68 46.2
1982 3.35 5.36 43.6
1983 3.35 5.14 41.8
1984 3.35 4.93 40.3
1985 3.35 4.76 39.1
1986 3.35 4.67 38.2
1987 3.35 4.51 37.3
1988 3.35 4.33 36.1
1989 3.35 4.13 34.7
1990 3.80 4.44 37.9
1991 4.25 4.77 41.1
1992 4.25 4.63 40.2
1993 4.25 4.50 39.2
1994 4.25 4.38 n/a
1995 4.25 4.25 n/a

t Adjusted for inflation using the CPI-U-X1.

Source: Center on Budget and Policy Priorities.

 YES Thomas Rustici / 59

niary income, then anything forcing them demand of $60 per day would have cost
to accept another mix of benefits would the high skilled worker his job. Thus the
clearly make them worse off. For exam- effect of the minimum wage is to price

ple, suppose worker A desires his income the high skilled worker's competition

in the form of $3.00 per hour in wages, out of the market. 16

an air-conditioned workplace, carpeted

Labor competes against labor, not
floors, safety precautions, and stereo mu-
against management. Since low-skill la-
sic. If he is forced by the minimum wage
bor competes with high-skill labor, the
law to accept $3.25 per hour and fewer
minimum wage works against the lower-
nonpecuniary benefits, he is worse off
skill, lower-paid worker in favor of
than at the preminimum wage and the
higher-paid workers. Hence, the conse-
higher level of nonpecuniary income. A
quences of the law are exactly opposite
priori, the enactment of minimum wage
its alleged purpose.
laws must place the worker and em-
ployer in a less-than-optimal state. Thus
it may not be the case that only unem- Capital Substitution Effects
ployed workers suffer from the minimum To produce a given quantity of goods,
wage; even workers who receive a higher some bundle of inputs is required. The
wage and retain employment may be net ratio of inputs used to produce the

losers if their nonpecuniary benefits are desired output is not fixed by natural
reduced. law but by the relative prices of inputs,
which change continuously with new
Labor Substitution Effects demand and supply conditions. Based on
The economic world is characterized by a relative input prices, producers attempt

plethora of substitutes. In the labor mar- to minimize costs for a given output.

ket low-skill, low-wage earners are sub- Since many inputs are substitutes for
stitutes for high-skill, high-wage earners. one another in the production process,
As Walter Williams points out: a given output can be achieved by
increasing the use of one and diminishing
Suppose a fence can be produced by
the use of another. The optimal mix
using either one high skilled worker or
will depend on the relative supply and
by using three low skilled workers. If the
demand tor competing substitute inputs.
wage of high skilled workers is $38 per
day, and that of a low skilled worker As a production input, low-skill labor
is $13 per day, the firm employs the is often in direct competition with highly
high skilled worker because costs would technical machinery.A Whirlpool dish-
be less and profits higher (S38 versus washer can be substituted tor low-skill
$39). The high skilled worker would manual dishwashers in the dishwashing
soon recognize that one of the ways to 38, ,\nd m\ automatic el-
increase his wealth would be to advocate
take the place ot a nonautomatic ek
a minimum wage of, say, $20 per day in
and a manual operator [hta [is] not to
the fencing industry. After enactment
. . .

imply that automation "d

of the minimum wage laws, the high
skilled worker can now demand any
common uddite myth. As rederic Bas-
I 1

and tiat explain

wage up to $60 per [Link] retain

employment. Prior to the enactment oi \utomation

the minimum wage of $20 per d. shifts I : jobs to be done in
60 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

ety but does not reduce their total num- to decide among low-wage workers on
ber. Low-skill jobs are done away with, the basis of price differentials; hence,
but higher-skill jobs are created simulta- they face fewer disincentives to deciding
neously. When the minimum wage raises according to some other (possibly racial)
the cost of employing low-skill workers, criteria.

it makes the substitute of automated ma- To see the racial implications of min-
chinery an attractive option. imum wage legislation, it is helpful to
look at proponents of the law in a
Racial Discrimination country where racial hostility is very
in Hiring Practices strong, South Africa. Since minimum
At first glance the connection between wage laws share characteristics in com-

the level of racial discrimination in hir-

mon with equal pay laws, white racist
ing practices and the minimum wage unions in South Africa continually sup-
may not seem evident. On closer ex- port both minimum wage and equal-pay-

amination, however, it is apparent that for-equal-work laws for blacks. Accord-

the minimum wage law gives employ- ing to Williams:

ers strong incentives to exercise their ex- Right-wing white unions in the building
isting racial preferences. 18 The minimum trades have complained to the South
wage burdens minority groups in general African government that laws reserving
and minority teenagers most specifically. have been broken
skilled jobs for whites

Although outright racism has often been and should be abandoned in favor of
blamed as the sole cause of heavy minor- equal pay for equal work laws The —
conservative building trades made it
ity teenage unemployment, it is clearly
clear that they are not motivated by
not the only factor. William Keyes in-
concern for black workers but had come
forms us that
to feel that legal job reservation had been

In the late 1940's 1950's, young

and early so eroded by government exemptions
that it no longer protected the white
blacks had a lower unemployment rate
than did whites of the same age group. worker. 21

But after the minimum wage increased

The reason white trade unions are
significantly, especially in 1961, the black
restless inSouth Africa is a $1.52-per-
youth unemployment rate has increased
hour wage differential between black and
to the extent that it is now a multiple of
white construction workers. 22 Although
the white youth unemployment rate. 19
the owners of the construction firms
To make the case that racism itself are white, they cannot afford to restrict
is the cause of the employment and employment to whites when blacks are
unemployment disparity among blacks willing to work for $1.52 per hour
and whites, one would have to claim that less. As minimum wages eliminate the

America was more racially harmonious wage differential, the cost to employers
in the past than it is now. In fact, during of hiring workers with the skin color
the racially hostile times of the early 1900s they prefer is reduced. As the cost of
71 percent of blacks over nine years of discrimination falls, and with all else
age were employed, as compared with remaining the same, the law of demand
51 percent for whites. 20 The minimum would dictate that more discrimination
wage means that employers are not free inemployment practices will occur.
 YES Thomas Rustici / 61

Markets frequently respond where [FJor the disadvantaged young worker,

they can, even to the obstacles the min- with few skills and below average
imum wage presents minority groups. In education, producing enough to earn
fact,during the NRA blacks would fre- the minimum wage is incompatible

quently be advanced to the higher rank with the opportunity for adequate on-
the-job learning. For this group, the
of "executives" in order to receive ex-
minimum wage implies high short-run
emptions from the minimum wage. 23 The
unemployment and the chronic poverty
free market demands that firms remain
of a life of low wage jobs. 25
color-blind in the conduct of business:
profit, not racial preference, is the pri- Feldstein also finds a significant irony in
mary concern of the profit-maximizing the minimum wage: "It is unfortunate
firm. Those firms who fail the profit test and ironic that we encourage and sub-
get driven out of business by those who sidize expenditureon formal education
put prejudice aside to maximize profits. while blocking the opportunity for in-
When markets are restricted by such laws dividuals to 'buy' on-the-job training." 26
as the minimum wage, the prospects for This is especially hard on teenagers from
eliminating racial discrimination in hir- the poorest minority groups, such as
ing practices and the shocking 40-50 per- blacks and hispanics —a truly sad state
cent rate of black teenage unemployment of affairs, since the law is instituted in the
in our cities are bleak. name of the poor.

Human Capital Development Distortion of the Market Process

Minimum wage laws restrict the employ- Relative prices provide the transmission
ment of low-skill workers when the wage mechanism by which information is

rate exceeds the workers' marginal pro- delivered to participants in the market
ductivity. By doing so, the law prevents about the underlying relative scarcities

workers with the least skills from acquir- of competing factor inputs. They serve as
ing the marketable skills necessary for in- signals for people to substitute relatively
creasing their future productivity, that is, less scarce resources for relatively more
it keeps them from receiving on-the-job scarce resources, in mart] :thout
training. their even being aware Oi

Itan observable fact, true across

is Whenever relative price differentials
ethnic groups, that income rises with exist tor input substitutes m the pr
age. 24 As human capital accumulates over tion pi Urepreneurs
r will switch

time, it makes teenagers more valuable to from higher-priced inputs to lower-

employers than workers with no labor- priced inputs. In a dynamically changing
market experience. But when teenagers economy! this switching i ntinu-
are priced out of the labor market by allv. Init when prices are not allow

the minimum wage, they lose their transmit market information accurately,
first and most crucial opportunity to as in the Case Ol prices artihcialh

accumulate the human capital that would by government, then distorted

trolled in-

make them more valuable to future formation skews the market ai ..

employers. This stunting reduces their to something dearly less than optic
lifetime potential earnings. As Martin Minimum wages, being such a d
Feldstein has commented: tionot the] :n,lcad to the v.
62 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

Table 2
Dates and Amounts of Minimum Wage Changes
As a Percent of the Average
Wage in Manufacturing
Date Amount (Old Minimum/New Minimum)
February 1967 $1.40 44.8% / 50.2%
February 1968 $1,60 47.6% / 54.4%
May 1974 $2.00 37.8% / 47.3%
January 1975 $2.10 42.7% / 44.9%
January 1976 $2.30 41.7% /45.6%
January 1978 $2.65 38.5% / 44.4%
January 1979 $2.90 40.8% / 44.6%
January 1980 $3.20 41.7% / 44.5%
January 1981 $3.35 40.1% / 43.3%
April 1990 $3.80 31.4% / 35.6%
April 1991 $4.25 33.6% / 37.6%

factor input mix between labor and all ment in the standard of life of the Puerto
other inputs. As a result, industry mi- Rican people and to intensify poverty in
grates to locations of greater labor supply the island. 30

more slowly, and labor-intensive indus-

In summary, the evidence is in on
triestend to remain fixed in non-optimal
the minimum wage. All eight major
areas, areas with greater labor scarcity.
effects of the minimum wage examined
Large labor pools of labor-abundant ge-
here make the poor, disadvantaged, or
ographical areas are not tapped because
the controlled price of labor conveys the
young in society worse off —the alleged
beneficiaries turn out to be the law's
wrong information to all the parties in-
major victims
volved. Thus, the existence of price differ-
entials, as knowledge to be transmitted
through relative prices, is hidden. 29 The CONCLUSION
slowdown of industrial migration keeps
labor-abundant regions poorer than they George Stigler may have startled some
otherwise would be because economic economists in 1946 when he claimed that
growth there is stifled. As Simon Rotten- minimum wage laws create unemploy-
berg explains for the case of Puerto Rico: ment and make people who had been re-
ceiving less than the minimum poorer. 31
The aggregate effect of all these distor- Fifty years of experience with the law has
tions was that Puerto Rico could be ex- proven Stigler correct, leaving very few
pected to produce fewer goods and ser- defenders in the economics profession. 32
vices than would have otherwise been
But economists have had little suc-
produced and that the rate at which insu-
cess in criticizing this very destructive
lar per capita income rose toward main-
land United States income standards [Link] Rottenberg demonstrated the
could be expected to be dampened. In government's disregard for what most
sum, the minimum wage law could be economists have to say about this issue in
expected to reduce the rate of improve- his investigation of the Minimum Wage
 YES Thomas Rustici / 63

Study Commission created by Congress

NOTES
in 1977. He noted the numerous studies
presented to the commission that without 1. Leverett Lyon et al. The National Recovery
Administration: An Analysis and Appraisal (New
exception found that the law had a neg- York: Da Capo Press, 1972), pp. 31 ft
ative impact on employment and inten- 2. Benjamin M. Anderson, Economics and the
sified the poverty of low-income earners. Public Welfare: A Financial and Economic History of
the United States. 1914-1946 (Indianapolis: Liberty
The commission spent over $17 million Press, 1979), p. 336.
to conduct the investigation and on the 3. Jonathan Grossman, "Fair Labor Standards

basis of the evidence should have elim- Act of 1938: Maximum Struggle for a Minimum
Wage," Monthly Labor Review 101 (June 197-
inated the law. What was the outcome?
4. "Wage and Hours Law," New York Times, 24
The commission voted to increase the mini- October 1938, p. 2.
mum wage by indexing and expanding cover- 5. Grossman, "Fair Labor Standards Act," p. 29.

age. As dissenting commissioner S. Wame

6. Ibid., p. 28.
7. Ibid., p. 29.
Robinson commented about the investi- 8."Report 40,000 Jobs Lost," New York Times, 24
gation: October 1938, p. 2.
9. Anderson, Economics and the Public Welfare, p.
458.
The evidence is now and the findings
in, 10. Simon Rottenberg, "Minimum Wages in

of dozens of major economic studies Puerto Rico," in Economics of Legal Minimum Wages,
edited by Simon Rottenberg (Washington, DC:
show that the damage done by the
American Enterprise Institute, 1981), p. 330.
minimum wage has been far more severe 11. Rottenberg, "Minimum Wages in Puerto
than even the critics of forty years ago Rico," p. 333.
predicted. Indeed, the evidence against 12. Yale Brozen, "Minimum Wage Rates and
the minimum wage is so overwhelming Household Workers," Journal of Law and Economics
5 (October 1962): 103-10.
that the only way the Commission's
13. Finis Welch, "Minimum Wage Legislation in
majority was able to recommend it be the United States," Economic Inquiry 12 (September
retained was to ask us not to base any 1974) :

decisions on the facts. 33 Brozen, "Minimum Wage Rates and House-

14.
hold Workers," pp. 107-08.
15. Richard McKenzie, "The Labor Market Ef-
It cannot be that our elected represen- Minimum WageL. 1
.

\h\ (Falll-
tatives in Congress are just misinformed
16. Walter Williams, The St I Blacks
with respect to the minimum wage law. (New York: McGraw-Hill
To the contrary, the Congressional Record 17. Frederic Bastiat, Econcm:.. '^mg-
ton-on-Hud>> .nidation tor Economic-
demonstrates that they fully understand
Education, 1946), pp. lt>-19.
the law's effects and how the utiliza- IS. Walter Williams, "Government Sanctioned

tion of those effects can ensure reelec- Restraints That Reduce the Economic Opportunities
tor Minorities." [Link] RrvfctJ 22 (Fall 1977): 15
[Link] would do well to realize
19 [Link].i: - Minimum Wage and the
that governments have little interest in plovment Ettects on Minorities
the truth when its implementation would and Vuth," Jounu. wmth 3 (Fali

contradict self-serving government poli-

fata p. 41
Rather than attempting to bring
cies. 21 Ibid . :

eminent the "facts," economists should 44

educate the public. This is the only so- ml Recoxrry Adm-
lution to the malaise created when peo-
Buetauofthe
ple uncritically accept such governmen- i

tal edicts as the minimum wage.

 .

64 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

25. Martin Feldstein, "The Economics of the 32. Although there are a few supporters left such
New Unemployment," The Public Interest, no. 33 as John K. Galbraith, many "liberal" economists
(Fall 1973): 14-15. such as Paul Samuelson and James Tobin have
26. Ibid., p. 15. recently come out against the minimum wage. See
27. Thomas Sowell, Knowledge and Decisions Emerson Schmidt, Union Power and the Public Interest
(New York: Basic Books, 1980), p. 79. (Los Angeles: Nash, 1973).
28. Ibid. 33. Simon Rottenberg, "National Commissions:
29. Ibid., pp. 167-68. Preaching in the Garb of Analysis," Policy Review
30. Rottenberg, "Minimum Wages in Puerto no. 23 (Winter 1983): 139.
Rico," p. 329.
31 George Stigler, "The Economies of Minimum
Wage Legislation," American Economic Review 36
(June 1946): 358-65.
NO Charles Craypo

IN DEFENSE OF MINIMUM WAGES

This article refutes the dominant view held by orthodox neoclassical econo-
mists such as Thomas Rustici. These economists assert that minimum wage
laws should be abolished because they misallocate resources and cause pro-
duction inefficiencies. I reject Rustici's conclusion and instead take the po-
sition that in most instances high minimum wages are good for workers,
employers and consumers alike and hence are good for the economy as a
whole.
Three things are wrong with Rustici's neoclassical view of things. It de-
pends on an idealized world that by assumption favors more rather than less
market competition as the solution to economic problems. Second, it ignores
the reasons why governments enact minimum wage laws in the first place
and instead interprets and judges them on inappropriate grounds. Third, the
neoclassical argument against minimum wages is supported by contradictory
empirical evidence that casts doubt on its theoretical validity and practical
significance.
Critics of the orthodox neoclassical interpretation of minimum wages in-
clude both neoclassical and institutional applied labor economists. In fact,
most of the contradictory empirical studies in recent years have produced by
neoclassical economists whose findings prompt them to question the domi-
nant view. In addition to the research of mainstream economists, research crit-
ical of the orthodox position has come from the various institutional schools
of thought which emphasize evolutionary change and systemic rather than
deductive reasoning from an idealized model.
Most of the debate surrounds the federal minimum wage law contained
in the Fair Labor Standards Act (II SA) of L938, which represented I
tial part of President Roosevelt- agenda to get the nation out ot the Great

Depression. Labor law reformers had long advo ral wage .md hour

laws in response to an historic pattern oi low earnings among working fam-

ilies and intense wage competition among empl

struck down early attempts to establish federal .standards on grounds the

Copyright © 1997 by Charles Craypa

65
66 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

separate states had constitutional pri- ailment and to prescribe inappropriate

macy such matters. Individual states
in public policy.
were reluctant to pass regulatory laws, The problem is that in explaining how
however, because they feared industry the interaction between worker skill and
would avoid locating there. The enor- output determines wages the neoclassi-
mities of the depression nevertheless cal model uses circular reasoning. It pre-
drove working people to strike em- sumes that if we know the wage we
ployers and protest politically. Soon the also know the worth of the worker be-
Supreme Court changed directions and cause market competition ensures that
ruled that the constitution does in fact al- each worker is paid the value of his or her
low Congress to regulate interstate com- worth, as measured by the value of what
merce; Congress responded with numer- each produces. It further presumes that
ous regulatory laws including the FLSA. the worker's productive value is deter-
mined by his or her level of skill and edu-
The inherent bias in neoclassical analysis. cation, that is, by their accumulated "hu-
When polled, a large majority of Amer- man capital/'Therefore, if one worker is
ican economists support Rustici in his paid more than another worker, then the
opposition to minimum wage increases. first worker must be worth more (that is,

This reflects their prior training in the must have more skill and education) than
neoclassical wage model, which gener- the second; because the wage is, by def-
on
ally rejects labor standards legislation inition, equal to output value, which in
grounds that market outcomes are supe- turn is determined by skill and educa-
rior to anything government can achieve tion. Consequently, every worker must
through regulation. Employers and oth- be worth what he or she is being paid,
ers lobbying to abolish or weaken min- no more and no less. Workers who think
imum wage laws therefore can count they are not being paid enough must be
on the support of orthodox economists, wrong, because if they possessed more
despite widespread public approval of human capital they would be worth more
these laws. Indeed, in 1993, three-fourths therefore paid more.
of economists polled said that an increase This is tautological reasoning. It ex-
in the minimum wage would increase un- plains everything and nothing because it

employment, while a similar poll in 1996 uses the thing it is trying to explain as the
found that 84% of the public favored an evidence with which to explain it. It does,
increase. however, allow neoclassical economists
This vastly different view of the to reject any attempt to regulate wages on
world underscores the first problem the grounds that the worker currently is
with Rustici's neoclassical analysis. The being paid what he or she is worth. In the
competitive market model it uses simply world of the neoclassical economist, forc-
does not depict real labor markets ing employers to pay a higher wage will
accurately. It imagines all sorts of things simply place the individual employer at
that do not exist and ignores a great a competitive disadvantage and at the
many other things that do. When this same time discriminate against workers
analysis applied to particular labor
is who did not benefit from the regulated
market problems, such as declining real wage increase. As a result, neoclassical
wages, it is likely to misdiagnose the investigations of minimum wage effects
 NO Charli-sCraypo/67

usually ask a single question. How many cause they own the plant and equipment
workers will become unemployable fol- upon which the worker's livelihood de-
lowing an increase in the minimum wage. pends, they can threaten to relocate the
The question derives from the competi- workplace or to replace the worker
tive wage model, not from observed ex- machines or other workers.
periences or policy objectives.
In the absence of institutional protec-
With this mind-set, it is understandable tions such as union contracts and min-
that Rustici and other orthodox neoclas-
imum wages, workers are in constant
sical economists see the solution to labor
danger of having to compete with one
market problems, such as low earnings another to see which of them will
and unemployment, as more rather than for less pay and under the worst condi-
less market determination and the elim-
tions. If one or a few employers are able to
ination of existing regulations. If labor
reduce labor standards by taking advan-
markets deliver less than ideal results it is tage of labor's inherent bargaining .

because they are not free enough. Public ness,and in the process they expand mar-
policy must be to remove the imperfec- kets and increase their profits, then the
tions. Unions and minimum wages are race is on among all employers to take
logical targets in this regard. down labor standards. The labor market
The problem with such deductive rea- degenerates into what institutional labor
soning is that employers and employ-
economists call destructive competition.
ees seldom meet as equals in the labor As two institutional labor economists ob-
market, although the model assumes that served decades ago, "When an employer
they do. In blue-collar settings, for exam- can hire workers for practically his
ple, the employment relationship favors price, he can be slack and inefficient in
employers, who typically offer jobs on a his methods, and yet, by reducing v.
take-it-or-leave-it basis. Individual work- reduce his cost of production to the
ers find there are far more workers than of his more able competil nmons
there are good jobs and they take what and Andrews, 1936
they can get on the terms that are offered.
Employers simply have more options in
the hiring process than do workers— The irrelevancy of the
except perhaps when unemployment is This demonstrates the second thing
low and workers scarce in the lowest pay- wrong with Rustici - ska! inter-
ing, least desirable occupations and in- pretation. examines and evaluates min-
It

dustries, at which point employers turn imum wage laws onlv on the bfl
to immigrant labor to fill job vacant what would result in a competitive mar-
the going wage levels. Additionally, em- ket model. In domg bo, it ignores the rea-

ployers know far more than hourly work- sons why Mich laws are enacted m the

ers do about supply and demand condi- first place and whether or not thev solve

tions in local labor markets and are more the problems thi solve
mobile in terms of where and when to The problem with this approach is that it

hire. They also can hold out much l< only one ol the thi

financially than can workers in the event ial tor

of differences over wages ^n^ working a nation to sustain high-K <duc-

conditions. Finally, and importantly, be- tion and consumption: a nation's need to
68 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

provide high standards of living for its Because neoclassical economists large-
citizens. ly ignore macro- and technical efficiency
Robert Kuttner (1997) argues that neo- in their analysis of competitive labor mar-
classical preoccupation with allocative kets, their competitive model cannot es-
efficiency prevents an examination of timate the macroeffects of incremental
macroefficiency and technical efficiency. changes in prices and quantities in par-
Macroefficiency concerns a nation's abil- ticular markets. The 1930s, for example,
ity to sustain orenhance total produc- were characterized by the kind of intense
tion,employment, and family living stan- wage and price competition that neoclas-
dards; whereas technical efficiency refers sical economists associate with alloca-
to the ability to generate new products tive efficiency. Consequently, the econ-
and production methods through indus- omy should have been performing at its
trial invention and innovation. Allocative best. But we still refer to what happened
efficiency, on the other hand, is limited instead as the Great Depression.
to looking after the immediate interests Remember that the question deriving
of the consumer by minimizing produc- from the neoclassical market model is
tion costs and product prices. If only al- "How many workers are made unem-
locative efficiency is taken into account, ployable because the new wage prices
the long-term interests of both producers them out of competitive labor markets?"
and consumers ignored as the nation
is That is not, however, the question that
neglects its economic growth, job
overall advocates of the FLSA were concerned
and earnings performance, and progress with in 1938, nor what people are con-
in research /development. cerned with today in view of the long-
It must be remembered that neither term decline in median real wages and
macro- nor technical efficiency necessar- the increase in unstable jobs. The problem
ily results in optimal allocation efficiency then and now is not the ability to produce
in the short run, that is, in the lowest enough goods and services, but rather it
possible costs of production and con- is creating jobs at wages high enough to

sumer prices. Nor does optimal alloca- buy back what is produced and in the
tive efficiency necessarily help to max- process sustain high living standards for
imize either macro- or technical effi- everyone.
ciency. The postwar success of certain This was the task of the 1938 federal
West European and Asian economies, minimum wage. It was designed to do
led by Germany and Japan, testifies to two things: (i) increase employment and
the need to distinguish between alter- purchasing power in order to stimulate
native forms of economic efficiency and the slumping economy; and (ii) drive out
between short- and long-run goals and of the market employers who competed
performance. Japanese industrial strate- on the basis of cheap labor instead of
gists made these distinctions for example through better products and state-of-the-
when they targeted the global auto mar- art production methods. The country had
ket in the late 1950s. They gave up short- been in economic crisis for the better part
run cost efficiency in return for long-term of a decade. It had become increasingly
product and workforce quality on their clear that much of the problem was due to
way to world supremacy in autos by the low pay, long workweeks, and growing
1980s (Halberstam 1986). use of child rather than adult labor.
 2

NO Charles Craypo/ 69

Advocates of minimum wages were sidized by low-income households and

not the least dissuaded by neoclassical taxpayers.
forecasts that some jobs would be lost and This subsidization does not have to oc-
some employers driven out of business. example, restaurant
cur. In Australia, for
That is precisely what they wanted to workers, "bag boys" in grocery stores,
do, on grounds that a job that does not bartenders in taverns, and other work-
pay enough to support a family should ers who are generally low paid in the
not exist and an employer who cannot United States are paid in excess of SI
pay a living wage, even though other an hour. Nevertheless, McDonalds ham-
employers in that industry can and do burgers and Pizza Hut pizzas still abound
pay the mandated living wage, should in Australia. In the United States union-
be driven from the marketplace. ized waitresses in Las Vegas also eam $12
In brief, if a job pays less than enough an hour, before tips, and Las Vegas is one
to sustain workers and their dependents of the fastest growing economic regions
at the customary standard of living, in America. Waitresses in other parts of
then that job is not paying its way the country commonly receive about half
in a productive economy because it is the level of the minimum wage, before
being subsidized by some household, tips, which forces them to show a cer-
charitable organization, or government tainamount of servitude in order to eam
transfer payment. The beneficiary of this enough tips to make the job worthwhile
subsidy is either the employer paying (asubsidy to the employer from the cus-
the low wage and making a profit by tomer) and leaves the worker unsure of
doing so, or the customer paying a low her or his earnings from day-to-day and
price for the good or service. Fast-food week-to-week. Such market outcomes re-
restaurant fare, for example,is cheap flect the low-status, devalued nature of
in partbecause fast-food workers earn these workers and occupations more than
poverty level wages. Home owners in itdoes their value to both customers and
wealthy suburbs can get their houses employers.
cleaned cheaply because the women who
clean them live in low-income areas, need Contradictory evidence for the neoclassical
the money, and have few job options. A viezv. Rustici's ne approach I

subsidy is a subsidy, whether the worker necessarily ignores the economic and so-
is part of a poor household or an affluent cial problems associated with low-wage

household and whether the employer is jobs because it concentrates on workers

a large or a small business. rather than jobs. Such focus abo »hil
If you work for a fast-food restau- ibility foe kow-wagi bom -

rant why should your family subs bO workers by FoCUSmSJ On *

the owners of that restaurant? In a like behaviOC rather than industrial strategies
manner, why should taxpayers Mil- wemment pol ill thai the

manufacturers that employ fathers theory assumes the individual worker's

mothers who cannot support their fami- termmed by his or her worth
lies without receiving food stamp on the (ob; it further presumes thai this

tax rebate from the government? Why worth is determined in large part by
should the large employer have to the amount o!human capital the v
pete with a smaller rival that is beta possesses m bmnS Ol formal education
 —

70 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

(college degrees) and occupational train- maintained their workforces and tried to
ing (vocational and on-the-job training). offset the higher labor cost by increas-
Thus the job and its requirements are ex- ing output and sales. This allowed them
cluded from the analysis and low-wages to take advantage of the economies of
are linked to the worker's efforts to ac- scale (lower per-unit costs of production)
quire skill and education. When
neo- that accompany higher levels of plant
classical researchers like Thomas Rus- and equipment utilization. Lester went
tici want to verify their theory they on to note that workers doing the same
study the earnings and employment ex- jobs in different plants received differ-
periences of groups of workers having ent wages over long periods of time
low educational and vocational skills on another finding at odds with neoclassi-
grounds such workers are most likely to cal reasoning - therefore, it was not pos-
lose jobs as a result of minimum wage sible to predict the employment effects
raises. Most neoclassical studies do in- of a minimum wage raise. His and other
deed find greater unemployment among studies thus refuted the neoclassical no-
such groups following minimum wage tion of a single competitive wage. Work-
increases. ers with comparable skills often make
But the findings of empirical stud- quite different wages over long periods
ies themselves pose the third problem of time and those with different skills
with Rustici's analysis. The results of often earn the same wages. "Such mat-
far too many empirical studies —those ters are elementary and commonplace
conducted by neoclassical as well as in- to a student of labor, but they seem to
stitutional labor economists —
have con- be largely overlooked by theorists of the
tradicted the neoclassical model for it to [neoclassical] marginalist faith," he con-
remain very convincing. During the Pro- cluded (1947:148).
gressive Era prior to World War I, for ex- In the 1990s, another group of neoclas-
ample, government economists surveyed sical revisionists using much the same in-
jobs before and after passage of state min- vestigative methods as Lester, but with
imum wage laws covering women work- more sophisticated equipment and tech-
ers (Obenauer and von der Nienburg niques at their disposal, produced simi-
1915). This and a later study conducted lar findings and came to much the same
by Commons and Andrews (1936), found conclusion. Princeton economists David
that mandated wages alleviated the de- Card and Alan Krueger demonstrated
generative effects of low wages and ac- that modest increases in minimum wage
tually enhanced productivity by increas- rates have little if any negative impact on
ing worker desire and ability to produce. the most exposed workers teenagers. —
Only "parasitic" employers were threat- Instead of analyzing what happens to
ened by minimum wages and relatively workers following minimum wage in-
small numbers of jobs were eliminated. creases, they, like Lester before them,
Some years later, Princeton labor asked what happened to the jobs them-
economist Richard Lester surveyed selves. And like Lester, they discovered
southern manufacturing employers after that employers did not respond as antic-
World War II and found they had not laid- ipated. Jobs in fast-food restaurants and
off marginal workers in response to min- other low-wage establishments did not
imum wage increases, but instead had decline, and in fact they even increased
 NO Charles Craypo/ 71

slightly in New Jersey when that state wage because they contrast it with a
increased its minimum wage above the theoretical system that is said to provide
federal level. More surprising perhaps, optimal results; but it is a system that
in adjacent Pennsylvania, where no in- ultimately is nonfalsifiable because of
crease in the state minimum wage had its tautological nature. They purport to
occurred, fast-food employment actually refute the minimum wage on grounds it

fell slightly! Card and Krueger substanti- destroys low-wage jobs despite the fact
ated these findings in similar studies in- that this is what it is supposed
precisely
volving fast-food restaurant jobs in Texas to do. Finally, by limiting the inquiry to
and teenage workers in all industries the dictates of a model that is inherently
in California (Card and Krueger 1995: hostile to government regulation, they
Chapters 2 and 3). preclude serious debate on regulation as
These results, clearly at odds with a policy tool.
the neoclassical literature, prompted one
somewhat shaken but faithful neoclas- Alternative analyses of minimum wage laws.
sical reviewer of Card and Krueger 's The shortcomings of traditional neoclas-
work to conclude in 1995, just as the sical analysis become apparent when con-

debate was getting underway on a pro- sidered in terms of macro- and technical
posal to raise the federal minimum wage efficiency. Wage-based competition dur-
"we just don't know how
to $5.15, that ing the 1930s reduced already depressed
many would be lost if the min-
jobs earnings and worker purchasing power,
imum wage were increased to $5.15" which in turn decreased product demand
(Kennan 1995:1964). Orthodox certainty and caused additional workers to be un-
was beginning to be eroded by the con- employed. The effect was to cut output,
tradictory findings, but the basic model incomes, and profits. With no recovery in
was not questioned. Many neoclassi- sight, large firms could not be expected to

cal economists hold doggedly to the make more cars, radios, and appliances
view that jobs must be lost if minimum than they could sell, nor could they be
wages are increased. Consider, for ex- expected to design and manufacture new
ample, a standard neoclassical labor eco- products when consumers could afford
nomics text now in its sixth edition. The neither old nor new models.
authors dismiss the Card-Krueger find- Economu did not occur un-
.

ings and "While the

insist instead that: til total war production during 1940-45,

impact of the minimum wage on em- when all the neoclassical rules of alloca-
ployment, especially that of young work- Efidency wen repealed industry
ers will undoubtedly continue to receive .irtelized, wages ,md price-

a great deal of research and public pol- controlled, and productive decision mak-
icy discussion, the best evidence remains pite the to-

that the overall impact of the law is to tal violation of market rules, the de-
lower employment of unskilled workers fense plants were running day and
while increasing the earnings of those fotmal and in-

who are able to get jobs" (Filer, Hamer- formal education ,md training
mesh, and Rees 1996:175). .md pi ;h Then, from the
In sum, neoclassical economists like mtil the mid-1970s, kndi
Rustici find fault with the minimum and labor in
72 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

government in administering the produc- that its elimination would increase the
tive system, again in violation of alloca- number of laborers and their productiv-
tive efficiency. But we look back fondly ity while also lowering taxes and birth
on those decades as the golden age of in- rates. As a secondary benefit, they went
creased living standards and job security. on to claim, this would also enhance fam-
Since then, however, the economy has ily stability and values by making parents
been deregulated in keeping with .neo- responsible for their children and both
classical doctrine and both product and children and mothers /wives dependent
labor markets made more competitive by on and therefore respectful of and obe-
domestic and global changes in indus- dient to wage-earning fathers /husbands.
trial structure and behavior. Labor pro- Conservatives still argue generally along
ductivity has been increasing, albeit mod- these lines.
estly, and labor resources probably have Trie second alternative is preferred by
been allocated more efficiently than in the liberaleconomists and policy makers. It
postwar decades, but real earnings are seeks to assure low-wage workers a liv-
falling, job security declining, and living ing income by supplementing their in-
standards stagnating (Mishel, et al. 1996). adequate earnings through the Earned
As a society we have three broad Income Tax Credit, a tax rebate of up
policy responses. One, we can remove to several thousand dollars a year to
a certain portion of the population from the employee based on his or her pay-
the productive system by offering social ments into the Social Security fund. Ad-
insurance and welfare benefits to able- vocates favor this approach because it

bodied individuals including laid-off or employee's real

effectively increases the
displaced males and single mothers. wage rate and at the same time it off-
This should raise wages by reducing sets undesirable market outcomes of low
the supply of workers. Two, we can wages without distorting wage and em-
force some idle workers into productive ployment structures and obstructing al-
roles by abolishing their financial support locative efficiency. They also believe that
and subsidy systems, giving them no the long-run solution is worker training
practical choice but to work under the and education to enhance human capital.
terms offered. This should lower wages Conservative and liberal economists and
by putting the new low-wage workers in policy makers tend to agree on that. They
competition with existing ones. Finally, differ, however, on whether it should be

we can legislate high minimum wages publicly financed and broadly available.
and other protective labor measures In view of the bipartisan support for
to ensure the lowest paid workers a more education, a word of caution is in
conventional standard of living. This order. More education is always laudable,
would raise wages directly. but by itself cannot solve the problem of
The first alternative has been the fa- low wages. This is because employers use
vorite of conservative economists and formal educational credentials, especially
moral reformers since the early 1880s college degrees, to screen applicants for
when industrial poverty appeared in good jobs. Therefore, as the overall ed-
Britain (Persky 1997). Free market advo- ucational level of the workforce rises,
cates urged the abolition of welfare sup- the amount of education needed to get a
port and wage supplements on grounds given job also increases. This jeopardizes
 NO Charles Craypo/ 73

the effectiveness of education as the jus- sumers. But this is true only if the jobs
tification forhigh pay. For if a college de- available to them pay wages that afford a
gree were to be conferred magically upon decent living.
the entire working population tomorrow,
In addition, the high wage economy is
who would bus and wait tables the day most consistent over time with the three
after? Employers would find and apply
economic efficiencies. It is true that min-
other screening criteria, perhaps a gradu-
imum wages are inconsistent with the
ate or professional degree, in order to de-
neoclassical definition of allocative effi-
termine which college grads would man- ciency in the short run; but it is the long
age restaurants and which would bus and term that should concern us as a nation.
wait tables. High-paid workers stay with their em-
Moreover, the supply of educated ployers, which encourages the latter to in-
workers does not automatically create the vest in worker skill and education, which
demand for them. American engineering in turn encourages employers to adopt
students, for instance, may wonder ex- state-of-the-art production methods and
actly what it is they are going to engineer sophisticated product design and perfor-
when they read about U.S. companies hir- mance. High-paid workers also have the
ing pools of low wage but college trained purchasing power to buy the goods and
information technologists in developing services that they and other high-paid
countries to work on computer software workers produce.
projects using high-speed satellite infor-
mation links, or when they hear about
A high wage policy is the best hope
for a bright future for the American econ-
domestic aerospace companies transfer-
omy. It ensures a proficient labor force in
ring technology overseas in exchange for
a stable macroeconomy and encourages
sales contracts, or of NASA purchasing
steady technological advancement. The
rocketry equipment from other industri-
larger society is only as prosperous as its
alized countries in order to get the low-
individual parts. Thus when labor stan-
est possible price (Barlett and Steele 1996:
dards are high the larger society prospers.
49-52,93-9).
The third alternative favors policies
that increase earnings and incomes di-

rectly, that is, before taxes and trans- REFERENCES

fer payments. High minimum wages are Barlett,Donald L, and James B. Steele. 19%.
a logical policy choice in this analy-
Ame* k the Dream? Kansa-
Andrews it McN
sis because they contribute directly to
Card, David Edward and Alan B. K
sustained economic growth (macroetti- Myt ;
: -rment: 77i<-

ciency) and industrial capitalization and

University Press.
innovation (technical efficiency). It is
based on the premise that with rare ex- Commons. John R ., and John B. Andrews
nh edition).
ceptions people want the dignity and . -nnt).
independence that comes with gainful
Filer. Randall K Daniel S Hair- Albert
employment, and therefore they should
, I

work because it is good for them as indi- edit i

viduals and good for the society in which I 1986. Vie Rnkonr
they are stakeholder producers ind
74 / 4. IS IT TIME TO ABOLISH THE MINIMUM WAGE?

Kuttner, Robert. 1997. Everything For Sale: The Virtues Obenauer, Marie L., and Bertha von der Nienburg.
and Limits of Markets. New York: Alfred A. Knopf. 1915. Effect of Minimum Wage Determinations in
Lester, Richard A. 1947. "Marginalism, Minimum Oregon. Bureau of Labor Statistics, Bulletin No.
Wages, and Labor Markets." American Economic 176. Washington: GPO.
Review 37 (March) pp. 135-48. Persky, Joseph. 1997. "Classical Family Values:
Mishel, Lawrence, Jared Bernstein, and John Ending the Poor Laws as They Knew Them."
Schmitt. 1977. The State of Working America, 1996- Journal of Economic Perspectives 11 (Winter) pp.
97. Armonk, NY: M. E. Sharpe. 179-89.
POSTSCRIPT
Time
Is It to Abolish the Minimum
Wage?
The impact of the minimum wage can be expressed in many ways. Two partic-
ularly rewarding ways of looking at such legislative initiatives are to examine
minimum wages over time in real dollars and as a percent of manufacturing
wages.
A clear pattern should emerge from an examination of this data. The 1965-
1970 period saw the highest level of the minimum wage in real terms. In con-
stant 1982-84 dollars, the minimum wage for these years was approximately
$4 an hour and reached nearly 50 percent of the prevailing manufacturing
wage. For the next 20 years, however, the value of the minimum wage in real
terms and as a percentage of the manufacturing wage fell. It is only in recent
years that it has begun to recover.
The renewed interest in the minimum wage can be traced in part to the
research findings of David Card and Alan Krueger. These economists, as
Craypo points out, have shaken the economics profession with their empir-
icalresearch findings that moderate increases in the minimum wage have
few negative consequences on employment patterns and in some cases are
associated with the increases in employment. Their work has been published
widely in professional journals: Industrial and Labor Relations Review (October
1992 and April 1994) and in the American Economic Revk nd 1995).
They have also detailed their findings in a book entitled Myth and
ment: The New Economics of the Minimum Wage (Princeton University Tress,
1995).
Two vocal critics of the Card/Krueger research are David Newmark and
William Wascher. Their empirical studies are supportive of the traditional
neoclassical findings that the minimum wage causes unemployment par-
ticularly among teenagers and young adults. See their work published in
g
Industrial and Labor Relations Review (September l ^2 and Apr. SER .

Working Paper No. 4617 (1994); Journal c

and American Economic i99G). Still of-

ten considered the best antiminimum wage Statement h is George

J. Stigler's
1946 essay entitled "The Economics ot Minimum Wage Lev:

tion," American Economic

75
ISSUE 5
Are Rent Controls the Cause of
America's Homelessness?

YES: William Tucker, from "How Housing Regulations Cause Homeless-

7
ness/ The Public Interest (Winter 1991)
NO: Richard P. Appelbaum et al., from "Scapegoating Rent Control: Masking
the Causes of Homelessness/' Journal of the American Planning Association
(Spring 1991)

ISSUE SUMMARY
YES: Journalist William Tucker analyzes the problem of homelessness across
the United States and suggests that rent controls and homelessness are cor-
related.

NO: Sociologist Richard P. Appelbaum and

his research associates submit
that Tucker's statistical analysisflawed and that he ignores the real causes
is

of homelessness: poverty, the lack of affordable housing, and inadequate

support services for those who suffer from mental illness and alcoholism.

Most spend some time discussing rent

principles of economics textbooks
controls and how they distort the operation of the market system. Most use
rent controls as an example of a price ceiling, which is a legal maximum on
the price that may be charged for a commodity. The objective of rent control
is, of course, to protect the consumer from high rents. However, supply and

demand analysis suggests that, as a result of rent controls, an excess in the

quantity demandedfor rental housing occurs. This in turn forces landlords
to ration the limited supply of rental units on some nonprice basis (personal
habits, family size, and length of residence in the community, for example).
With the imposition of rent controls, the market is not allowed to reach its
equilibrium level, and a "net loss" to society is assumed to result as consumers
are forced to pay a high price for the relatively small quantity that suppliers
of housing units make available to the market.
Some textbooks go beyond discussing the efficiency implications of these
market interferences and examine the historical experiences of New York City,
Boston, Los Angeles, San Francisco, Washington, D.C., and other U.S. cities
that have experimented with rent controls. These textbooks generally assume
that purely competitive market conditions, which are necessary to utilize
a supply and demand analysis, are or would be present in these housing
markets if there were no rent controls. They conclude that these well-meaning

76
governmental interventions in housing markets have left those in search of
affordable housing worse off than if the market were allowed to operate
on its own. They allege that renters hold on to apartments because rents
are low, while at the same time these low rents discourage landlords from
maintaining, upgrading, and/or investing in new units. Thus there are simply
fewer housing units on the market.
It is only in recent years, however, that homelessness has been linked to

the imposition of rent controls. This connection can be directly traced to the
research findings of William Tucker.
In the early 1980s, under pressure from groups charged with the responsi-
bility to provide social services to the homeless, the Reagan administration
began to count the number of homeless persons. In 1984, the U.S. Department
of Housing and Urban Development issued a study entitled "Report to the
Secretary on the Homeless and Emergency Shelters," which estimated that the
national homeless population was somewhere between 250,000 and 350,000
persons. (This study forms the statistical foundation for the Tucker selection
in this debate.) This estimate and the Reagan administration's hands-off pol-
icy to deal with this problem came under intense attack. Groups such as the
Coalition for the Homeless in New York and the Committee for Crea I

Violence in Washington, D.C., estimated that this population was in reality

between 2 and 3 million persons in 1984.
Who are these people who find themselves homeless? (Homeless refers to
an individual who regularly has no place to sleep and must seek refuge in
a shelter or remain on the streets after nightfall.) Besides the mentally ill
who have not found adequate community care following deinstitutionaliza-
tion and the drug and alcohol addicts, there are low-income families who
have been evicted for nonpayment of rent; the unemployed; those who have
lost their benefits from federal or state welfare or unemployment programs;
battered women; and individuals and families who have been displaced by
condominium conversions, gentrification, and urban renewal.
It seems reasonable to ask, Why has the market not responded by providing

"affordable housing" for these people? It we are to believe Tucker, it is because

of rent controls. Prospective landlords do not believe that they can cam a
financial return sufficient tocompensate them for the n>k that they must
bear. Richard P. Appelbaum and his research team reject Tucker's ana
and his conclusion, largely on the basi! ttematk Statistical critiqi.
the Tucker study.

77
 William Tucker
YES

HOW HOUSING REGULATIONS

CAUSE HOMELESSNESS
The problem of homelessness in the 1980s has puzzled liberals and conserva-
tives alike. Both have tended to fit the problem into their preconceived views,
without looking at what is new and different about the phenomenon.
For liberals, the issue has been fairly straightforward. Homelessness, they
say, stems from a lack of government effort and compassion. Reacting almost
reflexively, liberals have blamed homelessness on federal spending cuts and
the heartlessness of the Reagan administration. The most commonly cited
figure is that budget authorizations for the Department of Housing and Urban
Development (HUD) were cut 75 percent in the Reagan years, from $32 billion
in 1981 to $8 billion in 1988. Everything else is presumably self-explanatory.
This compelling logic has even been repeated in the Wall Street Journal.
Conservatives, on the other hand, have taken two approaches. Either they
deny the problem's existence or they assert that homelessness is almost al-
ways the result of personal pathologies. On the first count, it has often been
argued (as in Martin Morse Wooster's June 1987 Reason article, "The Home-
less: An Adman's Dream") that homelessness is really no worse than it ever
was, but that the problem has been exaggerated to justify increases in gov-
ernment spending. On the other, conservatives have also argued that most of
the homeless are insane, alcoholics, or drug addicts, and that their personal
failings make it impossible for them to find housing, even when it is available.

UNPERSUASIVE EXPLANATIONS
But these arguments, whether liberal or conservative, do not really hold up
under close scrutiny.
The most obviously flawed explanation lies in the figures that seem to
indicate a massive federal cutback in housing assistance. There has been
no such cutback. Federal low-income housing assistance actually increased
from $5.7 billion in 1980 to $13.8 billion in 1988. The number of households
receiving low-income housing assistance also rose, going from 3.1 million to
4.2 million during the same period.

From William Tucker, "How Housing Regulations Cause Homelessness," The Public Interest, no.
102 (Winter 1991), pp. 78-88. Copyright © 1991 by National Affairs, Inc. Reprinted by permission.

78
 YES William Tucker/ 79

The commonly cited "cutback" from has walked the streets of New York or
$32 billion to $8 billion is the figure Washington over the last decade knows
for HUD's future authorizations. This that there are more beggars sitting on the
figure has nothing to do with actual sidewalks and sleeping on park benches
housing assistance, however, since it only than there were ten years ago.
indicates the amount of money that Although many of the homeless are
Congress authorized HUD to spend in obviously alcoholics, drug addicts, and
the future. These authorizations often run people who are clinically insane, large
forty years in advance- —and much of the numbers appear only to be down on
money is never spent anyway. their luck. The most widely accepted
The reason for this cutback has been statistical breakdown was first proposed
the changeover from a program centered in a 1988 Urban Institute paper "Feeding
around public-housing construction to the Homeless: Does the Prepared Meals
one centered around housing vouchers. Provision Help?" According to authors
When Congress authorizes a unit of new Martha Burt and Barbara Cohen, one-
public housing, it must include all future third of the homeless can be categorized
mortgage payments, running decades as released mental patients, one-third as
ahead. In authorizing a housing voucher, alcoholics and drug abusers, and one-
Congress pledges money for only five third as people who are homeless for
years —the lifetime of the voucher. purely economic reasons.
In addition, vouchers provide the Thus the component of homeless
same housing at only half the price. people who are not affected by personal
A of public housing costs the
unit pathologies is large. It should also be
federalgovernment $8,000 a year, while noted that being a chronic alcoholic or
a voucher costs only $4,000. Thus, twice drug addict does not condemn a person
as many people can be reached with to living in the streets. Even "winos"
the same amount of money. This is why or "stumblebums" were able to find
HUD has been able to extend housing aid minimal housing in the pi
to more low-income people without an And so paradoxes remain. How can we
equivalent increase in spending. have such a large homeless population at
But if the liberal argument about a time when rental vacancy rates are near
"spending cuts" is based largely on postwarhighs? How can then be plenty
a misunderstanding of the budgetary of housing but not enou rdable
process, the conservative argument that housing"? In short, how can there be
homelessness has not really increased at scarcity in the housing market whf

allseems equally ill-founded. much ho;. il availab

There were indeed homeless people
long before 1980, and their numbers have VARI\MO\S AMONG
always been difficult to count. But it is HOISIM. MARKETS
hard to ignore the almost unanimous
reports from shelter providers (many Ihese ivhen
of them conservative church
old-line we recognize that the housing market i>
groups) that the problem has been getting not a national market but i^ instead the

steadily worse since 1980. The anecdotal sum ot many regional and local DMU
evidence is also abundant. Anyone who Rental I probabl.
80 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICA'S HOMELESSNESS?

the best measure of the availability ing demand even as their populations
of affordable housing, since most poor grew rapidly. Boston and San Francisco,
people rent. These rates vary widely on the other hand, have highly regulated
from city to city During the 1980s, rental housing markets. Both are surrounded
vacancy rates in Dallas and Houston were by tight rings of exclusionary suburbs,
rarely below 12 percent a figure that is— where zoning and growth-control senti-
about twice what is considered a normal ment make new construction extremely
vacancy rate. At the same time, housing difficult. In addition, both have adopted
has been absurdly scarce in other cities. rent control as a way of "solving" local
New York has not had vacancy rates over housing shortages. As a result, both have
3 percent since 1972. San Francisco had extremely high housing prices and ex-
normal vacancy rates during the 1970s, tremely tight rental markets. The median
but they plunged to 2 percent during the home price in each approaches $200,000,
1980s, where they remain today. while in Dallas and Phoenix the median
Since the poor tend to be limited in price is below the national median of
their mobility, vacancy rates significantly $88,000.
affect their ability to find housing. Thus it makes little sense to talk
Although southern and southwestern about a national housing market's effect
cities claim to receive a regular seasonal on homelessness. Local markets vary
migration of homeless people during the widely, and municipal regulation seems
winter months, there is little evidence to be the deciding factor.
that people are moving from city to This is what has misled both liberals
city to find housing. Other factors, like and conservatives. Conservatives look at
work opportunities, proximity to family the national superabundance of housing
members, and sheer inertia, seem to and conclude that local problems do not
dominate people's choice of locale. exist. Liberals look at local shortages and
What should be far more mobile is conclude that there is a national housing
the capital that builds housing and problem. In fact, housing shortages are a
has created such a superabundance in local problem created by local regulation,
specific cities. If it is difficult to find which is the work of local municipal
tenants for new apartments in Dallas governments.
and Phoenix, why don't builders shift to It is not surprising, then, to find that

Boston or San Francisco, where housing homelessness varies widely from city
is desperately needed? to city, with local housing policies once
Once we start asking this question, again the decisive factor. These conclu-
the impediments in the housing mar- sions are supported by research that I
ket suddenly become visible. It is obvi- conducted in 1988: 1 calculated compara-
ously not equally easy to build housing tive rates of per-capita homelessness for
in all cities. In particular, the local regula- various cities, using the homelessness fig-
tory climate has a tremendous impact on ures for the largest thirty-five cities in-
the housing supply Dallas and Houston vestigated in the 1984 Report to the Secre-

are free-wheeling, market-oriented cities tary of Housing and Urban Development on

with little or no zoning regulation and the Homeless and Emergency Shelters. I also
negligible antigrowth sentiment. They added fifteen other large cities that were
have been able to keep abreast of hous- not included in the initial HUD survey.
 YES William Tucker/ 81

I then subjected the comparative rates with their positions in correlation with
of homelessness to regression analysis, median home prices.
in order to look for possible associations Altogether, these data suggest that
with other factors. housing variables are a better indicator
of homelessness than are the traditional
Among the independent variables that
Iconsidered were the local unemploy- measures of unemployment, poverty,
ment rate, the poverty rate, city size, the and the relative size of a city's public

availability of public housing, the median housing stock. High median home prices
are usually found in cities with strict
rent, annual mean temperature, annual
rainfall, the size of the minority popu-
zoning ordinances and a strong no-
lation,population growth over the past growth effort. Cities with a tight ring
of exclusionary suburbs (such as Boston,
vacancy rate, the
fifteen years, the rental
presence or absence of rent control, and New York, Washington, San Francisco,
the median home price in the metropoli-
and Los Angeles) have high home
prices. Strangely enough, most have also
tan area surrounding each city.
adopted rent control.
Of all these variables, only four showed At the same time, rent control is closely
a significant correlation: the median
correlated with low rental vacancy rates.
home price, the rental vacancy rate, the
Every city in the country with rent control
presence of rent control, and the size of (except Los Angeles) has a vacancy rate
the minority population. The first three below 4 percent, while the average for
formed an overlapping cluster, with the cities without rent control is 01
median home price being the strongest percent.
predictor (accounting for around 42 When viewed historically, these low
percent of the variation, with a chance of vacancy rates are obviously the result
error of less than .001 percent). The size of rent control rather than its cause.
of the minority population added about When most of these cities adopted rent
another 10 percent. The total predictive all had vacancy rates
control in the 1970s,
value for both factors was 51 percent, around the norm of 6 percent. Rather than
with a margin of error below .00001 being spurred bv low vacancies, the rent-
percent. control ordinances that swept the East
When combined on a single graph and West Coasts during the 1970s were
(see Figure 1), the figures for the forty advert roe to inflation. The
cities for which all of the relevant data housing shoi mo later. (New York,
are available show a strong trendline for On the other hand, has had rent control
median home prices; the cities with rent when it was imposed a> part
control are predominantly clustered m of World War II price controls. Vacancy
the top right-hand quadrant. Of the tour \ but have
I

major with minority populations

cities been abo> e 5 percent rinoe t!
of more than 60 percent, the two ended; thev have been below 3 percent
rent control (Newark and Washington) the late 1960s.)

on the trend line, while the n these facta, the moot plausi-
are right
two without it (Miami and Detroit) an' ble explanation ot the relation Ol home-
the sole "outliers"— cities whose rates ol h median home |

homelessness do not seem to correspond And the Off

82 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICAS HOMELESSNESS?

Figure 1

Homelessness in Forty American Cities, Correlated with Rent Control, Size of

Minority Population, and Median Home Price
18

1 I I I I I I I I

40 50 70 80 90 100 110 140

Median Price of Home (in thousands of dollars)

I Cities with Minority Populations > 60 percent A Cities with Rent Control
• All Other Cities

(R = . 649; P<. 0001)

of rent control seems to be what might they try to compensate by imposing

be called "intense housing regulation." rent control, which they claim "protects"
Many cities, such as San Francisco, Berke- tenants from rising rents.
ley, and Santa Monica, have adopted But of course rent control makes things
rent control as part of municipal efforts only worse, by causing vacancy rates
to slow growth and stop development. to decline and apartments to become
These efforts are often aimed against much harder to find. The words of Assa
new housing construction, particularly of Lindbeck, the Swedish socialist (and now
apartments and rentals. chairman of the Nobel Prize Committee
for Economics) can hardly be improved
Since most communities that adopt no-
growth ordinances usually like to think upon:
of themselves as liberal-minded, they do The effects of rent control have in fact
not like to admit to limiting housing been exactly what can be predicted
opportunities for low-income people. So from the simplest type of supply-and-
 Y\ s William Tucker/83

—
demand analysis "housing shortage" hibited new development. The ordinance
(excess demand for housing), black mar- was eventually overturned in the Califor-
kets, privileges for those who happen nia courts in 1975. Then in 1978, Howard
to have a contract for a rent-controlled Jarvis made an ill-fated promise that
apartment, nepotism in the distribution
Proposition 13 would lower rents by re-
of the available apartments, difficulties
ducing property taxes. When rent reduc-
in getting apartments for families with
tions failed to materialize, angry tenants
children, and, in many places, deterio-
ration of the housing stock. In fact, next
in more than a dozen cities retaliated by
to bombing, rent control seems in many adopting rent control.
cases to be the most efficient technique As a result, housing in highly regu-
so far known for destroying cities. lated metropolitan regions around San
Francisco, San Jose, and Los Angeles has
become very scarce. At the same time,
ATTACKS ON GROWTH AND SRO'S homelessness has become a pronounced
problem. Santa Monica, which imposed
Perhaps the best place to see this syn-
rent control in 1979 as part of an in-
drome at work is in the San Francisco
tense antidevelopment campaign, has be-
area, which has some of the country's
come the homelessness capital of the
most intense and innovative housing reg-
West Coa.-t.
ulation and is also generally considered
Once growth control, tight zoning,
to be the center of some of the nation's
and rent control are in place, even
worst homelessness.
middle-class people may have trouble
It may be
hard to believe, but housing finding housing. A municipality in effect
prices in California in 1970 were no becomes a dosed community, open only
higher than the national average even — to its current residents (who either
though the state experienced astonishing experience remarkable run-ups in the
population growth during the 1950s value of their homes or live at rents
and 1960s. It was not until the wave far below market) and people with
of environmental regulation and no- strong inside connections. Mark Kann's
growth sentiment emerged in the 1970s 1986 book Middle I ttiaUi sm in
that housing prices began to climb.
'

San til
Throughout California, the increase in the city's housing polk
home prices has consistently outpaced a "woman who tried to gel a !

the national average over the last two Monica apartment for more than I
decades. By 1988, the median price for a without success[;]... *t*B broke into the
home stood at $158,000 there, in contrast citv,finally! by mar: rone who
to the nationwide figure of $88/3 already had an apartment th<
the highly regulated San Francisco Has growth ordinances and rent control
area, the median was $178,000, more than have not, of com tnbraced every-
twice the national median. where; but city administrations have of-
California also experienced a wave ten produced comparable n'sults through
of rent-control ordinances in the I
intense housing-code ontoivemer.'

Berkeley adopted rent control in Irive "undesirable homing

shortly after imposing a "neighborhood (mk\ the people who li\ e in it) out ot their
preservation ordinance" thai all but pro- jurisdictions.
84 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICA'S HOMELESSNESS?

In New Homeless and Old: Community and incorporated into dra-

cial scientists,

and the Skid Row Hotel, Charles Hoch and matic change-oriented programs like ur-
Robert Slayton have traced the disap- ban renewal.
pearance of the single-room occupancy
7
Nor have these policies abated today.
(SRO) and ''cubicle hotels that once pro-
'

Despite the hue and cry over the loss of

vided cheap housing to thousands of
SRO hotels, their replacement is still gen-
marginal tenants in downtown Chicago.
erally forbidden by zoning ordinances. In
Over 8,000 of these hotel rooms^still
Los Angeles, there is a movement afoot to
available to Chicago's low-income tran-
sients in 1963 —
have disappeared, leav-
close down SRO hotels —
even those sub-

ing barely 2,000 today. These lost ac-

sidized by the city government because—
they are not built to withstand earth-
commodations were all supplied by the
quakes. Peter Smith, president of the New
private market. Although remarkably in-
York City Partnership for the Homeless,
expensive (often costing only $2 a night),
comments: "It's essentially illegal for pri-
these rooms offered residents exactly
vate developers to build SRO hotels in
—
what they wanted security and privacy.
New York anymore."
Most of the hotels had elaborate security
systems, with desk clerks screening vis-
itors and protecting residents from un- RESTRICTING DEVELOPMENT
wanted ones. In addition, the cheap ho-
tels were usually convenient to stores What is causing homelessness, then, is

and public transportation, allowing low- the familiar phenomenon of government

income residents with few family connec- regulation. This regulation tends to

tions to lead frugal but relatively digni- escape the attention of the public and the
fied lives.
enthusiasts of deregulation, because it is
done at the local rather than the state or
What happened to these old SRO ho-
national level.
tels? Almost without exception, they be-
came the target of urban-renewal efforts The truth is that cities and towns do
and municipal campaigns to "clean up not always welcome new development.
downtown." Intense building-code en- At bottom, even the most enthusiastic
forcement and outright condemnation advocates of progress would often prefer
drove most of them out of business. Strict to see their ownneighborhoods remain
just as they are. People will usually
zoning ordinances have since made it vir-
settle for higher-priced housing, because
tually impossible to build replacements.
it raises the value of their own homes;
Hoch and Slayton conclude:
but few want tenements, rentals, or other
We do not believe that the demise of forms of "low-income" housing.
Skid Row and the SRO hotels was the
Through regulation, most cities and
inevitable result of market forces, or that
towns hold a tight rein on their hous-
Skid Row residents embodied peculiar
ing markets. Suburbs are particularly ex-
social and psychological characteristics
clusionary, zoning out everything but
that produced deviant and pathologi-
cal social behavior. . . . [Instead,] this loss
high-priced single-family homes (which
was the result of decades of antago- require large lot sizes), and prohibiting
nism from civic and business leaders, the rental of rooms or apartments. Cities
legitimated from the 1950s on by so- themselves, although sometimes offering
 YES William Tucker/ 85

rhetorical welcomes, often play the same trict, a notorious skid row. Although not
exclusionary games. particularly dangerous, the surroundings
An example can be seen in Takoma were decidedly unpleasant. Weather-
Park, Maryland, a nineteenth-century beaten young men, each of whom seemed
"streetcar suburb" of Washington, D.C., to have his entire worldly belongings
which until recently had a long history of wrapped in a sleeping bag, lounged
tolerant housing policies. Takoma Park is along the sidewalks. Ragged holdovers
a hodgepodge of two-, three-, and four- from the sixties perched on public mon-
family homes within easy commuting uments, performing drunken imitations
distance of Washington. During World of rock singers. Veterans of motorcy-
War II, homeowners rented attics and cle gangs weaved past timid pedestri-
spare bedrooms to wartime officials who ans, carrying on garrulous arguments
could not find housing in Washington. with their equally disheveled girlfriends.
This tradition continued after the war, Along the side streets, tattoo parlors
when many returning GI's sought hous- jostled with cheap cafeterias, pornogra-
ing while attending nearby Columbia phy shops, and the inevitable flophouse
Union College. Many homeowners per- hotels.
manently converted their homes to two- It is easy enough to imagine some

and three-family units. ambitious politician surveying the scene

During the 1970s, however, a group and deciding that it was time to "clean
of homeowners living in a recently up Market Street." Such campaigns have
constructed, more suburban part of occurred all over the country and have
the city asked Montgomery County to inevitably produced the disjuncture that
enforce a sixty-year-old zoning ordinance we now find between the supply of
that prohibited rentals in single-family housing and the price that poor people
zones. (Zoning is controlled by county can afford to pay for it.
governments in Maryland.) After a long Yet distasteful as it may seem, skid
dispute, the city council adopted a rows play a crucial role in providing the
compromise in 1978, which permitted poor and near-poor with cheap housing.
anyone who was renting before 1954 to Not everyone can live in suburban sub-
continue to do so for another ten years. In divisions or high-rise condominiums. To
1988 the reprieve expired, however, and provide tor evervone, we also need :

evictions began. More than six hundred for rent, fleabag hotels, tenements, trailer

tenants were forced to leave their homes. parks —

and the "slumlords" who
run them. Although usuallv imagined
to be rich ,md powerful, these bottom-
THE APPEAL OF UTOPIANISM rung entreprcneurs almost always turn
It is important to realize that housing out to be only slightly more affluent than
regulations are to blame for a lot of .% horn they are providing
homelessness. But at the same tinu housing.
must acknowledge the impulses that In the Utopian dreams of regulators

make people want to intervene in the "housing acth I

landlords ire
I 4

housing marketplace. always elimm.r .tahly

About a year ago, -pent I a tew tkya nmcnfl and

in San Francisco's Market S the'r. .

b) thedry
86 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICA'S HOMELESSNESS?

planners and visionary architects who tear down the old "substandard" housing
would "tear down the slums" and replace that no longer needed. If we let the
is

them with "model tenements" and the best become the enemy of the good or —
"garden cities of tomorrow." —
even the barely adequate the homeless
It is not wrong to have such visions. But will have nothing more substantial to
let us do things in stages. Let us build live in than the dreams of the housing
—
the new housing first and only then visionaries themselves.
 .

NO Richard P. Appelbaum et al

SCAPEGOATING RENT CONTROL

MASKING THE CAUSES
OF HOMELESSNESS
The would withhold
U.S. Congress has recently considered legislation that
federal housing funds from the numerous locales that have adopted rent
control. Such legislation is supported by HUD [Department of Housing and
Urban Development] Secretary Jack Kemp, who strongly believes that rent
control is needed investment in
partly responsible for discouraging badly
rental housing. Sixteen states currently have laws that restrict the ability
of localities to enact rent control, while another 29 have been targeted for
such laws by the National Apartment Owners' Association and the National
Multi-Housing Council. While the belief that rent control has adverse conse-
quences for housing markets has long been advanced by housing economists,
a new claim has recently emerged in support of anti-rent control legislation:
the assertion that rent control should be dismantled because it is the chief
underlying cause of homelessness. The evidence for this claim can be traced
to a single study by journalist William Tucker (1987a, 1987b, 1989a, 1989b).
Since homelessness is such a visible national issue, local rent regulations
— affecting millions of tenants nationwide —
are more vulnerable to federal
anti-rent-control legislation than at any time in the recent past. . .

Despite the widespread attention it has received, Tucker's research

ously flawed. The link between rent control and homelessness it purpo:
demonstrate does not withstand serious scrutiny. Given the political 001
in which the research appears, the following critique of Tucker's the-
doubly important. Unchallenged, Tucker's work represents a serious threat
to local rent control by linking it with a national problem of high concern.
Pointing the finger at rent control can onlv divert attention from I
uncover and address the actual causes of hoir.
effort to
The growth of homelessness during the 1960s is not linked with t!
by a handful of local governments to regulate skyrocketing tents. Iome\ 1

ness is directly related to the overall level the availabilr

affordable housing, and to the accessibility ot sup- ople

From Richard P. AppdKuim. Michael IV!- and John I

"Scapegcmtin^ Rent Control: Masking t!

Platu;
Association. Reprinted by penni
88 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICA'S HOMELESSNESS?

suffering from mental illness or alco- rentalhousing stock is estimated to be

holism. It is no accident that the num- covered by some form of rent control
ber of homeless Americans increased (Baar 1983). Current rent control mea-
dramatically during the 1980s. The past sures can be categorized as moderate,
decade has witnessed growing poverty, in comparison with the more restrictive
especially among the " working poor"; rent control that was in effect in New
a decline in low-rent housing, including York City during the immediate postwar
sharp cuts in federal low-income hous- period.
ing assistance; and a failure to adequately
Moderate rent controls permit rent
serve the deinstitutionalized mentally ill.
increases sufficient for the landlord to
As a result, since the early 1980s the
maintain an adequate return on invest-
homeless population has increased be-
ment, while protecting tenants against
tween 20 and 25 percent a year, according
rent gouging. All ordinances currently in
to the U.S. Conference of Mayors annual
effect aremoderate in nature. Such con-
surveys (1989, 2). Moreover, the profile
trols typicallypeg annual rent increases
of the homeless population includes a
to increases in the landlords' costs, and
growing number of families with young
exempt newly constructed rental units
children, as well as individuals with jobs
from controls altogether. They also often
(U.S. Conference of Mayors 1989).
require adequate maintenance as a con-
This assessment of the underlying
dition for annual rent adjustments: ten-
causes of America's homeless problem
ants in buildings that are inadequately
would seem to suggest fairly straightfor-
maintained can appeal their rent in-
ward remedies directed at increasing the
creases. Some rent control laws permit
wages of America's working poor, ex-
vacated units to be temporarily decon-
panding the supply of affordable hous-
trolled so that rents can be raised to
ing, and providing residential and social
market levels for incoming tenants, af-
support programs for the nation's men-
ter which they are recontrolled. Moder-
tally ill. A comprehensive examination of
ate rent controls thus contain a number
the evidence gives no support to the claim
of provisions explicitly designed to en-
that rent control is the root cause of home-
courage both construction of new rental
lessness in the United States
housing and maintenance of existing
units.
THE EFFECT OF RENT CONTROL In a few highly inflationary California
ON INVESTMENT IN housing markets, some controls are
RENTAL HOUSING
coupled with an additional provision:
Two hundred cities and counties cur- they exclude increased mortgage costs
rently have some form of rent regulation. from the formulas relating landlords'
This group includes over 100 communi- costs and allowable rent increases. This
ties in New Jersey, as well as cities and provision isdesigned to discourage
counties in Massachusetts, New York, speculation in rental housing. Under such
Virginia, Maryland, Alaska, Connecticut, an exclusion, a landlord who has incurred
and California. Most of these ordinances increased capital costs (either through
were first enacted in the early 1970s. Ap- recent purchase or through refinancing
proximately 10 percent of the nation's to obtain equity capital) cannot pass the
 g

NO Richard P. Appelbaum et al. / 89

higher financing costs through to tenants highly effective in communicating this

in theform of rent increases. analysis to its members and the media.
In sum, current rent controls contain Major news organizations, including the
provisions that are intended to guarantee Wall Street Journal and Forbes magazine,
the landlord a fair and reasonable rate have editorialized against rent controls
of return on investment, while protect- (Gilderbloom 1983).
ing the interests of tenants by preserv-
ing affordable housing. Maintenance is

strongly encouraged; newly built units Numerous empirical studies have been
are not controlled at all. conducted on the effects of moderate rent
Nonetheless, critics continue to argue control on rental housing investment;
that rent control discourages investment none support the views just described. A
in rental housing. According to Tucker comprehensive review finds that such
. . .

(1987a, 1987b, 1989a), for example, lo- controls have not caused a decline in con-
calities that enact rent control rob land- struction, capital improvements, mainte-
lords of their rightful returns. So de- nance, abandonment, or demolition of
prived, landlords cut costs. Maintenance controlled units relative to noncontrolled
abandoned. Badly
suffers; buildings are ones. This because of the nonrestric-
is

needed new units are never constructed. tive nature of moderate controls, which,
Although rents may be lowered in the as we have seen, guarantee landlords a
short run, the argument goes, housing fair and reasonable rate of return. Rent

scarcity eventually results. Scarcity, in controls eliminate extreme rent increases,

turn, causes homelessness. In posh ar- particularly in highly inflationary mar-
eas like Santa Monica, Cambridge, or the kets, but they do not eliminate the prof-
Upper West Side of Manhattan, yuppies its necessary to encourage investment

squeeze out low income tenants in the in private rental housing (Gilderbloom

fight for scarce apartments. In blighted 19S4, 1986; Heffley and Santerre 1985;
areas like the South Bronx, buildings are Mollenkopf and Pynoos 1973; Daugh-
abandoned, and eventually razed by ar- erbaugh 1975; Vitaliano 1983). In par-
sonists or government bulldozers. Either ticular, the vacancy decontrol-recontrol

way, says Tucker, the poor are relegated .on in some localities results in

to the streets and shelters. significantly higher avenge rents than

This analysis not original to Tucker;

is those that would occur in the ab

on the contrary, shared by a number

it is of such a pro\ '.derbloom and
of housing economists as well as many Keatir iartman I k and
people in the real estate community. For He>k. .dell 1961
example, ten years ago a national survey Rent StabflJ
of economists found virtually unanimous moderate rent control i- :ul in

agreement that "a ceiling on rents reduces eliminating exorbitant pent BM

the quantity and quality of hous in impact on redistributing income trom
able" (Kearl et al. 1979). These conclu- landfc

sions are not based on empirical stud- to which market conditions

ies,but on theoretical assumptions about would otherwise have led to real e>

how housing markets are supposed to d the allowable

operate. The real estate lobby has been rent U

 —
90 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICA'S HOMELESSNESS?

eas over 250,000 in population: Day-

RENT CONTROL AND
ton, Davenport, Colorado Springs, Scran-
HOMELESSNESS:
ton, Raleigh, and Baton Rouge. These
TUCKER'S ANALYSIS
six places were reportedly eliminated be-
Tucker's study is the first to look at the cause of "the great difficulty in determin-
impact of rent control on homelessness. ing local vacancy rates" (Tucker 1989a,
In order to support his argument that 5, n. 4).For unexplained reasons, Tucker
rent control produces homelessness by then added to his list one of HUD's small-
discouraging investment and thereby est (under 250,000) metropolitan areas
creating housing scarcity, Tucker sought Lincoln, Nebraska. He also mistakenly
to show that cities with rent control classified Hartford as a city with rent con-
had lower vacancy rates and greater trol. Finally, he added 15 additional cities
homelessness than cities without rent "to include some notable HUD omis-
control. sions" (1987a, 1); he does not explain how
For his primary data set, Tucker relied these cities were selected out of thou-
on the single comparative study of home- sands of possible places across the United
lessness that had been done at the time were not a part of
States. Since these cities
—
of his study the HUD survey of home- HUD's original study, Tucker developed
lessness in 60 metropolitan areas (1984). his own homeless estimates by making
HUD had conducted a random sample telephone calls to unspecified informants
of 20 cities in each of three size strata in each city. This misguided sampling
(50,000- 250,000; 250,000-1,000,000; and methodology yielded a final list of 50
over, 1,000,000). For each city, HUD tele- places for his analysis.
phoned people they labeled "knowledge- Once he had obtained his list of places,
able informants" and asked for their Tucker identified factors that might be
estimates of the homeless street popu- important determinants of homelessness.
lation in their areas. (Shelter estimates He originally chose rates of poverty,
were more accurately obtained from in- unemployment, public housing avail-
formation provided by shelter operators.) ability, and rental housing vacancy; to-

The various estimates for each locale tal population; mean annual tempera-
were then combined into an average fig- ture; and the presence (or absence) of
ure that was weighted to reflect the pre- rent control. Two additional variables
sumed reliability of the different sources. population growth rate and mean an-
Tucker took the HUD estimates for the —
nual rainfall are employed in a recent
40 metropolitan areas in the two largest study (1989a) but apparently not in the
strata. He then computed a homeless rate original studies (1987a, 1987b); nonethe-
for each city by dividing HUD's esti- less, the appendix in the recent study

mate of the total number of homeless by reports only the seven original vari-
the population of the core city for each ables. High rates of poverty and unem-
metropolitan area. ployment are indicative of an economi-
Tucker did not rely exclusively on cally marginal population, and therefore
HUD's random sample of places; rather, should be associated with greater home-
he modified the HUD sample in sev- lessness. Public housing availability, on
eral ways. First, he dropped six cities the other hand, provides one form of
from among HUD's 40 metropolitan ar- protection against homelessness, and so
 NO Richard P. Appelbaum

should be associated with lower rates. Worcester, which ranks fourth. T. ,act
Low vacancy rates indicate scarcity in that three out of four places with the most
the private rental housing market, and severe homeless problems lack rent con-
— —
according to Tucker should be asso- trol would seem to provide a prima facie
ciated with both rent control and home- case for rejecting Tucker's claim out of
lessness. Larger, faster-growing places hand.
may well attract the unemployed with The major difficulty in Tucker's
first

the lure of jobs, thereby contributing to study with his use of HUD's mea-
lies

homelessness in such cities. Finally, lo- sure of homelessness (1984) as his key
cales with warm temperatures and low variable. According to two congressional
rainfalls have an obvious appeal to the hearings that examined HUD's methods
homeless. measure was highly un-
in detail, that
Having selected these key variables, reliable. HUD relied on what it called
Tucker employed them in two- and three- "knowledgeable informants" police de- —
variable regression equations predict- partments, social service agencies, shelter
ing homelessness. While his results vary staffs — who simply t the num-
somewhat among his various reports, he bers of homeless people in the 60 ar-
generally found that the only variables eas HUD reviewed. There was no ac-
that made any substantial difference in tual count of the number of homeless
the rate of homelessness were the lo- in the streets, park benches, abandoned
cal vacancy rate and rent control —and cars, and elsewhere —and certainly no es-
that the latter statistically accounts for timate of the "invisible" homeless tem-
much of the impact of the former. In fact, porarily living in overcrowded apart-
Tucker found that rent control by itself ments with friends or relatives. Although
explains fully 27 percent of the differ- the guesses were mainly for downtown
ence in homelessness among cities; when neighborhood-, HUD acted as if they
combined with mean temperature, it ac- applied to much larger metropolitan
counts for 31 percent. According to these —
areas Rand McXallv marketing areas
findings, homeless people are attracted (RMAs), areas with four or five times
to cities with hospitable climates; when as many people. This method, not sur-
such places have rent control, increased prisingly, produced verv low ml
housing scarcity is assumed to result, and homelessness tor the metropolitan ar-
— —
with it greater homelessness. eas HIP studied, since they guaran-
In evaluating Tucker's findings, it is teed that homeless people outside the
important to bear in mind that he clas- downtown areas would be excluded from
sified only 9 of the 50 cities as having the Study Tucker's principal variable,
any form of rent control at all. Since all therefore, substantially undercount> the
of the cities had homeless problems to homeless.
varying degrees, it is obvious that rent 1 he Second majOI problem result-
control cannot be the principal cau the questionable pi by which
homelessness, as Tucker contend- Mi- Tucker arrived at his 5 which
ami, with the highest rate of homekss- .% ill be demonstrated in the next

ness in the cities under study, does not section ot this utk '.

his results

currently have rent control ondusfon

St. Louis, which ranks second w\ w ith HUD's ran-
 —
92 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICA'S HOMELESSNESS?

dom sample of 40 medium and large Committee of Congress 1988, ch. VII). The
metropolitan areas, added one smaller largest increase is among the "working
HUD metropolitan area, selectively elim- —
poor" people who earn their poverty
inated six places, and then added 15 oth- on the job because of low wages.
ers of his own choosing. Since only five of Among the "welfare poor" primarily—
HUD's cities were among the more than single mothers and their children Aid —
200 places with rent control, Tucker made to Families with Dependent Children
certain that three rent-controlled cities (AFDC) and other benefits have declined
were included among those he added. far below the poverty level. These are
But sampling problems are compounded people who are only one rent increase,
by the fact that the three rent-controlled hospital stay, or layoff from becoming
cities he added are already presumably homeless. In fact, a recent report by
included in HUD's homeless estimates: the U.S. Conference of Mayors (1989,
Newark and Yonkers are part of the New 2) found that almost one-quarter of the
York City metropolitan area, while Santa homeless work, but simply have wages
Monica is part of Los Angeles. too low to afford permanent housing.
Tucker's third major error is his failure The plight of the poor is worsened
to consider the possibility that high rents by the steadily rising housing costs that
might themselves be a chief cause of have plagued the economy throughout
homelessness, while at the same time the past decade (see U.S. Comptroller
causing tenants to demand rent control. General 1979 for an early announcement
In other words, his reported correlation of the housing crisis). On one hand, rising
between rent control and homelessness homeownership costs have forced many
might be an artifact of the association of would-be first-time buyers into the sta-
both with high rents. He nowhere looks tus of reluctant long-term renters, greatly
at the possible causal effect of rent on increasing pressures on the rental hous-
homelessness ing market. Homeownership rates have
been declining steadily since 1980, par-
ticularly among first-time homebuyers.
WHY DO WE HAVE A Among households where the head was
HOMELESSNESS PROBLEM? under 25, for example, ownership has de-
The United States now faces the worst clined from 23.4 percent to 15.1 percent
housing crisis since the Great Depression. of all households, a drop of 36 percent;
The underlying problem is a widening for those headed by someone aged 25 to
gap between what Americans can afford 34, the decline has been from 51.4 per-
to pay and what it costs to build and cent to 45.1 percent, or 12 percent (Ap-
operate housing. In this situation, the gar 1988, 24). In 1973, took 23 percent
it

poor are the most vulnerable to joining of the median income young fam-
of a
the ranks of those without a home. ily with children to carry a new mort-

The number of poor Americans, now gage on an average-priced house. Today,

about 33 million people, is growing, it takes over half of a young family's in-

and the poor are getting poorer (Center come (Children's Defense Fund 1988, 57).
on Budget and Policy Priorities 1988, On the other hand, renters confront
1; Children's Defense Fund 1989, 16- chronic production shortages and ris-

26, 100-106, 115; U.S. Joint Economic ing rents. Between 1970 and 1983 rents
 —

NO Richard P. Appelbaum et al. / 93

tripled,while renters' income only dou- mediately at risk of being homeless. And,
bled. As
a result the average rent-income while the number of poor families has
ratio grew from roughly one-quarter to risen during the 1980s, the number of
one-third; the proportion of tenants pay- low-rent private apartments has plum-
ing 25 percent or more income into rent meted as a result of rising rents, urban
increased from one-third to one-half. By redevelopment activities, condo conver-
1985, close to one out of every four renters sions, and arson. Between 1974 and 1985,
paid over half of their income for housing the number of privately owned, unsub-
costs. Eleven million families now pay sidized apartments renting for less than
over one-third of income on rent; 5 mil- $300 (measured in 1988 dollars) fell by
lion pay over half. one-third, a loss of nearly 3 million units
The problem is especially acute for (Apgar et al. 1989, 4). The swelling wait-
the poor, who are now competing
with ing lists even the most deteriorated
of
the middle class for scarce apartments. subsidized housing projects are telling
It is estimated that by 1985 there was evidence of the desperation of the poor
a national shortage of some 3.3 million looking for affordable homes.
affordable units for households earning The already existing shortages of af-
—
under $5,000 an increase of more than fordable private housing sened
80 percent since 1978 (Leonard et al. considerably by the short-sighted actions
1989, 9). Among the nation's nearly of the Reagan administration. The 1986
7 million poor renter households, 45 Tax Reform Act, for example, removed
percent spent more than 70 percent of many of the tax benefits that previously
their income on housing in 1985; 65 made it profitable for the private sector
percent paid more than half; while 85 to rent housing to poorer families. It is
—
percent some 5.8 million households estimated that the loss of tax shelters for
paid more than the 30 percent officially housing will eventually reduce the value
regarded as "affordable" under current of income property by 20 percent, forcing
federal standards. The median tenant compensating rent increases ol !

household paid almost two-thirds of its by the early 1990s, The National Asso-
income on rent (Leonard et al. 1989, 1- ciation of Home Builders predicted that
2). The typical young single parent pays rental housing construction would de-
81 percent of her meager income just to cline by halt as a direct Result (Furlong

keep a roof over her children's heads 1986, 16); an MIT market simulation pre-
(Children's Defense Fund 1988, 59). dicted an eventual loss of 1 .4 million units
Despite the severity of these problems, (Apgar etal. 198
less than one-third of poor households The Reagan administration's budget
receive any kind of housing subsidy cutbacks virtually Ipublicly 1

(Leonard et al. 1989, 27; U.S. Con owned and subsidized housing, all but
sional Budget Office 1988, 3). This hous- eliminating the already mall ft
ing subsidy level is the lowest commitment to providing housing for the
dustrial nation in the world. Some 6 to .;rams

7 million low-income renter tamil. cut in general, but housil lected

ceive no housing assistance whats< II the brunt oi budgi

and are therefore completely al the D men! il ex-

of housing markets that place them nn- penditures tor subsidized housing de-
94 / 5. ARE RENT CONTROLS THE CAUSE OF AMERICA'S HOMELESSNESS?

clined by four-fifths, from $32 billion to thisunfolding tragedy. According to one

$6 billion. Total federal housing starts de- estimate (Clay 1987, i), by 2003 "the

clined from 183,000 in 1980 to 20,000 in gap between the total low-rent housing
1989 (Low Income Housing Information supply (subsidized and unsubsidized)
Service 1989). The administration even and households needing such housing is
proposed to sell off 100,000 units of pub- expected to grow to 7.8 million units,"
lichousing, an effort that was stymied representing an affordable housing loss
largely because public housing tenants for nearly 19 million people. This figure
were too poor to afford their units. A represents the probable constituency of
number of specific programs, including the homeless, as the United States moves
several directed at the needs of the home- into the twenty-first century.
less, were "zeroed out" in the 1989 bud- On its own, rent control can't solve

get. It should be pointed out that, as the housing crisis. It is merely one
severe as these measures may appear, tool available to local governments for
President Reagan's proposed cuts were confronting skyrocketing rents and a
still deeper: philosophically committed shortage of affordable housing. Tucker's |

to ending federal involvement in hous- study does not demonstrate what it sets
ing altogether, he was prevented from out to do, and so cannot be used to justify
doing so only by the lobbying efforts of a scapegoating of rent control for the
low-income housing advocates before a mounting tragedy of homelessness.
Democrat-controlled Congress. A single
statistic tells unambiguous
the story in
AUTHOR'S NOTE
terms. When President Reagan came to
office in 1981, the federal government We would like to thank Jon Lorence
spent seven dollars on defense for every and William Bielby us special
for giving
dollar on housing. When he left office in assistance in the analysis of this data.
1989, the ratio of dollars spent was 46 to Carrie Donald, Gary Dworkin, Neal
one. King, and Bob Nideffer also provided
In sum, declining incomes at the important technical assistance. Special
bottom have converged with rising thanks go to Kevin Quinn and the staff
housing costs to produce a potentially of the Economic Policy Institute, who
explosive situation, which unwise short- published an earlier version as a briefing
term federal policies have served to paper. Authors are listed in alphabetical
worsen. Rent control plays no role in order.
POSTSCRIPT
Are Rent Controls the Cause of
America's Homelessness?

This is a debate where the protagonists defend their positions with reasoned
arguments and evidence. But note, the provision of statistical ev-
statistical
idence can be subject to challenge. Your task here is to bring critical
itself
questions to bear on the statistics used as you untangle the conflicting claims
made in these two essays. Which essay provides the most reasonable set of
assumptions? Which analysis employs data that are least subject to question?
Which set of conclusions is justifiable?
These are not easy questions to answer. Yet if we do not attempt to system-
atically examine the assumptions, data, economic theories, and conclusions
of empirical studies such as those of Tucker and Appelbaum et al., we would
simply allow our uninformed preconceptions to determine which argument
we would accept as the foundation for the public policy we endorse. If we
lean toward the conservative, free-market camp, we might be inclined to
accept unquestioningly Tucker's analysis, since it suggests that government
interferences in the market rent controls cause the social problem of home-
lessness. If, on the other hand, we find ourselves sympathetic toward the
liberal, institutional, or even the radical view of econom: ^uld tend
to accept without question the Appelbaum et al. work, since they suggest
that the interference-free market fails to provide affordable housing to the
large majority of individuals and families who find themselves homeless.
By now we hope we have convinced you that a knee-jerk reaction is never
correct. That means that, on occasion, we must reject the arguments of some
researchers, even if we want to believe them.
To help you make this determination, we suggest that you look at other
published work in this area. In the anti-rent control camp you will find noted
housing authority Anthony Downs, Residential Re?it Controls: An Evaluation
(Urban Land Institute, 1988). You will also find other works published by
Tucker, since his work provides the empirical foundation tor the anti-rent
control camp. See, for example, The Excluded . Homelessness and
Housing (Regnery Gateway, 1990) and Th
Policies
Problem: Look in Your Own Back Yard, Policy Analysis Series, no. 127 (Cato
Institute, February 6, 1990). On the other side w e suggest that you read some
of the other work published by Appelbaum and Gilderbtootn. Among Other
contributions to this literature, Appelbaum has published Rent 1

Not Fiction (California State Senate Rules Committee, 1990). GUderbloOD

also written widely in this area, including logy of Rent,"
Social Problems (vol H no, 3, L!
ISSUE 6
IsManaged Competition the Cure for
Our Ailing Health Care System?
YES: Paul M. Ellwood Jr. and George D. Lundberg, from "Managed Care:
A Work in Progress/' Journal of the American Medical Association (October 2,
1996)

NO: John H. McArthur and Francis D. Moore, from ''The Two Cultures
and the Health Care Revolution: Commerce and Professionalism in Medical
Care," Journal of the American Medical Association (March 26, 1997)

ISSUE SUMMARY
YES: Physician and long-time advocate of managed health care Paul M.
Ellwood Jr. and George D. Lundberg, an editor of JAMA (The Journal of the
American Medical Association), argue that it is unrealistic to expect a return to
unmanaged, autonomous, fee-for-service medicine.
NO: Harvard Business School professor John H. McArthur and Harvard Med-
School professor Francis D. Moore warn that, if unchecked, professional
ical
commitment to patient care will be subordinated to new rules of practice that
ensure the profitability of the corporation.

A quiet revolution has taken place in our health care industry. Overnight we
have gone from a fee-for-service system, where health care users (consumers)
had maximum choice and doctors and hospitals (producers) had maximum
autonomy, to a system of health maintenance organizations (HMOs) and pre-
ferred provider organizations (PPOs), where both consumers and producers
of health care are subject to the discipline excercised by those who pay for
the large majority of privately provided health care: the insurance industry.
The results have been remarkable. In the 30 years from 1965 to 1995, the
consumer price index (CPI) for all items increased almost fivefold. The cost
of health care, on the other hand, increased nearly tenfold. Yet, if we compare
the all-item CPI and the medical care sector of the economy since 1993, the
rate of inflation in the latter sector has fallen each year so that by 1996 it is

actually less than the overall rate of inflation in the economy.

Those who would like to blame the government for all the problems in
our economy are quick to point out that the public sector is no stranger to
the health care industry. For more than 30 years the U.S. government has
actively shaped both the supply and the demand for services in this industry.
Although governmental involvement can be traced back to the passage of the

96
personal income tax in 1913, which explicitly excluded the cost of employer-
—
provided, health insurance fringe benefits from taxation a policy which
—
reduced the relative price of health care most agree that the real impact of
government was not felt until the mid-1960s.
In an attempt to provide access to the U.S. health care system for the aged
and often poverty-stricken retired population, Congress amended the Social
Security Act in 1965 and created what is known as Medicare. A short time
later, it extended these benefits to the non-aged poor by passing Medicaid.

These two pillars of President Lyndon B. Johnson's War on Poverty brought

about fundamental changes in the health care industry. Few can deny that
some of these changes were good. Indeed, large numbers of American cit-
izens were provided with much-needed health care, which they could not
otherwise have purchased. But few can also deny that this government in-
trusion into the marketplace set in motion a tidal wave of price increases in
the industry that are easily discernible four decades later.
These increases in price and relatively small (but very significant) increases
in consumption of medical services have had major consequences. Consider
how much of the U.S. income is devoted to health care. In 1965 it was 5.9
percent. By 1992 it had skyrocketed to 14 percent. Some estimated that with-
out intervention it might have reached 19 percent of the nation's total gross
domestic product (GDP) by the year 2000. In the face of these rapidly ris-
ing health care costs, President Bill Clinton proposed a new federal initiative:
managed health care. This ambitious program, designed to provide universal
coverage, was a market-based system that attempted to preserve consumer
choice and build upon the employer-based private insurance system that was
already in place. When the president's proposals were defeated by Congress,
employers took matters into their own hands. They turned to the insurance
industry, demanded lower costs, and threatened to take their business else-
where if demands were not met.
their
Seemingly overnight, doctors who were in a solo practice or who practiced
in small groups found that if they did not join an HMO or a PPO, the large
insurance carriers that represented the major employers in their community

would not cover their medical charges. Indeed, when they did join t:
groups out of necessity, they found that they had to agree to I fixed, often
low, price for their services and abide by a set of medical policies established
by the HMO or PPO.

97
 Paul M. Ellwood Jr.
YES and George D. Lundberg

MANAGED CARE: A WORK IN PROGRESS

The modern JAMA [Journal of the American Medical Association] has been work-
ing toward comprehensive American health system reform since 1987, em-
phasizing cost control, access for all, and promotion of quality. One of us 1

(P.M.E.) has been developing market-based health system thinking for more
than 25 years. 2 The concept of managed care is hardly new. The Kaiser plans
began in the American West in the 1930s. 3 The massive reform that has oc-
curred in the 1990s has been phenomenal and largely unpredicted, although
much of it has been called for by many authors. 4 6 Many patients, providers,
"

and purchasers alike consider the system to be in turmoil, some even in chaos.
But movement is profound and irreversible, at least in the short run.
As we go forward, we believe that physicians should be more involved
and influential in determining where the American health system is going. It
is unrealistic to expect to return to unmanaged, autonomous, fee-for-service

medicine where those who paid the bill often exerted little influence over
medical practice. We should expect a more integrated, selective, epidemio-
logic data-dependent, and consumer-driven health system. We physicians no
longer have a health system that was built by us and sometimes for us.
The new American health system works. It has contained costs, it provides
easily accessible comprehensive health care to its insured members, and, on
the whole, it has not yet jeopardized quality. But patients, physicians, the

uninsured, and the country deserve better. The American health system is a
work in progress; it can and, we believe, will get better.

ORIGINS OF THE NEW AMERICAN HEALTH SYSTEM

Only 5 years after the establishment of Medicare, the Nixon administration
became alarmed by the program's unanticipated run-up costs. Searching for
remedies, the leadership of the Department of Health, Education, and Welfare
in 1970 found — —
and the president accepted a unique American approach to
health reform combining social insurance with market forces.

From Paul M. Ellwood Jr. and George D. Lundberg, "Managed Care: A Work in Progress/' Journal
of the American Medical Association, vol. 276, no. 13 (October 2, 1996), pp. 1083-1086. Copyright ©
1996 by The American Medical Association. Reprinted by permission.

98
 .

YES Ell wood and Lundberg/99

The idea, labeled the "health main- tioned to manage a carefully selected pro-
tenance strategy/' 7 was to allow Medi- fessional workforceand its attendant in-
care beneficiaries to make a choice be- formation systems and capital resources
tween health maintenance organizations to produce more consistent health value
(HMOs) and traditional fee-for-service for patients and purchasers. The health
systems that were competing on price delivery function was so much more cen-
and quality. It was anticipated that tral, and difficult to manage, than the

the government's actions would cat- marketing and insurance activities that
alyze similar restructuring in the private, physician leadership in managing the
largely employer-financed segment of the health enterprise seemed assured but it —
j
health economy that also was having dif- was not guaranteed by law or precedent.
coping with medical inflation.
ficulty Beyond the structural arrangements
HMOs were designed to take
The and the distribution of power and
2 forms: nongroup independent prac- revenue so important to the supply side
tice associations (IPAs) favored and pi- of health care, the demand side of the
oneered by medical societies in the health maintenance strategy represented
far West, and prepaid group practices much more of an experiment. Would
(Kaiser Permanente Health Plan was the consumers be motivated to choc-
prototype). Both organizational arrange- best value based on a mysterious balance
ments were to combine in a variety of of untested financial incentives and as
ways the health insurance risk-bearing yet unavailable objective comparisons of
function with the responsibility to deliver health care results? It may seem obvious
health care to voluntary enrollees for 1 now, but early advocates of market forces
year or more. In keeping with the free could not prove that demand based on
market philosophy of the Republican ad- prices of HMO care would be elastic.
ministration, rapid expansion of HMOs
was encouraged by placing few limita- THE TRANSITION
tions on the ownership or tax status of
the fledgling HMO firms. The sugges- After rapid, unhera! ige by the
tion of the architects of the health mainte- House of Representatives, the more
nance strategy, that an independent com- conservative Senate Finance Committee
mission be formed to establish measures rejected the Nixon administration

to make HMOs publicly accountable for posals tor HMO market-! ;cher-

the impact on their enrollees' health, was i/ed" Medicare Although many
not incorporated into the Nixon adminis- later Medicare risk contracting by 1 IMOs
tration proposal. was approved b » and me White
The health maintenance strategy as- House, no Health Care Financing Ad-
sumed that IPAs, which resembled more ministration (HCFA) administrator has
closely the existing arrangement of health chosen to aggressively aeU ofl to the

care, would initially be more appealing private sector the opportun

to consumers and most practicing pin si- has to run a huge public conventional
cians. Later, as competition over |
health Knsurano uther-
and the novel approach to qualitj most ol the :
tlth plans"
countability took hold, the group prac- not quite read) for the high-risk, in-
tices were expected to be better pod- pulatton !
100 / 6. IS MANAGED COMPETITION THE CURE FOR OUR HEALTH CARE SYSTEM?

managed Medicaid also lagged despite a employer. Their unstandardized, unad-

contrarian but successful switch to cap- justed,and unaudited claims of qualita-
itation in Arizona in 1982. Far from be- tive superiority didn't sell to consumers.
ing the catalyst for public sector and The potential unprecedented growth
private sector reforms, the government's
in earnings in the burgeoning, formerly
program preferred the status quo except nonprofit, health industry attracted en-
for complex encounter-based payment
trepreneurs and venture capital to the
tinkering like diagnosis related groups
hot new health plans. Naturally, for-profit
for hospitals and relative value scales
health plans, responding to Wall Street's
for physicians. Unfortunately, these ap-
short-term earnings growth mentality,
proaches to price controls failed to con-
avoided major capital investments except
tain Medicare costs.
for acquisitions, and sought to circum-
The large private-employee-benefits
vent the uncertainty that objectively com-
purchasers of health insurance lagged by
peting overtly on quality might bring.
a decade in taking advantage of the con-
cepts held within the ill-fated employee- Individual consumers, especially those

oriented 1973 HMO

Act. Then, in the
who had long-standing relationships

mid-1980s, faced with the prospect of

with physicians, were cautious and slow
to switch from the company's tradi-
intensifying global competition for sale
tional indemnity plans. Ultimately they
of products and uncontrollable health
care costs, employer purchasers began
succumbed to the lower out-of-pocket
costs, lack of hassle, and aggressive mar-
seriously encouraging their employees
to join health plans. But the employ- keting of the new health plans. After
all, the physician and hospital panels
ers, too, defied the health maintenance
of the loosely integrated health plans
strategists by offering a very limited
number of health plan choices (usually
were almost like the familiar Blues. Then,
1 or 2 health plans and an indemnity with the advent of point-of-service health
plan) in each community. The resulting
plans, the door was open for consumers
to go out of their own plan to any
health plans, consisting of rapidly as-
provider if it was worth the extra out-
sembled broad provider networks with
of-pocket payments. But they continued
rich benefit packages and low prices,
appealed to employers and employees. to rely on the informal advice of others
Quality was dealt with the old-fashioned
about the quality of the health plan, sup-
way, by word of mouth, and by satis-
plemented often with information sup-
plied by the health plan about the avail-
faction with patient-physician relation-
ability of primary physicians.
ships. This approach to purchasing by
large corporations more than anything In the past 3 years, the Clinton plan
else shaped the new health care mar- of "managed competition" and the Re-
ketplace. overlapping provider
Large, publican "Health Contract for Amer-
networks required less financial commit- ica" foundered on more than politics.
ment by health plans and less profes- Congressional Budget Office (CBO) un-
sional commitment by physicians. Most certainty over whether savings would
provider-controlled group practice and accrue from price competition induced
hospital-based entities couldn't cover the delays and revisions. The arithmetic of
urgent territorial demands of the typical the CBO —rather than just political inepti-
 YES Ellwood and Lundberg/ 101

tude and organized backlash killed ma-— based outcome data. The more highly in-
jorgovernment health reforms. tegrated group practice plans (most of
Following all of this recent political them nonprofits and provider controlled)
posturing over a market-based approach have grown more slowly and locally but
to medical care was federal government think they've found a way to reassert
inaction and a demand-side private themselves.
sector revolution. But the character of the Why does the new house of medicine
resulting 1996 managed care system (not look so different from what the HMO ar-
health maintenance) has been a surprise. chitects designed? The customers weren't
Extraordinarily effective price compe- ready for a spartan, efficient, high-tech,
tition has developed between various computerized, Saarinen-like house of sci-
health plans. Prices were very elastic and entific medicine. Instead, their tastes
the old system was even more poorly were traditional and tended to favor a
managed and inefficient than anticipated. new home that looked and felt like their
There remains a moribund indemnity —
old home cluttered, warm, and secure,
fee-for-service system (mainly Medicare) close to school, to work, to shopping, and
that may stay alive for a year or 2 on to freeways. The demand side of health
political life support. Consumers, espe- care preferred a much more traditional
cially healthy families, have been remark- health system than the planners expected
ably price sensitive, exhibiting surpris- —one that was paid for in a new way but
ingly little loyalty to physicians or health felt like the old system.
plans During the years since Medicare was
enacted, American medicine has become,
by some calculations, the world's largest
THE CURRENT ENVIRONMENT business. The pace of restructuring in
Thomas Pyle has called health care's rev- the American health system has been
olutionary changes "the unbungling" of continuous, responding to innovations
health care; others regard it as the re- in health delivery, advances in im

bungling (personal communication, Au- technologv rising public expectations,

gust 10, 1996, Jackson Hole, Wyo). The and the demands of other sectors of
largest and fastest-growing health plans the economy. Now the new health
are national or regional for-profit enti- system is faced congruence
with a

ties over which providers exert little con- of discontinuities produce

that could
trol. The health plan's power is exercised clinical advances along with economic

through legal contracts with purchasers, ones more like the health maintenance
consumers, and providers. Genuine col- strategi>t> eiw iMoned.

laboration between most health plans' There will be no letup m

management and providers is tenuous, containment ptl It anything re-
but the understanding of what the health sembling the Republican Medicare plan
insurance money is buying and its com- paaSCSi it will be ditticult to rely on the

patibilitywith sound medical practice old underfunded Medicare at ^n Income

have vastly improved Physidant typi-

cally work for several health plans, mak- joining dak-bated health plans at a record

ing virtually impossible to differentiate

it
.\nd more plans an becomir
between them on the basis of population- indi-
 —
102 / 6. IS MANAGED COMPETITION THE CURE FOR OUR HEALTH CARE SYSTEM?

vidual purchasers who do not require few health plans have

tent of care, but
the broad dispersed networks originally information systems or organizational
sought by employers. Many have chronic structures to fundamentally challenge
illnesses and are particularly concerned traditional approaches to medical care.
about quality. The rush by states to Med- The IPAs, group practices, and physi-
icaid managed care plans opens up yet cian management corporations detect an
another individual-choice market that is opening. Many believe they can manage
not attached to any existing insurer ex- quality better than the large, more en-
cept the state. trepreneurial health plans. Does quality
The public media have chosen to competition, more choices, and the loyal
feature some health plans' highly paid chronically ill Medicare constituency pro-
executives, gag rules, and physicians' vide an opportunity for physicians to by-
being paid to "undertreat." Anecdotes pass the managing health plan and con-
about skimping on care are hyped tract directly with the purchasers? But
enough to make the cover of Time. even the best of the provider-controlled
Barron's, Newsweek, and Consumer Reports group practice plans have a long way to
all have attempted to rate differences go in successfully practicing population-
in plan quality based on inadequate based medicine. At present, their largely
information; yet despite anecdotes (some uncomputerized clinical record systems
lurid) we have no objective evidence and weak epidemiologic perspective
of any overall decline in the quality leaves them unprepared for population-
of care in the new system. Consumers based medical care. However, advances
are confused. State legislators —alerted in medical computing projects, like the
by the headlines encouraged by offbeat Medical Group Management Associa-
—
and conventional providers see votes in tion's conduct of outcomes management
designing laws to inhibit health plans. trials, and the accumulation of large open

More than 100 health care bills have been databases, like that of the American Col-
introduced in the California legislature lege of Surgeons on cancer, give a glimpse
alone. of the opportunity.
Employers continue to demand low
price increases in the 1% and 3% range
WHAT'S NEXT
but now want proof of quality. Employers
are joining purchasing coalitions on a Health plans have become enormous and
regional basis (like the Pacific Business important actors in the new American
Group on Health) and national scale health system. They have the capital
(Washington Business Group on Health) and character to influence how care is
to coordinate contracting and to assess delivered and how resources are used.
quality. Some (like GTE) are paying If pointed in the right direction, even

higher portions of the premiums for those the most entrepreneurial Wall Street-
employees who join what the company oriented health plan has the opportu-
believes to be the highest-quality health nity to compete on quality. Such plans
plans can establish extensive premier medi-
The easy ways to cut costs — like cal networks (PriMe) within their larger
shorter hospital stays —are reaching their organization, assemble their own selec-
limits. Now it is time to evaluate the con- tive provider networks, integrate finan-
 YES Ellwood and Lundberg/ 103

cial management (and rewards) more is an attempt to meet this need through
closely with clinical practice, and build a a voluntary collaboration. Led by pur-
culture of excellence. Furthermore, they chaser and patient groups, FACCT has
have the capital to buy advanced infor- just published its first recommended set
mation technology to support the deliv- of patient-oriented outcomes measures.
ery of more scientifically based and more These measures are the product of mea-
efficient medical care. surement science that focuses on patients'
But we have no assurances that the perceptions of their own function and
competition of such plans in the current well-being. Their initial measures cover
market will reward those who deliver diabetes, cancer of the breast, major de-
higher-quality care. First, we lack strong pression, health risk behaviors, and pa-
national standards that hold these plans tient satisfaction with care. The founda-
accountable for the results they achieve tion will not be in the auditing business
— either in terms of clinical quality, im- but is urging various accrediting and au-
proving the health of their enrolled pop- diting organizations to apply their mea-
ulation, or even satisfying the expecta- sures.
tions of their enrollees. Second, we have At this stage of our health system re-
no evidence that the economic success of construction, there is good reason to be
these plans is being affected by their clin- hopeful. Compared with 25 years ago,
ical performance —purchasers and con- we have achieved a great deal:
of new organizations that can
creation
sumers have not, so far, rewarded or allocate
punished plans based on quality. Third, money and way, re-
talent in a rational
a sound market is always a work in liable and pervasive tools for measur-
progress. The large for-profit plans that ing health outcomes, growing consensus
appear to be dominant today may not be on the importance of preventive services,
as important tomorrow. If purchasers and uniform screening and other "best prac-
consumers had tools that allowed them to tices" incorporated into guidelines, initial
buy on quality, and if they could actually systems for reporting to the public on the
begin to use that power to shape the mar- quality oi care they are receiving and the
ket, the thinking that lay behind the orig- impact of the health system on the pub-
inal HMO movement may still play out: verall health, and information sys-
provider-managed organizations might tems that support, monitor, and provide

demonstrate that they are better able to feedback on the health sex
meet patient expectations and get good The - :or American health

results and operate more efficiently than [Link] aa1 being offered more
their less integrated and disciplined com- choices that are DIOR easily understood.
petitors Medicare is evolving from a traditional
Two alternatives exist: strong public and unorganized array of providers to a
policy or effective public interest collab- more apptopiial Seringa that al-

oration. Congress may ultimately K low individuals to choose arrangements

proper body to articulate standards tor that best meet their own d we |

health care quality, but it Is unlikely to ; that the

take this on soon or in the short-term. [tainmenl have

The recently established not-fo] reached their limits i :
con-
Foundation for Accountability (FA< sumers know that it i com-
104 / 6. IS MANAGED COMPETITION THE CURE FOR OUR HEALTH CARE SYSTEM?

pare plans and providers based on qual- for those most in need. But we should pay
ity and are becoming more sophisticated them for the additional responsibility and
in demanding this information. costs they incur. Quality measures and
Ultimately, this trend may lead to a payment systems must be risk adjusted in
sound, efficient, and truly effective health order to shape the kind of health system
system. If we document the benefits we want. Despite its importance, there is
achieved by our health care systems, we no well-funded coordinated effort to de-
can respond properly to public concerns vise risk adjustors and to reward health
about expenditures, entitlements, and plans that serve the sickest patients well.
reform. At the same time, we will be Patient opinions should come first. Our
ensuring that consumers are themselves patients pay us, receive our services, and
responsible for their choices and that they have faith in our skill. In the market en-
are capable of making those choices in an vironment, they increasingly judge us. In
informed manner to the greatest extent the last 20 years, the science of measur-
possible. ing health outcomes and patient satis-
The health care system is coming out faction has made enormous progress. 6 8 -

of the closet. Professional black boxes Although not without limits, many self-
and undocumented claims of superior report measures are more reliable and rig-
individual credentials and results are orous than traditional clinical measures.
no longer enough! Organizational trans- The new measures of quality should em-
parency and readily available objective phasize consumers' perceptions of their
evidence of health improvement is in! own health function and well-being. At
Getting there will require the applica- the same time, they should provide the
tion of the following principles. level of feedback to providers that allows
them to continuously improve medical
practice.
PRINCIPLES OF ACCOUNTABILITY
It's timefor outcomes accountability. Man-
TO THE PUBLIC FOR HEALTH aged care organizations are structured to
QUALITY
facilitate accountability. We finally have
The quality measures must be powerful the measures and the structures in place
enough to provide direction to the new Ameri- to assess whether different practices or
can health system. Plansand providers will systems perform better. And we have an
seek to achieve the results on which they audience in purchasers and patients that
are measured and for which they are ac- is craving that information. As organiza-
countable. If the measures are sound and tions become responsible for outcomes,
the public understands and values them, we will see a growing link between the
they will become the central tool of health maturing disciplines of health services
care reform and redesign. research and the clinical practices em-
The measures must anticipate the behav- braced by health systems. 9 Already many
ioral changes they induce. If one plan or sys- large health plans have created sophisti-
tem proves to be exceptional at treating cated research centers to help infuse their
AIDS or diabetes, it will attract the sick- practices with evidence-based strategies,
est people in the community —
and that's and they are building large observational
good! We should want the most compe- series to continuously refine the care they
tent and committed organizations to care provide.
 YES Ell wood and Lundberg/ 105

The influence of health plans on the mea- lution, we also will be able to find an in-
sures chosen should be minimized. Health cremental way to provide access to basic
plans are one important device for or- health care for all of our people. 10
ganizing and financing medical services,
—
but there are others some not invented
NOTES
[Link] standards for assessing perfor-
mance must be based on the patient's 1. Lundberg CD, Bodine L Fifty hours for the
poor. JAMA. 1987;258:3157.
experience of health and illness, indepen- 2. Ellwood PM, Enthoven AC. ^Responsible
dent of the particular structure or phi- choices': the Jackson Hole Group plan for health

losophy of the care providers. With bil- reform. Health Ajf (Millwood). 1995;14(2):24-39.
3. Smillie JG. Can Physicians Manage the Quality
lions of competitive dollars at stake, no and Costs of Health Care? The Story of the Permanente
plan can be objective about how it should Medical Group. New York, NY: McGraw-Hill Book
be judged. The measures used to assess Co; 1991.
4. Williams AP. Memorandum to the president-
quality should not be constrained by the
elect: parameters for health system reform. JAMA.
self-interest of the provider or financing 1992;268:2699-2700.
organizations. We should not ignore the 5. Lundberg GD. United States health care
system reform: an era of shared sacrifice and
practical experience of health plans that
responsibility begins. JAMA. 1994;271:1530-1533.
have learned a great deal about measur- 6. Ellwood PM. The Shattuck Lecture: outcomes
ing and managing quality, and we should management: a technology of patient experience. N
Engl J Med. 1988318:1549-1556.
remain sensitive to unnecessary burden 7. Ellwood PM Jr, Anderson NN, Billings JE,

or cost. But our health system is account- Carlson RJ, Hoagberg EJ, McClure W. Health
able to the public, and the public must maintenance strategy. Med Care. 1971 ,-9:29 1-298.
8. Ware JE Jr, B<r gen WH, Kosinski
decide what level of reporting or burden M, Tarlov AR. Differences in 4-year health outcomes
is appropriate. for elderly and poor, chronically ill patients treated

first phase of the health mainte- in HMO and fee- for- sen. ice svstems: resu!-
The
the Medical Outcomes Study. JAMA. 1996276:1039-
nance strategy was a bold and success- 1047.
ful experiment that focused on and pro- 9. Yelin, EH, Criswell LA, Feigenbaum PG.

duced lower-cost health care. Now we are Health care utilization and outcomes among
persons with rheumatoid arthritis in
ready for the next phase that will measure service and prepaid grouj
and produce better-quality health care. 1996276:1048-1053.
10. Divii K. Incremental coverage of the unin-
And, surely, from the enormous savings
sured. JAMA. 1996;276:831-332.
that have been made through this revo-
 .

NO John H. McArthur
and Francis D. Moore

THE TWO CULTURES AND THE HEALTH

CARE REVOLUTION
There are two contrasting streams, two distinct cultural traditions, for pro-
viding services in the United States: the commercial and the professional.
While these two traditions stand in sharp contrast to each other, they have
shared a central role in the evolution of our society and its institutions. It is
our purpose here to explore threats to the quality and scope of medical care
that arise when the tradition of medical professionalism is overtaken by the
commercial ethic and by corporations seeking profit for investors from the
clinical care of the sick. We also explore the extent to which commercial be-
havior has invaded the nonprofit sector through the merger of the insurance
function with the clinical provider in prepaid health plans. Widespread pres-
sures to reduce the out-of-control costs of health care in this country, as well
as the cost to individual patients, families, and employers, have accentuated
some of these threats to clinical quality.
Effectivecommunication between the commercial and the professional
communities has been wanting with respect to their traditions, technology,
and motivation in the medical arena. To the interested public, it appears that
people are not listening to each other. It is our hope here to open communica-
tion between these two contrasting cultures, an idea expressed by C. P. Snow
in his Rede Lecture at Cambridge, in which he contrasted the traditions of
science and humanism. 1 . .

THE TWO CULTURES: PROFESSIONAL AND COMMERCIAL

The fundamental act of professional medical care is the assumption of re-
sponsibility for the patient's welfare —an unwritten contract assured by a
few words, a handshake, eye contact denoting mutual understanding, or
acknowledgment by the physician that "We will take care of you." The essen-
tial image of the professional is that of a practitioner who values the patient's

welfare above his or her own and provides service even at a fiscal loss and

Excerpted from John H. McArthur and Francis D. Moore, "The Two Cultures and the Health
Care Revolution: Commerce and Professionalism in Medical Care," Journal of the American Medical
Association, vol. 277, no. 12 (March 26, 1997), pp. 985-989. Copyright © 1997 by The American
Medical Association. Reprinted by permission.

106
 —

NO McArthur and Moore/ 107

despite physical discomfort or inconve-

nience. There no outside invested cap-
is
THE TWO CULTURES IN CONFLICT
ital seeking returns from the physician's When a corporation employing |

work. dans seeks profit by selling their ser

the physician-employees cease to act as
The fundamental objective of com- free agents. Professional commitment to
merce in providing medical care is patient care subordinated to new rules
is

achieving an excess of revenue over costs of practice that assure the profitability of
while caring for the sick, ensuring profit the corporation.
for corporate providers, investors, or in- Surprisingly, much the same enigma is

surers. A central feature in enhancing becoming evident in the voluntary non-

net of income over expense in a com- profit private sector, particularly in pre-
petitive market is a reduction in vol- paid health plans and teaching hospitals.
ume or quality of services so as to re- Physicians working in such plans, <:

duce costs, while maintaining prices to as those in fee-for-service plans both of —

the purchaser. While cost reductions of- them in the private, nonprofit sector
ten diminish the quality of services, such are finding themselves increasingly bur-
economies are not always passed along dened by clinical constraints intended to
to the public as lowered prices. Many ensure survival of the hospital, the plan,
families who seek insurance coverage but or the insurance carrier in a fiercely com-
are excluded by unaffordable prices are petitive market. While there is no legally
forced to seek public providers outside defined profit for tax purposes in a non-
prepaid plans and the commercial insur- profit institution, the same results are
ance system. threatened by the accumulation of large
operating reserves, excessive construc-
In this setting, the operation of mar- tion programs, large executive cohorts
ket forces is hampered because patients at high salaries with business support
and families can rarely acquire the in- structures, acquisition of other hospitals,
formation necessary to discriminate as or uncontrolled growth I :i and
to suitability and quality among alterna- teaching programs funded from patient-
tive clinical services or providers. With- derived income. A teaching-research hos-
out consumer input, market forces often pital that seeks excessive profit from
fail completely, or behave perversely, act- patient care to support its nonprofit ac-
ing strongly on price without regard to tivities (teachin h, community
quality or breadth. outreach, And education of nur>e> and
paramedical personnel) behaves like a
In purchasing commercial services, the for-profit facility. Both in mecomm

public has learned to beware both of And the nonpro: An appropriate

low quality and excessive prior balance must be sought between patient-
expressed in the Latin phrase derived income, reinvestment scientific
emptor — "letbuyer beware
the And educational ohligatu
American public is gradually becoming aid health plans inevitably in\ oh e
aware that caveat emptor may BOOT! a conflict bet ween the commercial and
become caveat morbidus
— "let the patient sional cultures dUson] has
beware." pointed out. prepaid health plai
108 / 6. IS MANAGED COMPETITION THE CURE FOR OUR HEALTH CARE SYSTEM?

the insurance function with the delivery 2. Pricing

function." This mixture dangerous be-
is In the familiar commercial market for
cause when markets are saturated and /or everyday goods and services, a less
premiums fixed, with costs still rising, fi- affluent population is assumed to exist
nancial ruin can be avoided only by re- that is unable to afford certain products or
ducing quality and breadth of services, services and must "get along without." In
endangering the health of individuals, medical care there is no such population:

families, or whole communities. need is universal. The charity threshold is

defined as the income level below which
Sensing this inherent conflict, En-
family costs for medical care must be
thoven and Kronick34 introduced the
borne by church, charity, or government.
term "managed competition," which sig-
Unless regulated, this threshold will
nified protection for the public from ex-
ploitation under the pressure of commer-
inevitably rise as health plansand other
insured providers increase prices and /or
cial competition, giving further currency
decrease services to ensure profitability.
to the term "managed care." 34

At the same time, while acting within 3. Risk Avoidance

the framework of professional commit- Exclusion of individuals and families
ment, some physicians and administra- from coverage because of prior disease,
tors have taken earnings out of the system genetic constitution, predisposition, or
that were beyond reasonable and custom- high cost is already noticeable in our
ary rewards for such services. health insurance system. Such risk avoid-
ance denies care to those most in need and
is not a characteristic of national health

COMMERCIAL MEDICINE: insurance plans in other industrialized

POTENTIAL HAZARDS countries.

[Link] Load on Public Providers

1. Diversion of Funds Exclusion of individuals or families
Funds for the care of the sick whether — because of high risk or unaffordable
from private sources, employers, or tax- prices will shift the burden of their
ation —are intended to support disease
care to other providers, including tax-
prevention, public health, and the care
supported public clinics and hospitals
of disease: public health and the health (federal, state, county, or municipal)
of the public. When a portion of this
and charity or church hospitals. Any
highly targeted national fund is diverted
economic overview of recent trends in the
for corporate objectives (such as divi- must
total cost of health care in the nation
dends, advertising, executive salaries),
by
quantify the increased burden borne
the resources available for health care are
these public institutions.
thereby reduced.

The same diversion from health care 5. Downgrading of Personnel

objectives results from excessive earnings Expertise is expensive. Among physi-
by physicians or administrators in the cians, nurses, and paramedical person-
nonprofit sector and the fee-for-service nel, those who are most highly qualified
establishment. require the highest compensation. These
 NO McArthur and Moore/ 109

highly qualified but expensive personnel threatened. These economies attract the
will be threatened by discharge in favor of attention of the media when they occur
others with less experience and fewer cre- in a health plan providing extravagant
dentials but lower income expectations. expenditures for executive salaries, pub-
lic relations, and advertising.
[Link] of Free Speech
Such compromises and distortions of
Another cause for dismissal is adverse
clinical care place physicians in a severe
comment or criticism about the quality of ethical dilemma: shall they follow the
care being given. This amounts to a gag
dictates of conscience and known good
rule andan example of the loss of free
is
practice in giving every consideration to
speech, not by order of public law but by
and comfort of the patient, or shall
the aid
the dictates of health care corporations
they save money for their employers?
thathave confused commercial success Such dilemmas are among the most
(and a favorable public image) with severe ethical challenges in the pr
professional obligation.
of physicians and surgeons today.

7. Distortions of Clinical Care

and Ethical Dilemmas 8. Managed Care Cui Bono? —
It is in these areas that most complaints The term "managed care" came into com-
have surfaced, as frequently reported in mon currency in the late 1980s to de-
the media. Problems include delayed ad- note clinical practices in prepaid plans.
mission, premature discharge, sloppy or It implied that an element of benefi-
unskilled services delivered in a shoddy cial professional management, based on
and ill-kempt or unfriendly environment, concern for patient w ould be es-
avoidance of surgery or radiologic scan- sential to ensure both equity and qual-
ning, and the overuse of multiple prof- ity in the highly competitive environ-

itable blood tests rather than definitive ment of corporate medicine. While it was
expert consultation or operation. Limita- never clearly specified by whom complex
tions in ambulatory care include deny- management choices would be made, or
ing prescriptions written by the physi- in whose interest clinical ;ld be

cian in favor of similar drugs marketed managed, there was a tacit assumption
by favored vendors and strict constraints that the provider would supply ma:
on the amount of time a physician can ment in the best interest primarily of the
spend with each patient. Time limita- patient, as well as the insurer or y

tions on patient-physician contacts arc corporation. Now, only 7 years la:

particularly destructive to patient con- many "managed can>" implies
the term
fidence and comfort. Rehabilitation and the n^ i (teem about the welfare
long-term care including psychiatry and ot the patient because they SUSped that

terminal cancer care, care of the trail el- caa> is being managed to minimi/e ex-
derly, and care for those with adva perhaps oven maximize in-
.\nd

heart disease or stroke are nonremu- come tor the employer; provider; and/or
nerative. In a commercial environment insurer, while masquerading as a benefit

seeking to maximize revenue from each tor the pat term is ir

both volume and qual-

clinical encounter, interpreted as meaning "mana|
ity of such clinical .services are ine\ itablv rather than in
110 / 6. IS MANAGED COMPETITION THE CURE FOR OUR HEALTH CARE SYSTEM?

9. Commercial Insurance been based on research supported by

in the Nonprofit Sector public funds.
As mentioned above, many of the pres-
sures of commercial medicine are already [Link] of Community
becoming evident even in the nonprofit Responsibility and Teaching
sector, especially in prepaid health plans, and Research
because of their structural combination of Many community hospitals were estab-
the insurance function and the delivery lished to include care for the poor, usually
obligation. In addition, indemnity insur- at a fiscal loss, accommodated by income
ance carriers apply continuous pressure from endowment or by shifting funds
on hospitals and physicians to lower costs from other revenue sources within the
of diagnosis and treatment, limit hospital hospital. As financial insecurity threat-
stay, and curtail therapy. ens their continuing support, commu-
nity hospitals are faced with takeover
by commercial for-profit corporations.
10. Physicians as Entrepreneurs The purchase of such hospitals by for-
in Care and Research
profit chains (often based in another city
The entry of physicians and biomed- or state) generates transition funds that
ical scientists into the world of for-
can be used to cover immediate wel-
profit commerce is becoming an increas- fare needs. Continuing support is often
ingly prominent feature of this landscape.
lacking.
Many physicians have become owners Teaching hospitals have assumed re-
and managers of commercial hospital sponsibility for a share of the university
chains and treatment centers. Biomedi-
functions of teaching and research as well
cal scientists longaccustomed to receiv- as responsibility to the broader commu-
ing charitably deductible support from nity they serve. This support is threat-
commerce are now becoming the owners, ened by commercial takeover.
stockholders, and operators of corpora-
tions seeking profit from the marketing
[Link]: Loss of Free Choice
of their own scientific discoveries. commerce fosters com-
Free enterprise
Sale of securities as well as the sale pensation and encourages consumer
of products has sometimes led to large choice among alternatives, but these
earnings for physicians. In some cases, choices cannot operate in rural areas,
the very scientists whose research was smaller communities, or inner-city ghet-
originally supported by public funds tos where the population and financial
are owners of corporations that are resources are insufficient to attract more
often risky and financially unstable than a single prepaid health plan or
but sometimes very profitable. Every HMO. Freedom of choice, long consid-
taxpayer has made an investment in ered an ideal by-product of free competi-
these biotechnical corporations. It seems tion, is compromised.
inevitable that some sort or repayment
to a special government research fund
STANDARDS
will be mandated for some fraction of the
profit accruing to scientific corporations Whether by voluntary self-regulation or
when their product development has by the passage of regional or national
 —
NO McArthur and Moore / 111

legislation, minimum standards will in- ical direction of highly qualified expert
evitably be required to abate some of physicians rather than administrative ex-
the hazards to society and abuses of pa- ecutives.
tient care arising from commercial pres- Decoupling the individual physician
sures on professional behavior. These from the insurance function frees physi-
standards address the potential hazards cians to manage their own clinical care

we mentioned in the foregoing. procedures while maintaining the iden-

Acceptable profit levels will require tity of the prepaid plan for business pur-

definition, as well as allowable diver- poses. In decoupling, the physicians, as a

sion of money to dividends, executive group, contract or make other group ar-
bonuses, promotional expenses, adver- rangements with their front office (ie, the
etc. By the same token, earnings insurance function) to deliver patient care
Itising,
of administrators, business consultants, or community preventive medicine at a
and physicians in the nonprofit or private group price to the insurer, thus reestab-
sectors will need to be subject to guide- lishing the primacy of professional judg-
lines in the interest of equity and econ- ment and supervision of clinical care for
omy. Pricing will necessarily be viewed individual patients.
in light of prevalent income and afford- Regular input of complaints and sug-
Assumption of risk will inevitably
ability. gestions from both patients and physi-
be required of all carriers and providers cians must be facilitated. Community
to share the risk for particularly high- responsibility should be accepted by all
cost cohorts such as congenital anoma- carriers and prepaid plans to avoid skim-
lies, familial disorders, human immun- ming —
the enrollment of the low-risk,
odeficiency virus infection, and chronic prosperous segment of a community
vascular disease. leaving newborns, the elderly, and those
Criteria for effectiveness, quality, and with prior illness to be cared for at pub-
patient satisfaction will need definition. lic expense. For teaching hospitals this

Patient satisfaction, while clearly impor- responsibility to their broader commu-

tant, must be viewed with suspicion nity includes a continuing commitment
because approximately 80% of a cov- to share in the support of postgraduate
ered population will, in any one year, teaching and research
be free of any disorder requiring medi-
cal care. Their "satisfaction" is easily as-
POTENTIAL BENEFITS OF
sured. Only be evaluation of the opinion
CORPORATE-COMMERCIAL
of those patients and families afflicted
MEDICINE
with serious illness can patient satisfac-
tion be a meaningful criteria. Morbid- Cost control (ie, a decline in the national
ity and mortality should never become budget for health care) has been antici-
the principal criteria of effectiveness since pated in the cost-cutting competitive at-
they are both subject to manipulation by mosphere of a commercial marketplace.
avoidance of risk. This may become increasingly difficult ei-
Staff organization is best served by the ther to secure or to demonstrate because
unit system common in most teaching patient costs must be embraced in such
all

hospitals whereby distinct medical and an accounting, including the increased

surgical disciplines are under the clin- burden on church, charity, tax-supported
112 / 6. IS MANAGED COMPETITION THE CURE FOR OUR HEALTH CARE SYSTEM?

institutions, or the patient's own pock- tives will arouse public opposition and
etbook. Physician earnings have already invite political attack. If private capital
shown a decline; total remuneration of disregards community needs, communi-
executives and administrators appears to well off and the attractive-
ties will be less
have risen over the last decade. ness of such ventures for investment will
If, as a result of the entry of com- decline.
merce into American medical care, na-
tional standards become a reality with — REFERENCES
appropriate agencies for surveillance, re-
porting, and local assessment of the ade- Snow CP. The Two Cultures and the Scientific
Revolution: The Rede Lectures. New York, NY:
—
quacy of health practices this will be a Cambridge University Press; 1959.
major benefit from the commercialization Gradison W. Issues in employment and insurance.
of American medical care. BullN Y Acad Med. 1995;72:586-594.
Enthoven A, Kronick R. A consumer-choice health
While access to capital investment will plan for the 1990's: universal health insurance
be a benefit from the entry of com- in a system designed to promote quality

merce into medical care, some caution and economy (in two parts). N Engl J Med.
1989;320:29-37.
and some years of experience will be Enthoven A, Kronick R. A consumer-choice health
necessary before realizing this benefit. plan for the 1990's: universal health insurance
Capital investment in medical care that in a system designed to promote quality
and economy (in two parts). N Engl J Med.
assumes responsibility only for the wel- 1989;320:94-101.
fare of stockholders, investors, or execu-
POSTSCRIPT
IsManaged Competition the Cure for
Our Ailing Health Care System?
Often considered the two most vocal advocates of managed care are Paul
Ellwood and Alain Enthoven. Enthoven served as the principal architect of
President Clinton's failed health care reform. Three books by Enthoven that
discuss his viewpoint are Health Plan: T)\e Only Practical Solution to the Soaring
Cost of Medical Care (Addison- Wesley, 1980); New Directions in Public Health
Care: A Prescription for the 1980s (Institute for Contemporary Studies, 1980);
and Theory and Practice of Managed Competition in Health Care Finance (Elsevier
Science, 1988). Ellwood and Enthoven are coauthors of an essay entitled
"Responsible Choices: The Jackson Hole Group Plan for Health Reform/'
Health Affairs (1995).
Finally, there are several books by Henry J. Aaron, the director of the
Brookings Economic Studies Program, which provide a more middle-of-the-
road analysis. In general he believes that there are still major changes in
the future of the health care industry that probably include a regulatory role
for government. See TJie Problem That Won't Go Away: Reforming U.S. Health
Care Financing (The Brookings Institution, 1996) and Rationing Health Care:
The Choice Before Us (The Brookings Institution, 1990).

113
ISSUE 7
Are More Prisons and Prison Beds the
Answer to America's Rising Crime Rate?
YES: Edwin W. Zedlewski, from "When Have We Punished Enough?" Public
Administration Review (November 1985)
NO: David F. Greenberg, from "The Cost-Benefit Analysis of Imprisonment/'
Social Justice (Winter 1990)

ISSUE SUMMARY
YES: Edwin W. Zedlewski, an economist with the National Institute of Justice,
argues that investment in more prison capacity is wise social policy because
the associated costs are more than compensated for by the value of the benefits
society would enjoy.
NO: Economist David F. Greenberg alleges that many of the costs of imprison-
ment are excluded from Zedlewski's calculations and that he has significantly
overestimated the benefits.

Few people feel totally safe walking the streets of urban America or even
pitching a tent in a wilderness area. It is well known that the country is

plagued by a terrifying crime rate. Crime reports in newspapers, on radio,

and on television are daily reminders that nearly 6 million people in the
United States annually suffer the effects of violent crimes murder, rape,—
robbery, and aggravated assault. Another 29 million Americans suffer the
effects of —
property crime arson, burglary, and larceny /theft. Stated differ-
ently, the1992 "crime clock" indicates that there is an automobile stolen every
20 seconds, a burglary committed every 11 seconds, a theft perpetrated every
4 seconds, a murder committed every 22 minutes, a rape reported every 5
minutes, and at least 1 robbery and 2 assaults occurring every minute of every
day!
These figures suggest that the American criminal justice system is under
siege, and there is no letup in sight. In fact, the 1990s may prove to be the
most violent period in the nation's history. In the 10-year period 1983-1992,
the numbers of persons arrested each year for committing a violent crime
increased from 391,000 to 590,000, which translates to a 50.8 percent increase.
Rather than winning the war against crime, America seems to be losing it on
a grand scale.
Perhaps even more frustrating is the fact that the country's incarceration
rate has increased at an even faster rate than the criminal activity it is intended

114
to contain. More than three-quarters of a million individuals are behind bars;
that is a population equal to the whole of Baltimore, Maryland, or Milwaukee,
Wisconsin, and substantially greater than the population of Atlanta, Georgia,
or Boston, Massachusetts. If we add together the prison population with those
on probation and parole, our ''city of criminals" would be equal to more than
—
4 million persons the second largest city in the United States.
In spite of this burgeoning prison population, Edwin W. Zedlewski argues
that the U.S. prison system is woefully inadequate. For him an efficient de-
termination of how many criminals should be sent to prison is predicated
on equating the marginal social costs with the marginal social benefits. This
cost-benefit analysis would compare the costs associated with incarceration
with the economic value of the benefits society would enjoy if these individ-
uals were no longer free. In a cost-benefit analysis, as long as the value of the
benefits of one more prison bed is equal to or greater than the costs society
must pay for this bed, society should increase its prison capacity.
The two readings that follow take up the challenge of determining the
associated benefits and costs of increased incarceration. This is not a simple
summation of easily identifiable expenditures and costs. We caution you to
read with great care the assumptions made by Zedlewski and by David F.
Greenberg.

115
 Edwin W. Zedlewski
YES

WHEN HAVE WE PUNISHED ENOUGH?

Today's criminal justice system is in a state of crisis over prison crowding.
Even though national prison capacity has expanded, it has not kept pace
with demands — National attention has focused on prison crowding. But
the common cry among corrections professionals is not a need for more
prisons but a need for alternatives to incarceration.
The search for alternatives to prison is curious inasmuch as public senti-
ment calls for more punishment. Recent legislative changes to penal codes in
the form of mandatory prison terms for drunk drivers and for gun crimes,
plus calls for the abolition of parole boards, argue for more prison space. Yet
many professionals resist, arguing that prison construction is too expensive
and does little for the reduction of crime. 1

Do we need more prisons or more alternatives to prison construction?

Before such questions can be answered, we need more information on both the
costs and benefits of punishment. Since so many elements of the sentencing
decision, such as victim harm, justice, and public fear, defy quantification,
any picture will be necessarily incomplete. Nonetheless, the data assembled
here quantify many of the missing benefits of prison capacity and thereby
contribute to debate over prison crowding and alternative sentencing.
Significantly, even discarding the emotional and psychological costs men-
tioned, the data strongly support the need for more prison capacity. Subse-
quent sections of this paper apply the social cost-benefit framework to alter-
nate uses of scarce prison space and the choice of alternatives to incarceration.
These sections are less prescriptive because research findings are less defini-
tive. They are sufficient, however, to offer at least some recommendations for
policy makers.

THE SOCIAL COST OF CRIME

Gary Becker first sketched an analytic framework for deciding upon optimal

expenditure for crime control. 2 By advancing the notion that the criminal
justice system ought to minimize the "net social harm" of crime, Becker
recognized that while expenditures to reduce crime drained resources, crime

From Edwin W. Zedlewski, "When Have We Punished Enough?" Public Administration Review
(November 1985). Copyright © 1985 by The American Society for Public Administration
Reprinted by permission.

116
 YES Edwin W. Zedlewski / 117

imposed other costs upon a community. Through their balancing, judges and
There nothing mystical about these so-
is corrections officials decide whether soci-
called social costs. Home and business ety will be better off if certain defendants
security systems, victim losses, and are set free. They are concerned with
prematurely abandoned buildings are as the future: whether defendants will pro-
much expenditures on crime as prisons duce useful social products through jobs;
and police salaries. whether the correctional system should
Three kinds of costs are involved: expend several thousands of dollars to
confine them; and whether society will
harm to victims, combating or prevent-
ing crime, and punishing offenders. Their
be spared damage from future criminal
sum represents the social cost of crime.
acts. Two "costs," at least implicitly, are

These elements are interdependent in compared, the costs of imprisonment and

the costs to society of setting a defendant
that an increase in punishment can si-
free.
multaneously increase punishment costs
and decrease victim and prevention ex-
penditures. The trick is to find the bal-
What Is a Year in Prison Worth?
ance among the elements that minimizes What is the social cost of a year in prison?
the total crime
That figure can be obtained with rea-
bill.
sonable accuracy. Custodial costs for a
Available data cannot determine with
year in prison are about $15,000 accord-
precise accuracy what criminal justice ing to the American Correctional Associ-
expenditures ought to be to minimize
ation. Constructionand financing costs,
net social costs. However, the logic of
ifviewed improperly, can make building
spending no more on a problem than seem overwhelmingly expensive. 3 But
one can realize in return is useful in construction financing costs are in fact
examining sentencing decisions. There is like mortgage costs facing homebuyers
now, moreover, sufficient data available who quickly find the relevant compar-
—more
to enable us to assess the direction
isons. To assess annual capital costs, one
or less prison — toward which sentencing simply discounts future repayments into
should move. current dollars (to obtain the discounted
Estimates of the social costs relevant present value of the investment) and then
to imprisonment decisions are generated prorates total costs over the projected
using the notion of balancing the harm life of the facility. More simply, one can

from crime against the costs of incarcera- multiply the current interest rate times
tion. Admittedly, this exercise is artificial the value of the construction. Construc-
in that defendants are imprisoned for a tion costs for new prisons average about
—
variety of reasons retribution, rehabili- $50,000 per bed space according to a re-
tation, just deserts among them. Minimiz- cent General Accounting Office report. 4
ing social harm may not even be among Using a 10 percent interest rate on state
the reasons articulated by policy makers. bonds as the rental cost of capital, a prison
Yet, judges and policy makers do in some space, with its share of the rest of the

sense weigh the safety of the community prison structure, costs about $5,000 per
against the costs of punishment in their year.
decisions and in that sense they are per- Lost social output from the defendant
forming a social cost-benefit balancing. is somewhat more difficult to value.
 —

118 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

If a prisoner had been unique in his Given that prison space is limited,
gainful employment, there would indeed judges try to reserve it for the most active
be a loss. But, if imprisonment means criminals. 6 For expository purposes, we
that some unemployed person replaces can envision omniscient judges trying to
him in the work force, then there might gauge a defendant's criminality in terms
actually be a social gain. Added into these of past and future offenses per year.
social dynamics are the net transfers. of If he were to focus on crime control,

dependents, if there are any, into and the judge would send to prison those
out of other welfare support programs. A with the greatest annual offense rates, q.
net social loss of $5,000 per year should Since prison space is limited, he would
generously account for lost social output. 5 eventually set free all those with offense
Decisions to imprison, therefore, imply rates greater than some q. The question
system costs of roughly $20,000 and total is whether the q crimes saved is greater

social costs of about $25,000. Subsequent than the expenditure to save them.
development of this analysis shows that Judges are neither omniscient nor do
results are not sensitive to substantial they sentence offenders to prison solely
errors in any one cost figure. on the basis of criminality. The average
criminality of currently imprisoned of-
fenders is, therefore, less than it would
Letting Them Go Free, Is Not be under a pure and omniscient crime
The social cost of an imprisonment control sentencing policy. Still, knowing
decision, about $25,000 per year, must be something about the criminality of cur-
weighed against the social cost incurred rent inmates at least helps us assess the
by the release decision. That cost can benefits attained from current prison ca-
be approximated, albeit crudely, by pacity.
estimating the number of crimes per year In order to approximate the numbers
an offender is likely to commit if left of crimes likely to be committed by freed
free and multiplying that number by an offenders, we used information about
estimate of the average social cost of annual crime rates obtained from inmate
a crime. We develop estimates of these interviews. Inmate characteristics should
two figures here, realizing in advance resemble those of marginal releasees
the substantial imprecision of the results. defendants that judges decided were
It is virtually meaningless to say that almost but not quite deserving of a
"the average criminal in the United States prison term. It is this group of borderline
commits q crimes per year" or that "the cases that would have been imprisoned if
average American crime costs X dollars." additional space were available and their
The numbers help focus attention on crimes that would have been averted.
important issues, however. The number Because of the severe limitations in
of crimes averted by imprisonment and predicting which defendants are most
the social costs attendant with crime criminal, there is good reason to believe
are critical determinants of how much that inmate offense rates approximate
prison space we should have. The results those of borderline releasees. 7
here suggest the direction that sentencing The estimates of annual offense rates
policy should take, even if they do not here are taken from a survey by the
suggest the magnitude of change. Rand Corporation of 2,190 inmates who
 —
YES Edwin W. Zedlewski / 119

were housed in jails and prisons in rive from them. Because the figure is
California, Michigan, and Texas. 8 The a gross average, it probably overvalues

average number of crimes per inmate petty larcenies and undervalues rapes
serves well to assess the crime savings or vicious beatings. Some overestimation
attained under current abilities to predict occurs because not all criminal justice
criminality. expenditures are crime-related. On the
Rates varied from 1 to 1,000 offenses
. . . other hand, many household and urban
per year, and individual offenders spe- expenditures are uncounted. At any rate,
cialized to varying degrees (a burglar for even fairly large errors will not alter the
instance, may have been involved in few conclusions reached.
other kinds of theft) —
Inmates averaged
somewhere between 187 and 278 prop- The estimates indicate that if judges
erty crimes of various kinds per year, were to sentence 1,000 more offenders
excluding drug deals. Those who said (similar to current inmates) to prison,
they had committed no property offenses they would obligate the correctional
— some 18 percent of the sample have — system to roughly $25 million per year.
been excluded in order to sidestep diffi- About 187,000 felonies would be averted
culties in valuing violent crimes. through incapacitation of these offenders.
These crimes would represent about $430
The Victim's Bill million in social costs. The conclusion
A final estimate is the value of a is insensitive to rather large errors in
crime to society. It is the most troubling estimates. If we were to double the

element in the exercise, partly because annual cost of confinement, halve the
of the statistical errors, and partly average crimes per offender, and halve
because of the conceptual difficulties the average cost per crime, we would still
in defining social value. Rather than conclude that $50 million in confinement
exhaust the reader with a long digression investments would account for $107
on the relationship between social value million in social costs.
and market costs or between average
expenditure on crime versus expected Since estimates of social costs were
savings, we shall simply state our based on money spent, not costs avoided,
procedure. We counted every published what actual savings would be realized is
expenditure on crime we could find open to speculation. One can, however,
and updated them to reach $99.8 billion envision several kinds of savings from
(1983). We
counted every victimization declining crime rates. If householders
we could estimate for 1983 and obtained and businessmen are objective in their
43.4 million crimes. We divided dollars expenditures, they would divert some
by crimes to get expenditures of $2,300 money from protection of goods to the
per crime purchase of more goods. Fewer buildings
Admitting the inaccuracies involved would be abandoned because of crime
in the estimation, does $2,300 per crime risks. Inner city businesses would enjoy
seem plausible, nonetheless? Expendi- lower operating expenses due to reduced
tures have some merit as measures of Mass transportation
incidences of thefts.
value because people do not spend more would be and more popular. The
safer
for services than the value they de- potential savings seem large. 9
120 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

The Fat Half of the Wishbone to 1, crime rates would have been re-

Our cost comparisons were based on an duced by 25 percent while prison pop-
implicit assumption that incapacitation ulations would have risen by 25,000 in-
of offenders was the only source of mates. Focusing on the appealing concept
crime savings. An extensive literature 10 of preventing crime through imprison-
argues that in fact the majority of crime ment misses most of the benefits of the
savings are attributable to deterrence. punishment.
General deterrence is the crime savings Deterrence estimates of crime savings
accrued because potential offenders take help corroborate our findings. A 1 per-
into account the risks of punishment cent increase in 1983 state prison pop-
(as measured by the fraction of crimes ulations would amount to 4,390 more
that resultpunishment) in their
in prisoners, or about $110 million in ex-
crime commission decisions. As the risk penditures. Using Wolpin's estimate of
of punishment increases, the number a 0.839 percent reduction in crime rates
of people willing to commit crimes means that 364,000 crimes would have
decreases. been averted at an assumed value of
Estimates of the savings attributable to about $837 million.
punishment risk vary with the data used Not surprisingly, the cost-benefit ratio
and the crimes and sanctions studied. has fallen from about 17:1 to 7:1 as
Ehrlich, 11 using state-aggregated data we moved from using inmate-based
from I960, estimated that a 1 percent estimates of crimes averted to general
increase in imprisonment risk (prisoners population estimates; inmates are likely
per crime) would produce a 1 percent to contain a disproportionate number of
decrease in crimes per capita. Wolpin, 12 high-rate offenders. So long as incoming
using a national-aggregate time series prisoners resemble current inmates, the
of England and Wales, estimated that higher benefit ratio is pertinent. If
a 1 percent increase in imprisonment incarcerations increased to the point
produced a four-fifths (0.839) percent that additional inmates more nearly
decrease in crime rates. Wolpin also represented the general population's
separated the deterrence savings from propensities for crime, cost-benefit ratios
incapacitation or imprisonment savings would move toward the lower figure.
and estimated that slightly more than half Society is likely to receive a substantial
the savings were due to deterrence for rate of return on prison investments in
both property and violent crimes. either case. 15
Other studies suggest that the deter-
rent component is even larger. Cohen's 13
SELECTIVE INCAPACITATION
review of incapacitation research uncov-
ered a range of 2 to 25 percent esti- Some opponents of prison expansion
mated for incapacitation's share. Nagin have argued that improved identification
and Blumstein 14 estimated that if sentenc- of high-rate offenders coupled with a pol-
ing policies in effect in 1970 had been icy of "selective incapacitation" might ob-
changed from a 25 percent chance of viate the need for additional capacity. Se-
prison upon conviction of a serious crime lective incapacitation emphasizes future
to 100 percent and if prison terms had criminality as a cornerstone of sentenc-
been reduced from 2.6 years on average ing decisions. It argues that long terms
 YES Edwin W. Zedlewski / 121

for high-rate offenders and short terms or offender (14 percent), and large numbers
non-prison sanctions for lesser criminals of high-rate offenders (13 out of 28 per-
can increase crime savings without con- cent) would receive minor sentences. 18
struction. It is in contrast to what many One would expect classification errors to
perceive current policies to be; namely, a be even greater in any operational setting
balance between the offense committed because a new set of offenders would dif-
and the offender committing. fer from the study sample in terms of pre-
The potential for selective incapacita- diction characteristics.
tion can be seen from the Rand sur-
. . . Subsequent research in a decision-
vey data. 16 Nearly half the sample admit- making environment reinforced pes-
ted to fewer than 10 crimes per year. At simism over near-term prospects for
the other extreme, some 20 percent ad- identifying habitual offenders. Peter-
mitted to more than 200 crimes per year. silia et a/. 19 found that even compre-
Imprisoning more high-rate offenders for hensive sentence investigations, which
longer periods would increase the inca- documented employment history, fam-
pacitation benefits of prisons. ily structure, and criminal records, were
Enhanced prediction of criminality poor predictors of the recidivists among
would be desirable even if current poli- a convicted population. Felons recom-
cieswere maintained. Unfortunately, the mended for probation and felons recom-
near-term prospects for improvements mended for prison but not incarcerated
are severely clouded. were back into the court system in nearly
Greenwood and Abrahamse 17 scored equal proportions. Only 3 percent of their
prison inmates on a scale of to 7 on sample of incoming prison inmates were
bases such as prior record, drug use, and predicted to be good probation risks.
employment history and then predicted Other problems requiring attention
which among a sample from the 781 rob- are the ethical questions raised for
bers and burglars from the Chaiken and the nation's judiciary. Among them are
Chaiken survey were likely to be high-, the proportionality of punishment to the
medium-, and low-rate offenders. They offense and the need to provide some
compared their predictions to inmate re- sense of justice to victims. How should
ports and concluded that they had pre- a judge decide between a first-time
dicted with fair accuracy. Unfortunately, murderer and a career thief? Between
this conclusion is sensitive to how their imprisoning one habitual offender for
predictions are aggregated. 10 years and five lesser offenders for
. . . The hypothetical policy under con- 2 years each? Such questions, largely
sideration gives long prison terms to high resolved under current policies, must be
rate offenders and very short terms or reconsidered for selective incapacitation.
probation to lesser offenders. This is con- A final consideration is whether pub-
sistent with a policy of targeting prison lic sentiment would support long-term
space for high-rate offenders. Using incarceration of juveniles. Youths under
the study's classification scheme, judges 18 accounted for over 30 percent of ar-
would err by nearly 50 percent in both rests for serious crimes in 1983; youths
directions: every high-rate offender sen- under 21 accounted for over 47 percent. 20
tenced to a long term (15 percent) would Thus, youths must figure into any crime
be accompanied by a misclassified lesser savings calculated. Either current juve-
122 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

nile punishment policy, which minimizes suspended sentences are not counted in
the use of confinement, would have to be these figures because they receive no
discarded or the hypothetical crime sav- supervision. Incarceration is the extreme,
ings estimated from selective incapacita- not the standard, punishment for a crime.
tionwould have to be revised. The criminal justice system operates
The implications of this section are that under a punitive philosophy nonethe-
selective incapacitation has many obsta- less, and 20th century penologists have
cles to overcome before it can be ad- designed many alternatives to incar-
vanced as a viable policy. Besides the eth- ceration. Fines, restitution, forfeitures,
ical issues of punishment structure and community service, supervised and un-
the social concerns over treatment of ju- supervised probation, and suspended
venile offenders, there is the distinct pos- sentences are among the current alterna-
sibility that predicted crime savings are tives. But despite the flexibility implied
mythical. Increasing sentence lengths for by the range of possibilities, alternatives
some offenders means that bed spaces to prison use either of two mechanisms:
are taken away from other offenders. Re- expropriation of assets (or work equiv-
ductions in punishment certainty are re- alent of assets) or monitoring of subse-
ductions in the deterrence power of sanc- quent behavior in the community.
[Link] saved through increased
incapacitation may be fewer than those The World of Fines
lost through reduced deterrence. Also, Becker argued that fines were socially
our current abilities to identify high-rate they punished offenders
efficient because
offenders from official statistics seem so without draining significant amounts
limited that half the offenders sentenced of resources for their administration.
to lengthy terms would likely be lesser While correct in theory, the argument
criminals. is eroded somewhat by two related

considerations: a convict's ability to pay

and the state's ability to enforce its fine
IF NOT PRISON, WHAT? policies. In Tate v. Short, 22 the Supreme
The same statistics that earlier argued for Court ruled that fines could not be
additional prison capacity support the set beyond a defendant's ability to pay
notion that some offenders are not worth and then converted to imprisonment.
imprisoning. Indeed, most convicted This decision was buttressed by Bearden
offenders serve no prison time. Few who v. Georgia23 in 1983 where the court
do serve prison time serve their full term. ruled that unpaid fines could not be
In 1983 American correctional systems converted to imprisonment unless the
were supervising 2.4 million persons. state determined that the defendant had
Some 73 percent of these persons were not made a bona fide effort to pay.
in the community, 252,000 as parolees These decisions do not reflect disfavor
from their prison terms and 1,502,000 of fines by the Supreme Court. In Bear-
probationers who had not been sent to den, the court explicitly recognized the
prison. Jails, which house both convicted enforcement of fines by imprisonment.
and some pretrial persons, held 224,000 What the court called attention to was
and prisons held 439,000 inmates. 21 the need for a rationaland equitable fine
Persons who received only fines or structure. Amounts levied must be sub-
 YES Edwin W. Zedlewski / 123

jected to some sort of means test and en- or labor. By combining punishment and
forcement must be tempered by subse- compensation, restitution offers a strong
quent considerations of ability to pay. sense of redress. But, only victims lucky
These restrictions do not appear to enough to have a convicted assailant can
have severely restricted the use of receive compensation through restitution
fines. Hillsman et al. 24 found that fines sentences. The large majority will have to
were the predominant sanction for non- look to other mechanisms. Victim com-
traffic violations in courts of limited pensation funds financed through fines
jurisdiction (misdemeanors and lesser and forfeitures, as established by the Vic-
felonies) which handled 90 percent of tims of Crime Act of 1984, can offer
all criminal cases brought and were more efficient and equitable restoration
also used in general jurisdiction felony of damages.
courts. Only 2 of the 24 felony courts
surveyed said they never imposed fines. Probation and Public Safety
The fraction of fine amounts actually While fines are popular in misdemeanor
collected, as much as 90 percent of the cases, the courts sentence the majority of
amounts levied, depended on the interest felons and serious misdemeanants to pro-
and persistence of the courts in collecting bation — [Tjhe relative use of probation
them. and imprisonment has remained fairly
Credible enforcement of fines requires stable despite perceptions of a large-scale
the establishment and monitoring of shift toward imprisonment. What has
payment schedules if the amounts set changed is the absolute use of both sanc-
are anything but nominal. Setting fair tions and their use relative to the number
but punitive fines requires information of serious crimes.
on the legitimate incomes of convicts. As practiced in the early 1970s, pro-
The equity problem has been solved in bation was a cornerstone of rehabilita-
part in Sweden and West Germany by tion. Probation officers operated in part
implementation of "day fines." Fines in They either gave re-
as social workers.
these countries are levied in units of ferrals and family counseling,
for job
work days of the defendant. Defendant drug and alcohol treatment, and voca-
income is used to estimate the value of his tional training, or provided these services
work day and transform the days fined personally. As disappointment over the
into a payable fine amount. Swedish and prospects for rehabilitation grew in the
German courts enjoy easy access to a late 1970s, probation officers gradually
defendant's salary information, but it is took on more of a watchman's role even
not clear that easy access an important
is though many social services were still
ingredient of success. Simply asking the provided.
defendant his salary may be sufficient, Whatever the underlying rationale,
particularly if the alternative to a fine is a probation has been perceived to be a
jail term. minor sanction. Foiling college students,
A popular American variation of the Sebba* Found that they ranked one
fine is restitution. Although the defen- year's probation just below a 12-month
dant is in essence fined, the fine amount is suspended sentence and above a $250
determined by the harm done to his vic- fine in terms of severity. Surveying
tim and is paid to the victim, either in cash prosecutors, Jacoby and Ratledge 26 found
124 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

that one year's unsupervised probation They estimated the social costs incurred
ranked between fines of $10 and $100; a from a cohort of Arizona burglars in
year's supervised probation ranked on a three supervisory settings: confinement
par with a 30-day suspension of a driver 's in prison or jail; community supervision
license. under probation, parole, and halfway
Concern over the severity of punish- houses; and, unsupervised release, pos-
ment implied by probation and the threat sibly after one of the aforementioned
to community safety has caused several treatments. They captured a substan-
states, among them Delaware, New Jer- tial number of the relevant cost com-
sey, Georgia, and Washington, to imple- ponents: corrections supervision, welfare
ment special probation programs that and other social support, crime preven-
have increased oversight and restricted tion, victim losses, and subsequent ap-
freedom in varying degrees. 27 Perhaps prehensions. Costs were estimated for a
typical, Georgia's Intensive Probation Su- variety of crimesand were applied to in-
pervision (IPS) is designed for prison- formation on crimes committed obtained
bound cases. IPS probationers must ei- from interviews with the burglars. No at-
ther hold a full-time job or be a full-time tempt was made to estimate deterrence
student, perform community service, and savings.
pay part of their supervisory costs. They They found that incarceration was con-
average 16 contacts per month with their siderably less expensive thancommunity
supervisors. supervision when identified crimes and
program as
State officials regard the —
costs were accounted for $11,640 ver-
Although IPS probationers
successful. sus $26,868 per year. As previous stud-
have been more expensive to monitor ies found, small numbers of offenders (10
than regular probationers ($1,595 versus percent) committed most of the crimes
$275 per year), they are still less expen- (90 percent). 30Haynes and Larsen also
sive than confinement at $10,814 per year. found that recurring system costs were
Earnings and taxes paid by IPS proba- substantial: $2,640 for arrest and prose-
tioners are offsets to program costs and cution of a burglary and $701 or a sim-
their higher revocation rates—25.5 per- ple shoplifting, exclusive of general crime
cent versus 16.7 percent for a matched prevention and victim losses.
group given regular probation— suggests
that the increased supervision increases Twisting Punishment to Fit Crimes
community safety 28 Given that large numbers of convicted
Many costs are not captured in this as- offenders are going to be released, how
sessment, however. Among the missing should one choose among alternatives
are victim losses, repeated criminal jus- to incarceration? Should a minor offense
tice costs for apprehensions and court by a habitual offender receive the same
procedures, and confinement costs for sentence as a more serious offense by a
some of those revoked. Thus the efficacy first offender? Should equal offenses be
of the program is unclear in a more com- treated the same if the defendants differ
plete cost environment. in criminal record?
Haynes and Larsen 29 made similar If answer to the last question is
the
comparisons among correctional treat- no, then there must be combinations of
ments under fuller accounting of costs. offender characteristics and crime seri-
 —
YES Edwin W. Zedlewski / 125

ousness that deserve equal amounts of

CONCLUSION
punishment. This does not mean that
identical punishments should be handed The objective of this paper was to present
down to dissimilar convicts. We sug- research findings pertinent to the ques-
gest that differences in propensities to tions of how much offenders should be
commit future crimes, perhaps as evi- punished. Rather than rely on traditional
denced by prior record, argue for dif- but difficult to quantify desiderata [de-
ferent forms of punishment. Extending sired needs] of punishment such as ret-
the cost-benefit reasoning presented at ribution and justice, a cost-benefit per-
the outset, it is suggested that defendants spective was used to investigate whether
with low propensities to commit future society spends more money punishing
crimes should be punished as inexpen- than it gains from punishment. Existing
sively as possible. As perceived future data are adequate only for a crude answer
danger increases, the punishment should to that question. Yet, the results over-
provide an opportunity to curtail future whelmingly support the case for more
social costs. This logic suggests fines for prison capacity. The case for current use
first offenders and appropriately super- of probation and fines is less clear be-
vised probation for repeat offenders cause there is less data on the application
of these sanctions. It appears, nonethe-

less, that social costs would be reduced

Absent evidence of habitual involve- if more probationers were given either
ment in crime, the system should try prison terms or fines. Incapacitating bor-
to punish efficiently; that is, exact the derline offenders now crowded out by to-
penalty consuming the least resources. day's space constraints would likely cost
Properly set, fines can be made painful. communities less in crime expenditure
If properly administered, nearly full pay- than they now pay in social damages and
ment can be extracted at low cost. Thus, prevention. Punitive fines for first offend-
finesproduce economical deterrence. Ev- ers would deter others and reduce system
idence of future criminality, on the other expenditures on supervision while pro-
hand, suggests that society may suffer ad- ducing revenues and perhaps compen-
ditional crimes. The data presented here sating victims.
indicate that these costs are likely to ex-
ceed any reasonable costs of monitoring
several times over. Supervised probation
NOTES
has a potential for detecting and limiting 1. See, for example, Prison Crowding —A Crisis in
Corrections, a Report of the Task Force on Criminal
crimes.
Justice issues of the Policy Committee of the Center
fbfMetropolitan Planning and Research (Baltimore:
Johns Hopkins University Press, December 1984),
p. 6.
Sanctions need not be administered
2. Gary S. Becker, "Crime and Punishment: An
separately. Judges can combined proba- Economic Approach," journal of Political Economy,
tion with a fine or with other forms of voL 76 (March 1968), pp 169 i

punishment. The important principle is 3. See, tor example, Gail S. Funke, Wlio's Buried
in Grant's Tomb'' (Alexandria, Va.: Institute for
that the punishment selected should min-
mfcand Polk) Studies, inc., 1982).
imize social costs while maintaining pun- 4. Federal, District of Columbia, and State Future
ishment equity. mi Correctional Institution Populations and
126 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

Capacities, GAO/GOD-84-56 (Washington, D.C.: in prison populations may generate more or fewer
U.S. General Accounting Office, February 27, 1984), crime savings depending on how much deterrence
p. 30. is created by sizable increases in prison risks.
Clark R. Larsen estimated tax losses per
5. 16. Table A. 15 in Chaiken and Chaiken, op. cit.

prisoner at $408 per year and average welfare 17. Peter Greenwood and Allan Abrahamse,
payments at $84 per year in Costs of Incarceration Selective Incapacitation, R2815-NIJ (Santa Monica,
and Alternatives (Phoenix: Arizona State University Calif.: Rand Corporation, 1982).
Center for the Study of Justice, May 1983). The 18. From Table 4.8, ibid., all robbers and burglars
reason for such low average costs was that few of the in the study. Definition of low, medium, and high
inmates were employed in legitimate occupations rates of criminal activity differed with each state
or married at the time of imprisonment. and crime in the sample.
6. Some weight is undoubtedly given to a need
19. J. Petersilia, S. Turner, J. Kahan, and J.
for punishment of major criminal events rather than Peterson, Granting Felons Probation, R-3186-NIJ
personalities. Justice demands that spouse killers be (Santa Monica, Calif.: Rand Corporation, 1985).
punished, for instance, even though repetition of the 20. Federal Bureau of Investigation, Crime in the
crime is unlikely. United States: Uniform Crime Reports (Washington,
7. Prior convictions alone have been found to be
D.C: U.S. Government Printing Office, 1984).
a weak predictor of underlying criminal activity.
21. Bureau of Justice Statistics, Probation and
See Barbara Boland, Age, Crime, and Punishment
Parole 1983, September 1984; The 1983 Jail Census,
(Washington, D.C.: The Urban Institute, 1978).
November 1984; and
Prisoners in 1983, April 1984.
8. Jan Chaiken and Marcia Chaiken, Varieties of
22. Tate v. 401 U.S. 395 (1971).
Short,
Criminal Behavior, R-2814-NIJ (Santa Monica, Calif.:
23. Bearden v. Georgia, 461 U.S. 660 (1983).
Rand Corporation, 1982).
24. S. Hillsman, J. Sichel, and B. Mahoney, Fines
See William W. Greer, "What Is the Cost of
9.
in Sentencing: A Study of the Use of the Fine as
Rising Crime?" New York Affairs (January 1984), pp.
a Criminal Sanction (Washington, D.C: National
6-16 or a comprehensive enumeration of social costs
Institute of Justice, 1984).
due to crime.
25. Leslie Sebba, "Some Explorations in the
[Link] A. Blumstein, J. Cohen, and D. Nagin
(eds.), Deterrence and Incapacitation: Estimating
Scaling of Penalties," Journal of Research in Crime
the Effects of Criminal Sanctions and Crime Rates
and Delinquency, vol. 15 Quly 1978), pp. 247-265.
(Washington, D.C: National Academy of Sciences, 26. Joan Jacoby and Edward Ratledge, Measuring

1978) for an extensive review and assessment of the the Severity of Criminal Penalties: Provisional Results

deterrence literature and evidence. (Washington, D.C: Jefferson Institute of Justice

11. Isaac Ehrlich, "Participation in Illegitimate Studies, 1982).
Activities: A Theoretical and Empirical Investiga- 27. The Delaware program is part of a compre-

tion," Journal of Political Economy, vol. 81 (May /June hensive revision of criminal sanctions. See for-
its

1973), pp. 531-567. mer Governor Pierre S. duPont's Expanding Sen-

12. Kenneth L. Wolpin, "An Economic Analysis tencing Options: A Governor's Perspective, Research in
of Crime and Punishment in England and Wales, Brief (Washington, D.C: National Institute of Jus-
1894-1967," Journal of Political Economy, vol. 86 tice, 1985).
(October 1978), pp, 815-839. Erwin, Evaluation of Intensive Proba-
28. Billie S.
13. Jacqueline Cohen, "The Incapacitative Effect Georgia Depart-
tion Supervision in Georgia (Atlanta:

of Imprisonment: A Critical Review of the Litera- ment of Offender Rehabilitation, 1984).

ture," in Blumstein, Cohen, and Nagin (eds.), op. 29. P. Haynes and C. Larsen, "Financial Conse-
tit, pp. 187-243. quences of Incarceration and Alternatives," Crime
14. Daniel Nagin and Alfred Blumstein, "On the and Delinquency, vol. 30 (October 1984), pp. 529-550.
Optimum Use of Incarceration for Crime Control," 30. See for comparison J. Petersilia, P. Green-
Operations Research, vol. 26 (May 1978), pp. 381-405. wood, and M. Lavin, Criminal Careers of Habitual
15. One cannot safely extrapolate too far from R-2144-DOJ (Santa Monica, Calif.: Rand Cor-
Felons,
observed values of the data. A 50 percent increase poration, 1977).
 David
NO F. Greenberg

THE COST-BENEFIT ANALYSIS OF

IMPRISONMENT

INTRODUCTION
For more than a decade, U.S. prison populations have grown at an historically
unprecedented rate. In 1974 there were 218,466 sentenced prisoners in state
and federal institutions; by the end of June 1989, there were 673,565. The
annual growth rate in this period was approximately 8%, much larger than
the 2.8% overall growth rate for the six decades between 1925 and 1985. Jail
—
populations have also grown from 141,588 in 1972, to more than 300,000 at
the end of 1989. So far there have been no signs of leveling off.
Critics of this expansion have long argued that the expansion of the incar-
cerated population is a terribly inefficient way of reducing crime rates. Point-
ing to the high cost of building and operating new facilities, these critics have
called for shorter sentences and/or greater use of alternatives to incarceration
for many persons who are now sent to prison (President's Commission, 1967:
38; AFSC Working Party, 1971; Keller and Alper, 1970; Citizen's Study Com-
mittee, 1972: 1; Board of Directors, 1973; Mitford, 1973; National Advisory
Commission, 1973; Killinger and Cromwell, 1974; Hahn, 1975; Perlstein and
Phelps, 1975; Fox, 1977; Dodge, 1979; Irwin and Austin, 1987). Greater use
of these alternatives would reduce the prison population, or at least prevent
further increases. The anti-expansionist critics have recently been challenged
by Edwin Zedlewski, a staff economist at the National Institute of Justice. In
a journal article, and in a summary of his research issued by the National In-
Zedlewski (1985, 1987) concludes that prisons are a highly
stitute of Justice,
cost-effective method of reducing crime, one whose use should be greatly
expanded. During the summer of 1988, newspapers gave his findings and
recommendations wide publicity.
Zedlewski's recommendations come in the wake of public campaigns in
which politicians and mass media editorialists have both attacked judges for
being too lenient and advocated putting more people in prison. President
George Bush has proposed adding one billion dollars to the federal budget

From David [Link], "The Cost-Benefit Analysis of Imprisonment," Social Justice, vol. 17,
no. 4 (Winter 1990). Copyright ©
1990 by Social justice. Reprinted by permission. Notes and
references omitted.

127
128 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

to pay for the addition of 24,000 beds vented crime. Thus Hellman (1980: 59-
to the federal prison system —a 77% 60) remarks:
increase in capacity —and the recent
director of federal drug policy, William J. The optimum amount of crime preven-
Bennett, called for even larger increases tion for society to produce can now be
denned; society should produce units of
(Berke, 1989).
crime prevention up to the point at which
Zedlewski's cost-benefit analysis pro- the marginal benefit of the last unit of
vides a seemingly scientific rationale for crime prevention equals the marginal
these proposals. Under this circumstance, costs of producing it. The marginal ben-
his analysis must be subjected to espe- efit of preventing one more crime is the

cially close scrutiny. When this is done, it harm avoided. The marginal cost is the
quickly becomes apparent that his com- additional cost of producing one more
putations are badly flawed. Once these unit of prevention.

flaws are corrected, Zedlewski's conclu-

sions no longer follow. Eventually a point of diminishing
returns will be reached, beyond which
In the pages below, review Zedlew-
I
further spending on prevention will not
ski's procedures and then show that they
produce commensurate benefits in lower
are invalid. I conclude with a broader dis-
crime rates. It is an empirical question to
cussion of the use of cost-benefit analyses
determine just what that point is.
in criminal justice policy-formation.
To determine whether the benefits
gained by putting people in prison to
ZEDLEWSKI'S COST-BENEFIT prevent crime are commensurate with
ANALYSIS the costs of incarceration, Zedlewski
estimates both the costs and the benefits
The fundamental premise of a cost-
of doing so.
benefit analysis of crime is that the
resources a society deploys in preventing
or coping with crime could, in the The Costs of Imprisonment
absence of crime, be used in other To compute the costs of putting more
ways. It follows that a policy designed people in prison, Zedlewski quotes from
to minimize the costs of crime must a 1984 report of the General Accounting
consider not merely injuries to persons Office the figure of $50,000 construction
and the destruction of property, but also costs per bed, which, assuming a 10%
the "opportunity costs" of preventing interest rate for borrowed money, leads to
—
crime the costs of paying for police, an annualized construction cost of $5,000
courts, prisons, watchdogs, locks, private per prisoner. This figure will obviously
security forces, taxi fares, etc. (Votey and rise and fall with the interest rate. To
Phillips, 1973; Cook, 1983). this he adds an annual maintenance
It is assumed that increases in preven- cost of $15,000 for a medium-security
tion costs will reduce crime, but if to- prison, and $5,000 per prisoner/year in
tal costs are to be minimized, preven- social costs (loss of economic production,
tion costs should be increased only to the taxes, and welfare payments to families
point where an extra dollar spent on pre- of inmates), for a total of about $25,000 a
vention yields a dollar's worth of pre- year.
 NO David F. Greenberg/ 129

The Benefits of Imprisonment by increasing the chances that a person

Zedlewski restricts his consideration of who commits a crime will be imprisoned
the benefits of imprisonment to crime for it.

prevention. He estimates the number of Translating an estimate for the number

crimes prevented by locking people up, of crimes a given policy prevents into
taking into account both the incapacita- dollars is always a problem in cost-benefit
tive (restraining) function of imprison- analyses. The standard procedure is to
ment and its deterrent effect. value stolen property at its cost, to set
To estimate the incapacitative effect the cost of injuries at medical costs and
of imprisonment, Zedlewski draws on lost income, and loss of life on the basis
a survey sponsored by the National of lost earnings for a person the victim's
Institute of Justice and conducted by the age, or at an arbitrary large figure such as
Rand Corporation of 2,190 inmates of $1 million.
prisons and jails in California, Michigan, This procedure is highly problematic.
and Texas. The inmates told interviewers Victims are probably less likely to report
that they had, on the average, committed a crime to the police when their loss
between 187 and 287 property crimes per is small; consequently, police records of
year, not counting drug dealing. To be on losses are likely to be biased upward.
the safe side, Zedlewski uses the smaller Victims may also inflate their losses for
of these figures in his computations. insurance purposes. The psychic costs
Because Zedlewski wants to examine of crime, which often greatly exceed
the implications of expanding the prison financial losses, are difficult to quantify
population by sending to prison "border- meaningfully, but for many victims, they
line offenders those— who would have
. . . undoubtedly exceed the monetary value
gone to prison had space been available" of lost property or the cost of medical
(1987: 3) —
(rather than by extending the care.
sentences of those who are now incar- Zedlewski's highly original approach
cerated), he proceeds on the assumption to the quantification of victims' costs is
that this figure can be applied to per- to abandon any attempt to establish an
sons who are now not imprisoned, but "objective" value for the cost of a crime.
are instead placed on probation or fined. His alternate approach is based on the
If assumption is correct, he reasons,
that assumption that criminal justice policy
then the imprisonment of a convicted de- can be regarded as if it were formulated
—
fendant who under present sentencing by a rational actor. In the restricted
policies is not imprisoned would pre- — sense that the term is conventionally
vent at least 187 felonies a year. used in economics, a rational person
Further crime reduction, above and be- will try to minimize the total cost of
yond what is achieved through incapac- crime and crime prevention by spending
itation, can be achieved by deterring po- money to prevent crime only so long
tential offenders. Zedlewski cites several as the marginal cost of preventing a
studieson the magnitude of this effect, crime is smaller than the marginal cost
which found crime rates to be fairly sen- of the crime prevented. Counting every
sitive to the size of the prison population. conceivable cost of the criminal justice
Interpreted causally, these findings sug- system, as well as private expenditures
gest that the crime rate could be lowered to prevent crime (and victim losses),
130 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

Zedlewski arrives at a figure of $99.8 2,187, about 7.3% of the total. The ratio
billion per year as the total cost of crime in of prison population to the number of re-
1983. Victimization surveys suggest that ported index crimes is roughly twice as
there were 43.4 million crimes against high in the District of Columbia as in the
victims committed in 1983. Dividing one rest of the United States. Consequently,
figure by the other yields a cost per crime the percentage of the U.S. criminal popu-
of $2,300. lation that was incarcerated in those years
Zedlewski reasons that imprisoning a was probably somewhat lower than 7.3%
thousand additional offenders compara- (U.S. Department of Justice, 1977: 16-21).
ble to those in the survey would cost an In a model of the Canadian criminal
extra $25 million each year, and leading to justice system devised and estimated by
187,000 fewer crimes, worth an aggregate Blumstein, Cohen, and Nagin (1976), the
of $430,000,000. With benefits exceeding ratio of prisoners to active criminals was
costs by a factor of 17, the conclusion found be about 0.05 in equilibrium. Of
to
that benefits substantially exceed costs re- course, the Canadian prison population
mains valid even if there are some errors is far smaller than that of the U.S. But
in the computation: so is its population, and the magnitude
of its crime problem. Cross-national
Doubling the annual cost of confinement,
halving the average cost per offender, comparisons of crime rates are always a
and halving the average cost per crime bit fuzzy, but if one takes index crimes as

would indicate that $50 million in a rough measure of the volume of crime,
confinement investments would avert then the ratio of prison population to
$107 million in social costs (Zedlewski, crime volume is only slightly higher in
1987:4). the United States than in Canada. This
does not suggest that a much higher
How Large an Expansion? proportion of criminals is behind bars in
Zedlewski does not say by how much the U.S.
prison populations should be expanded. If the estimate that only one criminal
The critical question is the size of the pop- in 20 is incarcerated at any given time,
ulation of offenders that is committing then there are approximately 19 million
crimes at very high rates without being offenders at large who are potential
imprisoned. Presumably Zedlewski be- candidates for incarceration. This could
lieves this population to be substantial- imply a call for prison construction
otherwise there would be little point to that would truly gladden the hearts of
his advocacy. But how large is it? construction contractors. For reasons that
Some research suggests that the pro- will be discussed below, however, the
portion of offenders who are not in prison figure of 19 million is quite misleading.
at any given moment is high. Greene
and Stollmack (1981) used arrest records
to estimate the number of criminals ac- A CRITIQUE OF ZEDLEWSKI'S
tively committing index crimes in the COMPUTATIONS
District of Columbia. Their estimate for
the years 1974-1975 was about 30,000. The Cost Computations
In those years, the average total jail and The procedure Zedlewski uses to esti-
prison population for the District was mate the costs of more imprisonment is,
 NO David F. Greenberg/ 131

as far asit goes, unexceptional. He simply the number of people going to prison on
adds up government expenditures and gun charges (Carlson, 1982; Currie, 1985:
loss of revenue to arrive at $25,000 per 63-64).
year for each additional prisoner. These We can obtain a rough estimate of the
figures will undoubtedly vary from state magnitude of these costs by noting that in
to state because of regional differences 1985, the total cost to federal, state, and
in the costs of construction, standards of local governments of judicial and legal
living considered appropriate for prison- services was $10.07 billion (Jamieson and
ers, etc. Flanagan, 1987: 2). In 1984 there were
However, as an overall figure, Zed- 180,418 new court commitments to state
lewski's number is unobjectionable. Yet, and federal institutions. If judicial costs
there are some costs of imprisonment not were allocated entirely to those cases that
included in Zedlewski's estimation. result in a commitment, the court costs
. . problem posed by Zedlewski's
. [A] per commitment come to $55,800.
analysis his assumption that the judi-
is Of course, a substantial fraction of
cial processing of offenders will be un- these costs must be allocated to the
affected by a tougher sentencing pol- prosecution of cases that do not result in
[Link] is every indication that this such commitments. Judges and attorneys
assumption is mistaken. Because most must still be paid for cases that are
defendants want to avoid being put in dismissed, or where sentences involving
prison, a sentencing policy that would in- fines, probations, or short jail sentences
carcerate large numbers of persons who are imposed. Numerically, those cases
are not now incarcerated would entail ad- considerably exceed those that result in
ditional court processing costs. Many de- a prison sentence. On the other hand,
fendants who now
plead guilty on the the cases where prison sentences are
promise of being sentenced to proba- imposed tend to be the more serious ones.
tion or to "time served" in jail awaiting They take more of the court's time, and
trial would surely contest their charges if they involve greater prosecutorial and
threatened with a substantial prison sen- defense efforts. It would be arbitrary to
tence. The proportion of cases that go to assign any given fraction of $55,800 to
trial would undoubtedly increase. Defen- the prosecution of these cases, but the
dants would be paying more for private fraction may be large enough to add
attorneys,and governments would have appreciably to Zedlewski's estimate of
to pay more for prosecutors, judges, sub- the cost of expanded imprisonment.
sidized defense lawyers, court reporters, A further cost of imprisoning peo-
and miscellaneous support staff. ple isimposed on those who now ben-
Another consequence has been higher efit from the crimes prevented. Most
acquittal rates. In Massachusetts, a 1974 of these crimes involve theft. Most of
law required a one-year prison sentence these thefts materially benefit someone,
without parole for illegal possession of a either the offenders themselves, or cus-
gun. Faced with this mandatory sentence, tomers who purchase stolen goods at a
more defendants declined to plead guilty, discounted price. The savings to low-
went to trial, and were acquitted. Indeed, income consumers who live on the mar-
the acquittal rate rose from about 5 gins of subsistence may have substan-
about 80%. The net effect was to reduce tially larger marginal utility to them than
 —
132 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

the marginal costs to middle- and upper- Michigan —whose crime rates are all
income victims of the loss of their prop- higher than the national average. These
erty. The aggregate benefit to low-income higher rates could stem from a higher
communities of cheaper goods is proba- proportion of the population engaging in
bly quite large. Some of these benefits are crime, with the average offense rate per
documented in such ethnographic stud- criminal being the same as in other parts
ies as Ianni (1974) and Walsh (1977). In of the country; or the proportion of the
the absence of such benefits, social wel- population that engages in crime could
fare costs, which are ultimately borne by be about the same as elsewhere, but with
taxpayers, might rise appreciably. active criminals violating the law more
These benefits of theft can be ignored often. If the latter case holds, Zedlewski's
only if one decides a priori that, as a procedure overestimates the national
matter of policy, benefits arising from benefits of incarceration, because the
illegal acts should not be counted. Such a incapacitation of offenders in other states
procedure, however, skews an analysis in will not yield as great a reduction in crime
favor of the legal and economic status quo. as in Texas, California, and Michigan.
Insofar as a cost-benefit analysis seeks To take this possibility into account,
to assess the implications of different Zedlewski's estimate of the crimes that
policies or procedures, such an a prior might be prevented nationally should be
decision should not be made without reduced by about 20%.
explicit justification. In addition, the population that is
now sentenced to prison is likely to be
The Benefit Computations unrepresentative of the population that
Zedlewski's use of the Rand survey is now convicted but not incarcerated.
to determine the benefits of expanded There are several reasons why this is
incarceration is, for a number of reasons, so. First, among those who violate the
extremely problematic. First, the figure of law, the frequency of violation is highly
187 crimes per person per year pertains skewed. Recall Zedlewski's estimate that
only to that fraction of the subject 43.4 million crimes are committed each
population that reported committing the year. Dividing that figure by the roughly
particular felonies under consideration. 19 million offenders we estimated to be
Yet, 53.3% of the prison inmates said that active every year, we find the average
they had not committed any of those number of crimes committed by each
crimes (these inmates had committed offender to be only 2.28, far smaller than
crimes that were not among those listed, the 187 crimes per offender posited by
e.g., drug offenses or kidnapping) (Chai- Zedlewski.
ken and Chaiken, 1979: 6, 210). For this The discrepancy is easily resolved: the
reason, the appropriate mean offense rate offender population at large is extremely
for the prison samplenot 187 offenses
is heterogeneous. What research has shown
per year but (187)(.467) = 87.3 property to be true of prison inmates is no doubt
offenses per year. This error alone leads true of offenders outside prison as well
Zedlewski to overestimate the benefits of a small proportion commits many crimes,
imprisonment by a factor of two. while a much larger proportion commits
Second, the survey was conducted few. Surely this is true of probationers as
in three states —Texas, California, and well. Some may be committing crime at
 NO David F. Greenberg/ 133

rates comparable to the high-frequency tenced to prison and then released. Wis-
offenders in the Rand study. How many consin felony offenders placed on proba-
of them are doing so is unknown, as tion recidivated less often than parolees
the shape of the distribution of offenses (29.4% vs. 39.4%), though the difference
across offenders not yet well known.
is was largely confined to those without a
Selection from this heterogeneous pop- prior record (Babst and Mannering, 1965).
ulation of offenders is unlikely to be to- Adults placed on probation by the Supe-
tally random. Other things being equal, rior Court in California's largest coun-
the more often people violate the law, ties avoided rearrest more often than
the greater the likelihood that they will those who had been jailed (65.8% ver-
be arrested for at least one of the viola- sus 48.6% after one year) (Beattie and
tions. Thus, the apprehended population Bridges, 1970). In a recent study of of-
is likely in the aggregate to commit crimes fenders from urban Los Angeles and
at higher frequencies than the offender Alameda counties, 63% of probationers
population at large. and 72% of parolees were rearrested on
After conviction, further selection oc- new charges within two years (Peter-
curs. A study of federal sentencing in San silia and Turner, 1986). And in two other

Francisco found that probationers dif- studies, the rate of recidivism was 22%
fered from those sent to prison in many lower for probationers than for released
ways —educational attainment, marital prisoners (Vito, 1987a; 1987b). Naturally
and employ-
status, stability of residence enough, the magnitude of the differences
ment, dishonorable discharge from mil- varies with the jurisdiction, as do the ab-
itary status, pre-arrest income, partici- solute levels of recidivism; but the direc-
pation in church activities, and length tion of the differences is consistent.
of prior criminal record —that are ex- These findings have extremely impor-
pected to be associated with lower rates tant implications. The use of self-reports
of criminality (Robison et al., 1969). In- from existing prison inmates to deter-
deed, many studies of the determinants mine how much crime would be pre-
of sentencing have found that length of vented by incarcerating persons now
prior record isa major influence on a placed on probation depends critically on
judge's decision to imprison or release the assumption that the distribution of of-
a convicted defendant (Vera Institute of fense rates in the target population is sim-
Justice, 1977; Greenwood, 1980; Hagan ilar to the distribution of offense rates in
and Bumiller, 1983; Panel on Sentenc- the study sample. For the reasons just re-
ing Research, 1983). Within the Rand hearsed, that assumption is most unlikely
inmate sample, there is a positive re- to be true. The target population is likely
lationship between self-reported offend- to be less criminally active than the study
ing rates and having a previous official sample, and less seriously criminal.
record (Chaiken and Chaiken, 1979: 85- Had we a reliable method for iden-
124). tifying the high-frequency offenders, it

These expectations are confirmed by might matter little for a policy designed
studies comparing the recidivism of pro- to achieve marginal effects that many of-
bationers and ex-prisoners. In the San fenders violate the law at low frequen-
Francisco study, 19.4% of the probation- cies. Yet, the accuracy of prediction meth-

ers recidivated, as did 35.4% of those sen- ods is notoriously poor. While one can
 .

134 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

select high-frequency offenders with a independently of the criminal justice

precision that exceeds random guessing, disposition they receive. However, one
the improvement is usually modest. This recent study that attempted to take
means that any selection scheme is likely account of such differences statistically
to miss some high-frequency offenders, found that imprisonment tended to
and incarcerate many low-frequency of- enhance rates of return to crime (Petersilia
fenders, a process that reduces the vol- and Turner, 1986).
ume of crime prevented (AFSC Working If criminal careers are on the aver-
Party, 1971; Von Hirsch, 1972, 1985: 105- age long, even modest enhancements of
114; Greenberg, 1975; Monahan, 1981; this sort could negate much of the crime
Blackmore and Welsh, 1983). Moreover, reduction that incapacitation achieves.
some predictors that could be used for Moreover, they will increase imprison-
predictive purposes are presumably al- ment costs, because recidivist criminals
ready available to judges and play a role will return to the courts more often, and
in the decision to grant or deny proba- be imprisoned in the future for parole vi-
tion now. This makes it seem unlikely that olations and new convictions.
there is a substantial body of identifiable A check of Zedlewski's high estimates
high-crime probationers who are not be- for theamount of crime more impris-
ing imprisoned already. . . onment would prevent can be obtained
It is also possible that incarcerating by noting that changes over time in
convicted criminals leads them to com- prison populations create "natural ex-
mit more crimes. Incarceration can do periments" whose consequences for the
this by stigmatizing convicts, weakening crime rate can be readily assessed. If it is
their ties to others who are not engaged in true that large increases in prison popu-
crime (family members, fellow workers, lations produce large reductions in crime
and community members), placing them rates, then the large increases in prison
in a milieu that facilitates affiliation with populations seen in recent years should
other criminals, generating feelings of bit- already have produced large reductions
terness toward "the law" or "respectable" in crime. A few simple "back of the en-
people, attenuating their work skills, etc. velope" calculations provide telling evi-
These processes could lengthen crime ca- dence that this has not occurred.
reers or increase rates of return to crime Between 1980 and 1985, for exam-
by released prisoners. ple, U.S. prison populations grew by
It is not altogether easy to determine 165,642, while index crimes reported to
whether this happens, and if so, to what the police fell by 978,300. This comes to
extent. A naive comparison of recidivism 5.91 index crimes per prisoner. This fig-
rates of probationers and ex-prisoners ure, unlike Zedlewski's, is comparable
falters because the selection procedures in magnitude to empirical estimates oth-
that determine who is sent to prison ers have obtained (Greenberg, 1975; Co-
serve as a filter that tends to keep hen, 1978, 1983; Moore et al., 1984). As-
those with low rates of involvement suming a causal relationship, it follows
in crime out of prison. So the two that an increase in the prison population
populations are not entirely comparable; of 100,000 (an increase of 31.6%) would
that is, they may differ in ways that have reduced the number of index crimes
account for differences in recidivism, —
committed by 591,000 a reduction of ap-
 NO David F. Greenberg/ 135

proximately 4%. This very modest re- It must be stressed that these estimates
duction, corresponding to an elasticity of are not to be taken too literally. My choice
about -.123, suggests that imprisonment of years was arbitrary. Had I chosen
is a relatively inefficient way to reduce a different set of years my estimates
crime. would have been somewhat different.
Our conclusion that rates of crime For example, a comparison of index
are relatively insensitive to the size of crime rates in 1981 and 1985 leads to
the prison population is confirmed by a the conclusion that the average prisoner
study of imprisonment and crime rates commits 8.13 crimes while at large. With
in Illinois, where a program designed to 1982 as a base year, the figure would have
relieve prison overcrowding reduced the been 5.60. Comparing 1985 with 1979, one
size of the prison population by about would conclude that the growth in the
10% from the level to which it would prison population did not prevent any
otherwise have grown. Austin (1986) es- crimes at all (the crime rate was higher in
timates that this reduction increased the 1985 than in 1979 even though the prison
crime rate by less than 1% (corresponding population had grown).
to an elasticity of approximately -.10). It could be objected that other factors,

Had Zedlewski's estimate of 187 which tend to increase the crime rate,
felonies been valid, the number of in- may have been at work in these years.
dex crimes (assuming for the sake of sim- In the absence of the rapid expansion
plicity that all those felonies were index of prison populations that occurred,
crimes) committed in the United States perhaps the crime rate would have risen
would have fallen by 30,975,054. Since more dramatically. There is, no doubt,
there were 13,408,300 index crimes re- some validity to this argument. The
ported to the police in 1980, the index population was growing, and cultural
crime rate would have fallen to zero and life-style changes contributing to the
by 1985 (even if we take crimes not re- growth in crime may also have been
ported to the police into account) had taking place. Yet the upheavals of the
Zedlewski's estimate been valid. 1960s were over. Though social change
Alternately, we can look at victimiza- was continuing, it was not of such a large
tion surveys. Between 1980 and 1985, magnitude that it could conceivably have
victimizations (as estimated by house- nullified the crime-prevention effects of
hold surveys) declined from 40,252,000 to such a large increase in the prison
34,864,000. If this reduction is attributed population, if Zedlewski's figures bear
entirely to the growth in prison popu- any resemblance to reality. The more
lation, the imprisonment of a single of- plausible conclusion isthat they do not.
fender prevents 32.65 victimizations per This conclusion is strengthened when
year. Had the Zedlewski estimate of demographic changes occurring during
187 victimizations been valid, victimiza- this period are taken into account. Be-
tions would have fallen to 9,276,946, less tween 1980 and 1985, the age composi-
than one-third their actual level. Further tion of the U.S. population shifted. In 1985
growth in prison populations after 1985 there were fewer people in the youth-
would have brought the victimization ful high-crime-rate age brackets than
rate down to zero. Nothing of the kind there wore in 1980. This demographic
has happened. shift undoubtedly contributed to the ob-
136 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

served decline in crime rates (Blumstein, publicly. This difficulty biases the provi-
1985; Cohen, 1985; Blumstein, Cohen, and sion of public goods toward overspend-
Rosenfeld, 1986; Steffensmeier and Harer, ing (Buchanan, 1967: Chapter 10).
1987). Taking this demographic shift into Third, Zedlewski forgets that
if pub-
account would reduce one's estimates of licspending were increased exogenously,
the crime reduction that might be ac- individuals might simply reduce their
complished through an expansion of Jhe own private spending on crime preven-
prison population. tion (Clotfelder, 1977). Depending on
Before proceeding to the final step in whether private or public expenditures
—
Zedlewski's analysis attaching a mon- are more efficient in preventing crime, a
etary value to each crime prevented, we change in the mix of private and public
may pause to point out the implications expenditures might raise or lower crime
for the comparison of costs and bene- rates.
fits to the scaling down of the average
Fourth, the procedure by which Zed-
rate of crimes per marginal candidate for
lewski derives his figure for the amount
incarceration. Taking without question
individuals are willing to pay to prevent
Zedlewski's estimate of the dollar value
crime is entirely mistaken. Recall that
of preventing a crime to be $2,300, the
Zedlewski derived this figure by adding
value of the crimes prevented by locking
victim losses of $35.4 billion to miscel-
up a marginal offender who commits 10
laneous private and public expenditures
crimes a year is $23,000 per year, slightly
for the prevention and punishment of
less than the cost of a year's incarceration.
crime ($61.4 billion). Though this may be
But can the figure of $2,300 be trusted?
the total cost of crime, it is not the appro-
There are several reasons it cannot. First,
priate figure to use for the amount that
a substantial fraction of the amount of
the public is willing to spend to reduce
money spent on crime prevention and
crime.
control goes for traffic offenses, and
crimes that are not victimizing at all, such Within the cost-benefit framework,
$61.4 billion is the amount being spent
as narcotics violations and prostitution.
Taxpayers do not pick and choose the to reduce crime to its present level from

kinds of crimes the criminal justice the higher levels of crime that would
system prosecutes; given that choice, presumably prevail in the absence of
some of us might opt for a very different any spending for crime prevention and
allocation of resources than the present control. It is anyone's guess just what that

one. As Zimring and Hawkins level would be. It could conceivably be

(1988)
note, the figure of $2,300 isan average extremely large, far higher than present
over all kinds of offenses, some of which levels.

would no doubt be costed at much more If one were to include only material
than $2,300, others at less. Under these losses in the cost-benefit calculus, it

circumstances, an average figure may not would be irrational to spend more money
mean much. to prevent victim losses than the $35.4
Second, budgeting procedures for pub- billion those losses cost. If, as seems likely,
lic goods can create a "fiscal illusion" that it would more than that to prevent
cost
makes it difficult for taxpayers to know all those crimes, it would be cheaper to
the full costs of providing those services compensate victims.
 NO David F. Greenberg/ 137

Of course, people may be willing to To say that Zedlewsi's conclusions

pay to avoid the psychological costs cannot be supported by the line of
associated with victimization as well. reasoning he advances is not to say that
Yet Zedlewski's computation is still they cannot be supported in other ways.
not the correct way of taking that The question of how many people should
willingness into account. The subjective be in prison is a difficult one that the
value of a marginal reduction in crime present essay does not even attempt
below its present level depends on how to address. The question of alternate
much additional spending beyond current sentences is equally outside the scope of
expenditures individuals would be willing the present discussion.
to accept to achieve that reduction. This,
too, is unknown. However, a recent
COST-BENEFIT ANALYSIS
survey of 400 Alabama residents suggests
RECONSIDERED
that it might not be high. Although 69%
of the sample said that Alabama needed Apart from the details of his computa-
more prisons, only 19% favored paying tions, theterms in which Zedlewski de-
for them with more taxes. Cutting back velops his argument can themselves be
on state spending in other areas, such as criticized on a number of counts. First, by
education or health care, to pay for more restricting the policy analysis towhether
prisons, was even less popular only 3% — more prisons should be constructed, he
supported that option (Doble and Klein, fails to consider whether other alterna-

1989: 22, 27). tives might not be more cost effective than
prisons. Even if all his calculations had
In the abstract, then, the public may
been valid, it would still not follow that
favor greater use of imprisonment, but it
prison construction would be rational; af-
does not appear to be willing to pay for
ter all, other alternate strategies might be
it. In any event, because Zedlewski uses
even more efficient. Note that this is not
an irrelevant figure for the number of
an argument against cost-benefit analy-
crimes (those not prevented, rather than
ses, only an insistence that the range of
those prevented by present policy) and an
policy options needs to be broadened be-
incorrect dollar figure (total costs of crime
fore such analyses are used to decide in
rather than costs of crime prevention),
favor of a given policy.
his procedure cannot be taken as offering
governments have only a
Second,
even a rough estimate of the marginal
limited amount of funds
to spend. Crime
value of preventing a crime.
control is only one of many claims
In sum, even when his caveats and competing for the public purse. Even
qualifications taken into account,
are if funding for crime control
further
Zedlewski grossly overestimates the po- would in be desirable, it may
itself

tential benefits of expanded prison con- not be desirable to take funds away
struction, and greatly underestimates the from education, pollution abatement,
costs. Unfortunately, it is not easy to offer or public health. Of course, by raising
superior estimates of some factors that taxes or borrowing, funding or crime
figure in his analysis because the em- control can be increased without taking
pirical base for improved estimation is funds away from other public programs.
lacking. However, there is a limit beyond which
138 / 7. ARE MORE PRISONS THE ANSWER TO RISING CRIME?

governments cannot tax or borrow. icy choices. In other circumstances, such

The reluctance of today's politicians to as the present one, cost-benefit analyses
propose higher taxes to reduce the federal will be inconclusive because they will not
deficit suggests some of the political be able to produce reasonable estimates
problems raising taxes can entail of costs and benefits, or will not be able
In a culture where utilitarian consid- to cope with interpersonal comparisons
erations are a widely accepted basis for of costs and benefits. On such occasions,
legitimating policy decisions, it is in- social scientists, who may be called upon
evitable that cost-benefit analyses will by policymakers to formulate and justify
continue to be produced and dissem- administrative initiatives, have a special
inated to justify penal policy innova- responsibility not to suspend their criti-
tions. In itself, this is not a bad thing; at cal sensibilities. When a policy cannot be
times, such analyses can illuminate pol- justified, we should say so.
POSTSCRIPT
Are More Prisons and Prison Beds the
Answer to America's Rising Crime Rate?
The most recent articulation of the call for a massive increase in the number
of prison cells is voiced by Princeton professor of politics and public affairs
John J. DiLulio Jr. DiLulio, along with Joan R. Petersilia, heads the Brookings
Institution project "The New Consensus on Crime Policy." See, for example,
the following two have appeared in the Brookings Review: "Does
articles that
Prison Pay?" (Fall 1991) and "Does Prison Pay?: Revisited" (Winter 1993).
Anne Morrison Piehl was coauthor of both these essays. In numerous essays,
which appear in a wide variety of publications from professional journals to
Readers Digest, DiLulio warns that the next generation of teenagers is a "wolf
pack" of depraved "superpredators." His comment is, "If incarceration is not
the answer, then what, precisely is, is the question."
DiLulio not without his critics. See, for example, Bruce Shapiro, "How
is

the War on Crime Imprisons America," The Nation (April 22, 1996). Shapiro
argues that DiLulio is not an objective observer. His immigrant grandmother
was mugged and severely beaten a few blocks from her home by black teens,
and his uncle was stabbed to death by a murderer, who was a drug addict
out of prison on parole. Shapiro reminds us that DiLulio himself has said that
these experiences "sure as hell concentrate your mind."
Another variation on this theme is captured in an exchange of views that
appeared in the June 1996 issue of Social Science Quarterly. Here J. R. Clark and
Dwight R. Lee argue that a short-run policy to reduce prison sentences, and of
course fiscal pressures, will in the long run increase criminal activity and the
demand for prison cells. They liken this to a Laffer Curve: At zero sentencing
length, there is a zero demand for prison space and correspondingly high
crime rates; as sentencing rates increase so does the demand for prison space.
But after a point, an increase in sentencing length decreases the required
prison capacity because you have locked up most of the bad guys and deterred
most of the other want-to-be bad guys. As you would expect, this hypothesis
is challenged in other essays in the June 1996 issue of Social Science Quarterly.

See in particular the essays by M. Dwayne Smith, "The Folly of a 'Lock Em

Up' Laffer Curve," and Dale O. Cloninger's "Sentence, Length, Severity, and
the Demand for Prison Space."

139
 . —

On the Internet . .

Consolidated Financial Statements of the U.S.

Government, 1995 (Prototype)
[Link] The Consolidated Financial Statements (CFS) of the U.S.
government provide information about government finan-
cial operations on an accrual basis. Links to the state-
ments, notes about them, and supplemental tables can
be found at this site.
[Link]

Joint Economic Committee

Start here to explore the work and opinions of the mem-
bers of the Joint Economic Committee on many topics
tax reform and government spending, Clintonomics, and
the growth debate, to name just a few.,
h ttp://www. sen a [Link] v/~jec/jechmpgt. html

The Public Debt

Here you The Public Debt of the United
will find links to
Expense and
States to the Penny, Historical Debt, Interest
the Public Debt, and Frequently Asked Questions.
h [Link] icdebt. [Link]/opd/[Link]

U.S. Macroeconomic and Regional Data

Hosted by the Department of Economics at the State Uni-
versity of New York, Oswego, this site contains the full
text of recent economic reports to the president and
links to various global and regional economic indicators.
[Link]

U. S. Treasury
Select Browse at this site to open up the U.S. Treasury,
which is divided into accessible areas: Banking and Fi-

nance, Money, Taxes, Treasury Services, to name just a few.

[Link] [Link]/
 PART 2
Macroeconomic Issues

Government policy and economics are tightly intertwined. Fiscal policy

and monetary policy have dramatic input on the economy as a whole,
and the state of the economy can often determine policy actions.
Decisions regarding balancing the budget or welfare reform must be
made in the context of broad macroeconomic goals, and the debates on
these issues are more than theoretical discussions. Each has a significant
impact on our economic lives.

Can Economic Growth Be Increased Just by Using More In-

puts and Improving Efficiency?

Is Our Current Social Security Program Securely Anchored?

Does the Consumer Price Index Overstate Changes in the Cost

of Living?

Is There a Need for a Consitutional Amendment to Balance

the Budget?

Is the Federal Reserve the Cause of Poor Macroeconomic Per-

formance?

Is the Nonaccelerating Inflation Rate of Unemployment a Use-

ful Guide for Macroeconomic Policy?

Would Adopting Wisconsin's Welfare Reforms End Welfare As

We Know It?

141
ISSUE 8
Can Economic Growth Be Increased Just
by Using More Inputs and Improving
Efficiency?

YES: Council of Economic Advisers, from Economic Report of the President

1997 (Government Printing Office, 1997)
NO: Felix G. Rohatyn, from "Recipe for Growth/' Wall Street Journal (April
11, 1996)

ISSUE SUMMARY
YES: The Clinton administration's Council of Economic Advisers believes
that the way to stimulate economic growth is to increase the availability of
physical capital and to improve efficiency.
NO: Felix G. Rohatyn, U.S. ambassador to France and former partner of an
investment firm, argues that an increase in the growth rate does not require
the redistribution of wealth and that the government must play an active
role in education, in infrastructure investment, and in the maintenance of a
corporate safety net.

Economic growth is generally defined as an increase in an economy's pro-

duction of goods and services. Because productive activity generates real
income, output and income are simply two sides of the same coin; that is,
economic growth is also referred to as an increase in real income. Societies
desire economic growth because an increase in the availability of goods and
services means that persons in that society are better off, at least in a material
sense.
Economic growth has always been a central concern of economists. Con-
sider the beginnings of modern economics, Adam Smith's Wealth of Nations.
Published in 1776, its title conjures up images of material well-being and

the forces that cause variations in material well-being between countries and
over time. The Full Employment and Balanced Growth Act captures the
importance of economic growth from an economic policy perspective. This
legislation, passed in 1978, states that "it is the continuing policy and respon-
sibility of the Federal government ... to foster and promote .increased real
. .

income."
In measuring economic growth, economists typically use the concept of
real gross domestic product (GDP). Simply defined, real GDP is the value of

142
an economy's production of goods and services measured in constant prices.
The percentage change in real GDP is typically referred to as the economic
growth rate.
In explaining economic growth, economists typically use the growth ac-
counting framework. This framework views production as the process of
converting inputs into output. An increase in the quantity of output occurs
with either an increase in the quantity of inputs employed or an increase
in the ability of the inputs to produce output. Accordingly, three sources of
economic growth are identified: increases in labor inputs, increases in capital
inputs, and increases in total factor productivity or efficiency.
Although the growth accounting framework is conceptually simple, its es-
timation is not. There are direct and independent measurements available
for real GDP, labor inputs, and capital inputs, but no direct and independent
measurement of total factor productivity. Therefore, total factor productivity
is measured indirectly as a residual. This means that whatever changes in

real GDP are left unexplained by changes in labor and capital inputs are at-
tributed to changes in total factor productivity. As a consequence, total factor
productivity, when it is estimated, not only includes the true contribution of
productivity to economic growth but also any errors in the measurement of
economic growth and changes in labor and capital inputs. For this reason the
empirical estimate of the contribution of total factor productivity to economic
growth has been called "a measure of our ignorance."
Policy concern with economic growth develops when growth performance
is less than desired. This is the current situation for the United States. During

the 1960s economic growth, measured as the simple arithmetic average of

yearly percentage changes in real GDP, was 4.4 percent, 3.2 percent during
the 1970s, 2.8 percent during the 1980s, and 1.8 percent during the first six
years of the 1990s. In short, during the 1990s, the growth rate for the U.S.
economy has been quite low by historical standards. The question then is,
What should be done to increase the growth rate?
The solution offered by Clinton's Council of Economic Advisers follows
almost directly from the growth accounting framework. Advisers say we
need to increase physical capital or capital inputs. They believe this will
happen if the government reduces its budget deficits. They also say we need
to increase total factor productivity. They believe this will happen if the
government takes actions to improve human capital, to stimulate research
and development, to increase competition, to expand trade, and to improve
public sector efficiency. Felix G. Rohatyn, on the other hand, takes a more
fundamental political view. He believes that improving economic growth
requires, among other things, the acceptance of a new definition of fairness
by Democrats and a new definition
the oi the proper role ofgovernment by
the Republicans. These new definitions will allow theAmerican economy to
break out of the "financial iron triangle/' which restricts economic growth
and generates serious social tensions.

143
 Council of Economic Advisers
YES

THE ECONOMIC AGENDA

The United States still faces major economic challenges. American technol-
ogy, the economy, and society are all changing rapidly. Instead of ignoring or
lamenting these changes, the Nation must embrace them, transforming prob-
lems into opportunities. We can do this only if we set a coherent economic
agenda. This [Clinton] Administration has already accomplished much with
the policies of the last 4 years. In the next 4 years the Administration will
continue to build on those policies, holding fast to its new vision of the gov-
ernment's role in the economy as the basis for an agenda to promote growth,
opportunity, and responsibility.

GROWTH
Productivity growth has been slow since the early 1970s. Since 1973, annual
rises in productivity innonfarm businesses have averaged 1.1 percent, a
drastic declinefrom the 2.8 percent annual average that the Nation enjoyed
between 1960 and 1973 (Figure 1). Biases in the methods used to calculate
these numbers may exaggerate the slowdown, but something has undoubt-
edly happened to slow the pace at which output per hour increases. Slower
productivity growth has the direct consequence of retarding increases in the
Nation's standard of living. It also places obstacles in the way of solving some
of the Nation's other challenges. Americans may be less supportive of freer
trade when trade liberalization has been associated, however spuriously, with
slower growth. It will be harder to balance the budget over the long term,
especially while supporting a growing aged population, when productivity
growth is slow. And workers are more reluctant to share their resources with
those who are worse off when they feel that their own wages are stagnant.
The sources of economic growth can be grouped under three headings:
increases in physical capital, improvements in human capital, and increases
in the overall efficiency of the economy —the amount of output per unit of
From Executive Office of the President, Council of Economic Advisers, Economic Report of the
President 1997 (Government Printing Office, 1997).

144
 —
YES Council of Economic Advisers / 145

input. The Administration's economic research and development. The deficit re-
agenda is based on strengthening each duction of the last 4 years, however, has
of these three pillars of economic growth. put the Nation in a position to address
these long-term issues in a manner that
Increasing Physical Capital preserves the important achievements of
The first pillar of economic growth is Medicare, Medicaid, and Social Security.
which en-
increases in physical capital, When the government runs a smaller
able workers to produce more goods and deficit, it absorbs less private saving
services. Because it reduces the govern- and frees up resources for private sector
ment's borrowing, deficit reduction will investment. But public investments in
remain the key to how much of national infrastructure, such as roads, schools, and
saving is available for private invest- airports, are also important. It is false
ment in physical capital. The Nation has economy to release funds for investment
made great progress in bringing down inone area by cutting back in another
the deficit in the last 4 years, but this where the need and the return are just as
ground will be lost unless we address great. Entrepreneurs will be reluctant to
the strains that some of the major enti- build new factories, homes, and offices if

tlement programs will place on the bud- the highways and bridges that link them
get over the long term. As the population are inadequate for the new traffic they
ages, expenditures on Social Security are generate.
expected to grow from an estimated 4.7 To be sure, government must take
percent of GDP [Gross Domestic Prod- pains to see that every dollar it invests,
uct] in 1996 to around 6.4 percent in 2030, like every other government dollar, is
then stabilize. A much more serious chal- well spent. We have to think hard about
lenge is posed by Medicare and Medi- how to put into place incentives that
caid. If nothing is done to reform these make such outcomes more likely. And we
programs, their outlays are projected to have to think carefully about which pub-
grow from an estimated 3.9 percent of lic investments should be the responsibil-
GDP in 1996 to 13.0 percent in 2050. Their ity of the Federal Government and which
projected growth is due not just to the ag- the responsibility of States and locali-
ing of the population, as in the case of So- [Link] fear of misdirected investment
cial Security, but also to the expectation should not lead to underinvestment, be-
that the volume and intensity of medi- cause too little investment is costly to
cal services consumed will continue their future growth. In short, we should not
rapid rise create an infrastructure deficit while at-
Assuming Federal tax revenues re- tempting to improve the budget deficit.
main at their historically constant level of
around 18 percent of GDP, the projected Improving Human Capital
increase in entitlements, especially Medi- The second pillar of economic growth is
care and Medicaid, will have one of two improvements in what economists call
effects: either it will balloon the budget human capital: the knowledge, experi-
deficit, or it will all but crowd out other ence, and skills of the workforce. As the
vital government expenditures, includ- economy has changed, the demands im-
ing those necessary to sustain long-term posed on the brainpower of the American
economic growth, such as education and workforce have increased enormously.
146 / 8. CAN ECONOMIC GROWTH BE INCREASED BY USING MORE INPUTS?

Figure 1

Actual and Trend Labor Productivity

110

100-
Trend ^^^^^7^''
90

80
Actual
f*
A'
<

Z-»
*
j^C Trend = 1.1% (annual
(1973:Q4to1996:Q3)
rate)

70 — J *

1^ '

Ic 60 rj' Trend = 2.8% (annual rate)

/' (1960:Q2to1973:Q4)

50 i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i I I l I I I

1960 1965 1970 1975 1980 1985 1990 1995

Labor productivity has grown at a 1.1 percent average annual rate since 1973.

Note: Data are for the nonfarm business sector.

Source: Department of Labor

[T]he returns to education, as measured Recognizing the challenge that these

by the difference in incomes between changes pose, the President has set am-
college and high school graduates, have bitious goals for the Nation's education
risen sharply in the last 20 years. Much system: every 8-year-old should be able
of this difference probably reflects the in- to read, every 12-year-old should be able
creasing importance of computer skills in to log onto the Internet, every 18-year-old
the workplace. should be able to go to college, and every
classroom and library in America should
Many American schools do a superb be linked to the Internet.
job of human capital formation, but some An array of policies, current and
are failing at the task. Standardized test proposed, are directed toward achieving
scores reflect only part of the learning these goals. The America Reads initiative,
that goes on in schools, yet the fact that working through the National Service
American children perform less well on program, will call on thousands of people
standard science and mathematics tests to mobilize an army of a million volunteer
than many of their foreign counterparts tutors, dedicated to ensuring that every
is a continuing source of concern. There child in America can read by the age
is no easy answer. of 8. A good education in the early
 —

YES Council of Economic Advisers / 147

years of a child's life is necessary, but classroom in the Nation. It is making sig-
hardly sufficient to endow that child toward ensuring that all
nificant progress
with the skills that our technological American students are computer literate,
society demands. Therefore, in addition equipped with the skills they will need
to early-education programs, we need to in the 21st century. Under this initiative,
promote technology in the classroom and 20 percent of all the schools in California
encourage young people to take more have already been wired to the Internet
years of college. —a good example of government and the
Although the returns to additional private sector complementing each other.
years of education are substantial The Federal Government served as en-
between 5 percent and 15 percent trepreneur for this initiative, but much
without government involvement many of the work was done by 50,000 volun-
students would find it difficult to borrow teers, with many of the Nation's leading
for college. Not only do they lack a credit high-technology firms donating equip-
history, but they cannot borrow against ment. The initiative also stresses the de-
—
expected future earnings human capi- velopment of educational software and
tal cannot be pledged as collateral. The the training of teachers to harness the po-
result is a classic market failure: markets tential of these new technologies.
by themselves do not provide all the ed- Other steps are important in prepar-
ucation for which the benefits exceed the ing the Nation's educational system for
costs, even when the benefits are mea- the 21st century. Recent reports have doc-
sured only in narrow economic terms. umented the extent to which America's
Since the G.I. Bill was passed in the 1940s, public schools have become dilapidated.
the Federal Government has had an ac- Schools with leaky and collapsing roofs
knowledged role in making higher edu- have had to be closed. Because students
cation more affordable. Policies already need a more conducive environment in
implemented by this Administration are which to has pro-
learn, the President
bringing us much closer to the day when posed $5 funding to
billion in Federal
every American who wants to will be able support a program, administered by the
to attend at least 2 years of college. Under States, that would spend $20 billion for
the new directstudent loan program, for school construction and renovation. Ad-
example, individuals can borrow money ditional efforts are focused on enhancing
for college directly from the Federal Gov- resources for those communities facing
ernment and tailor their repayments to the hardest problems (e.g., those with dis-
suit their own financial circumstances. proportionate numbers of disadvantaged
Seeking to build on the success of this children), improving standards through
program, the President has also proposed the Goals 2000 program, and promot-
tuition tax credits, to support those seek- ing new approaches through the charter
ing higher education, and penalty-free school movement.
withdrawals from individual retirement Education does not end with college.
accounts, to encourage them to save for That is why this Administration has con-
it themselves. sistentlyemphasized lifelong learning
Meanwhile the Technology and I iter- and employability security, to boost eco-
acy Challenge initiative is bringing ad- nomic growth and reduce the adjustment
vanced computer technology into every OOStS associated with a vibrant economy.
148 / 8. CAN ECONOMIC GROWTH BE INCREASED BY USING MORE INPUTS?

Unfortunately, the legacy of past efforts in productivity that today allow less than 3
this sphere has workers facing a com-
left percent of the workforce to feed the entire
plicated maze of dozens of government- Nation, and havemade the United States
assisted training programs, each with one of the world's leading agricultural
its ownrules, regulations, and restric- exporters.
[Link] President has proposed replac-
Detractors of government support for
ing this complex system with a single
research have often distorted the issue.
choice-based system for adults. This sys-
Some have posed a false dichotomy be-
tem should use a market-oriented ap-
tween basic research, for which public
proach, relying on training vouchers or
support is almost universal, and technol-
grants to empower people directly to seek
ogy, which they say should remain the
the training that will help them the most.
province of the private sector. Yet many
areas of technology have huge spillover
Research and Development
benefits and therefore would be under
The third pillar of growth is greater eco-
provided without government support.
—
nomic efficiency learning to produce
Critics have also accused government of
more output with fewer inputs. Addi-
tions to the Nation's technological arse-
—
trying to "pick winners" of seeking to
supplant the market at one of the things
nal through research and development
it does best. But government support of
are an important contributor to efficiency:
technology is not aimed at outguessing
private industry invests over $100 bil-
the market. Rather, it is focused on set-
lion in researchand development each
ting up partnerships and other structures
huge sum, but it may not
year. This is a
to identify, together with the private sec-
be enough: history and economic theory
tor, those areas in which large benefits to
suggest that, left to their own devices,
society are not likely to be produced by
private firms will not invest sufficiently
the market alone.
in improving technology, because they
themselves do not realize the full ben- In the spirit of the Administration's
efit therefrom. Even though the patent new vision for the economy, the Federal
system encourages invention by guar- Government has placed public-private
anteeing that inventors retain property partnerships at the center of its research
rights to their innovations, many very and development policy. The Advanced
useful ideas developed in more basic sci- Technology Program (ATP), expanded
entific research cannot (and should not) substantially under this Administration,
be patented. is a good example. ATP awards matching

The Federal Government has long funds to industry, on a competitive

played a critical role in promoting re- basis, to conduct research on cutting-
search and development. It has financed edge technologies and processes that,
growth in telecommunications, for in- despite their great economic potential,
stance, from that industry's inception, might otherwise not have been pursued.
with the first Baltimore-to-Washington The firms themselves set much of the
telegraph line, to its latest major de- research agenda, but this pairing has been
velopment, the Internet. In agriculture, an effective way to leverage government
government-funded research provided funding into larger increases in research
the basis for enormous improvements in and development. The record shows
 YES Council of Economic Advisers / 149

that the success rate of this and similar Today services and information are as-
programs is indeed formidable. suming the lead position, while at the
same time demand for U.S. goods is in-
Increasing Competition creasingly coming from abroad. Some-
Improving the efficiency of the economy times analysts focus on manufacturing as
is not just a matter of improving technol- if it still represented the core of the econ-
ogy. How the economy is organized plays omy. Manufacturing is important — it is

just as important a role in creating incen- the Nation's largest investor in research
tives for firms to use their capital and la- and development and its leading ex-
bor as efficiently as possible. If the mar- porter —but manufacturing employment
ket economy is to deliver on its promise today represents only 15 percent of total
of growth and prosperity, markets have employment, and service industries also
to be competitive, because it is competi- produce many of our important exports,
tion that drives firms to be efficient and for example in telecommunications, fi-
innovative. Firms, however, often find nancial services, and other intellectual
it easier to increase profits by reducing property.
competition than by improving efficiency Today, new technologies have ex-
in response to competition. Monopolies panded the scope for competition in
and oligopolies not only can charge inef- many sectors that have historically been
ficiently high prices and restrict output, highly regulated, such as telecommunica-
but may also have a diminished drive to tions and electric power. Traditional reg-
innovate. ulatory structures, however, with their
The traditional way com-
to increase rigid categories of regulation versus
petition is to prevent the growth of deregulation,and competition versus
monopoly power in the first place. This monopoly, have become increasingly un-
Administration has restored vigor to the helpful in guiding policy in these areas.
enforcement of the antitrust laws, block- These new technologies do not call for
ing anticompetitive mergers and, where wholesale deregulation because not all
warranted, prosecuting alleged violators. parts of these industries are adequately
But competition is not viable in some in- competitive. Instead they call for ap-
dustries, namely, those called natural mo- propriate changes in regulatory struc-
nopolies. Antitrust enforcement may be ture to meet the new challenges. Such
of little help in these areas; instead gov- changes must recognize the existence of
ernment regulation can help to ensure hybrid areas of the economy, some parts
that monopoly power is not abused. of which are more suited to competi-
The extent and the form of compe- tion, while others are more vulnerable
tition are constantly changing. Joseph to domination by a few. Market power
Schumpeter, one of the 20th century's in one part of a regulated industry can-
great economists, described capitalism as not be allowed to maneuver itself into
a process of creative destruction. New in- a stranglehold over other parts, or else
dustries constantly come into existence as economic efficiency may be severely com-
old industries are destroyed. The late L9th promised. The Administration's regula-
and early 20th centuries saw the trans- tory reforms in the telecommunications
formation of the economy from a mostly And electric power industries have at-
agricultural to a mostly industrial one. tempted to achieve competitive balance.
150 / 8. CAN ECONOMIC GROWTH BE INCREASED BY USING MORE INPUTS?

Even as these changes have intensified competitive practices abroad, for exam-
competition in some parts of the econ- ple, frequently cohabit with restrictions
omy, it remains limited in others. In par- on trade and may forestall entry of Amer-
ticular,where goods and services are lo- ican firms into foreign markets. Liber-
cally provided, and where transportation alizing trade in agriculture can lead to
costs are high, consumers in some ar- a more environmentally sound interna-
eas may have too little choice, even if tional allocation of farming activity. The
providers in the country as a whole are side agreements to NAFTA [North Amer-
numerous. In parts of the country, for ican Free Trade Agreement], on which the
example, a single hospital may be the Administration conditioned its approval
only one serving a large rural area. In the of the agreement, demonstrate that safe-
health care sector, new guidelines for an- guarding a shared environment, promot-
titrust enforcement were recently issued ing better working conditions, and liber-
in response to concerns such as these, and alizing trade are not mutually exclusive
the Administration has resisted attempts goods to be traded off against each other.
to scale back antitrust enforcement in Pursuing these goals in the multilateral
this area. The benefits of competition can framework of the WTO [World Trade Or-
be seen in our university system, where ganization] will be increasingly impor-
—
competition remains keen and perhaps tant. At the same time, it is important
partly accounts for the dominant position that countries not allow domestic regu-
American universities hold in the world lation to become a pretext for nontariff
of higher education. trade barriers whose real purpose is to
restrict competition.
Expanding Trade Some of the fastest-growing economies
The third source of increasing efficiency are the emerging markets of the devel-
in the economy is more-open markets oping world, many of them in East and
abroad. Like the freeing up of domes- Southeast Asia. To grasp fully the oppor-
tic markets, opening of foreign markets tunities that these new markets offer, the
shifts resources into relatively more pro- United States needs to strengthen eco-
ductive areas. The Administration will nomic relations with these countries.
continue to pursue its outward-oriented,
protrade agenda through multilateral, re- Improving Public Sector Efficiency
gional, and bilateral means, expanding The fourth and final way to increase
on and bringing to fruition initiatives like the overall efficiency of the economy
the Asia-Pacific Economic Cooperation is by improving the efficiency with

group and the proposed Free Trade Area which the government itself does its job.
of the Americas. By freeing up resources for potentially
The global economy, like the do- more productive uses in other sectors,
mestic economy, is evolving, and its and by reducing the cost of regulation,
change brings with it new challenges. government reform can raise economy-
A clean environment, a safe workplace, wide productivity. The Vice President's
and competitive markets are important reinventing government initiative has
to us internationally just as they are at been doing just that. Thousands of
home. Trade liberalization can comple- pages of Federal regulations have been
ment these goals in many ways. Anti- eliminated, and thousands more are
 YES Council of Economic Advisers / 151

being streamlined or improved in other by more than 250,000, and as a percentage

ways. Hundreds of obsolete Federal of the Nation's total employment it is
programs have been eliminated, and red now smaller than at any time since the
tape has been reduced dramatically. The early 1930s.
Federal civilian workforce has been cut
NO Felix G. Rohatyn

RECIPE FOR GROWTH

The American economy is now constrained by a financial iron triangle, in part
createdby the Republican majority together with the Clinton administration,
from which it is difficult to break out and which is beginning to generate
serious social tensions.
• The first leg of this triangle is the commitment to balance the budget in

seven years. Even though there has never been a rational explanation for this
time frame, it has now become part of the political theology. It would be as
dangerous for either party to depart from it, say by suggesting that eight or
nine years would be equally logical, as it was for George Bush to abandon
his "No new taxes" pledge.
• The second leg an extension of the first and is more restrictive in its
is

effect: It is by both parties and blessed by the Congressional

the acceptance,
Budget Office, that our economic growth rate will be 2.2% for the seven-year
period. Even though projections are notoriously inaccurate even over much
shorter periods, this particular projection is becoming both a prediction and
a self-limitation. It implies that this rate of growth is the limit of what our
economy is capable of without inflation. Since this view has the support of
the Federal Reserve, the Treasure and the financial markets, it has become
a de facto limit on economic growth. The markets and the Fed react to any
appearance of acceleration with higher interest rates and the economy then
falls back to 2.2% or below.
• The third leg of this triangle is the impact of technology and global
competition on incomes and employment. The lethal political combination
of corporate downsizing together with ever-increasing differentials in wealth
and income among Americans of differing levels of education and skills, and
the huge rewards to capital as the result of the boom in the securities markets,
are creating serious social tensions and political pressures.
Unless we can somehow break out of this iron triangle, we could face
serious difficulties, for a breakout is to make a determined
and the best hope
effort for a higher rate of economic growth. Only higher growth, as a result of
higher investment and greater productivity, can make these processes socially
tolerable. In order to deal constructively with the realities of technology and

From Felix G. Rohatyn, "Recipe for Growth," Wall Street Journal (April 11, 1996). Copyright ©
1996 by Dow Jones & Company, Inc. Reprinted by permission of The Wall Street Journal. All rights
reserved.

152
 NO Felix G. Rohatyn / 153

the global economy, Democrats and Re- urban quality-of-life and many others.
publicans may have abandon cher-
to Even though all of these require differ-
ished traditional positions and turn their ent approaches, the single most impor-
thinking upside down: Democrats may tant requirement to deal with all of them
have to redefine their concept of fairness, is the wealth and revenues generated by

while Republicans may have to rethink a higher rate of economic growth. John
the role of Government. Kennedy was right: A rising tide lifts

all boats. Although it may not lift all of

them same time and at the same
at the
ECONOMIC INSECURITY rate, without more growth we are sim-
The American economy is growing very ply redistributing the same pie. That is a
slowly despite occasional upward blips. zero sum game and it is simply not good
Growth and inflation are both around 2%. enough.
Our main trading partners, Europe and The fact that our 2%-2.5% present
Japan, are undergoing serious economic growth rate is inadequate is proven by the
strains of their own, with German unem- very problems we face. The question of
ployment nearing 10% and French unem- when, and especially how, to balance the
ployment near 12%. Fiscal contraction is federal budget deserves a great deal more
taking place on both sides of the ocean as intelligent discussion than the political
the Maastricht criteria are maintained in sloganeering we have heard so far. The
Europe and deficit reduction continues as budget is a document that reflects neither
a priority here, feeding a general sense of economic reality nor valid accounting
economic [Link] winds of defla- practices. If the budget is to be balanced
tion could be stronger than the winds of in order to satisfy the financial markets,
inflation. only real justification of this goal, then
At the same time, the Dow Jones Indus- it must be done with growth rather
trialAverage is near its all-time high of than with retrenchment. That higher
5700, mergers and restructurings are still growth, together with controlling costs
taking place at a record pace, and layoffs of entitlement like Medicare, Medicaid
and downsizing are continuing as the in- and Social Security, will generate the
evitable result of global competition and capital needed to provide both private
technological change. And Pat Buchanan and pubic investment adequate to the
has created a political groundswell, on country's needs.
the left as well as on the right, by Bringing the rate of growth from its

identifying real problems but proposing present 2%-2.5% to a level of 3%-3.5%

solutions based on fear, xenophobia, iso- would generate as much as an additional
lationism and protectionism. It is fright- $1 trillion over the next [Link] could

ening to think of the political impact of provide both for significant tax cuts for
a Buchanan if unemployment were now the private sector as well as for the
7.5% instead of 5.5%. All that it requires higher level of public investment in
is the next recession. infrastructure and education required as
The and economic problems we
social we move It would
into the 21st Century.
face today are varied. They include job in- obviously generate millions of new jobs.
security, enormous income differentials, The present bipartisan commitment to
significant pressures on average incomes, balance the budget in seven years,
154 / 8. CAN ECONOMIC GROWTH BE INCREASED BY USING MORE INPUTS?

based on the present anemic growth, a fair distribution of wealth. The expe-
is economically unrealistic and probably two decades, with the
rience of the last
socially unsustainable. In all likelihood, advent of the global economy, has very
higher growth is in fact the only way to much shaken that view.
achieve budget balance. The question is Fairness does not require the redis-
how to achieve it. tribution of wealth; it requires the cre-
The conventional wisdom among most ation of wealth; it requires the creation
academic economists as well as the Trea- of wealth, geared to an economy that can
sury, the Federal Reserve Board and Wall provide employment for everyone will-
Street is that our economy cannot gen- ing and able to work, and the opportu-
erate higher growth without running the nity for a consistently higher standard-
risk of triggering inflation. Not everyone of-living for those employed. Only strong
shares that view. In particular, the leaders private sector growth, driven by higher
of many of this country's leading indus- levels of investment and superior pub-
trial corporations believe that we could lic services, can hope to provide the job
sustain significantly higher growth rates opportunities required to deal with tech-
based on the very significant productiv- nological change and globalization. Only
ity improvements they are generating in higher growth will allow that process to
their own businesses, year-after-year. take place within the framework of a mar-
Economics is not an exact science as ket economy and a functioning democ-
we have painfully learned over and over racy.
again. It is the product of the psychol- We should have no illusions about the
ogy of millions of consumers, of business likelihood of reducing the level of present
leaders making long-term investment de- income and wealth they are
differentials;
cisions, of capital flows instantaneously likely to increase in the near future as
triggered by events and ideas. We must the requirements for skills and education
do away with the false notion that we increase. The world is not fair; we must,
must choose between growth or infla- however, make it better for those in the
tion. Our experience, even in the more middle as well as at the lower end of
recent past, shows that technology and the economic scale. The key is enough
competition can produce growth with- growth that, even if initially the lower
out serious inflationary pressures. In the end does not gain as rapidly as the upper,
face of today's totally new environment it can improve its absolute standard of

of almost daily revolutions in technology living, and being a process of closing the
combined with globalization, we should gap-
be willing to be bolder, both in fiscal and Higher growth requires a tax system
monetary policy. that promotes growth as its main objec-
As a traditional Democrat, I have al- tive. It must encourage higher investment
ways believed that freedom, fairness and and savings. That is not the case today. To-
wealth, basic to a modem democracy, day's tax system aims at a concept of fair-
required an essentially redistributionist ness dictated by distribution tables. That
philosophy of wealth, that a fairly steeply may not be the best test. A tax system
graduated income tax was required as a with growth as its main objective may be
matter of fairness and that lower deficits a variation of the flat tax; or it may be a
would guarantee adequate growth and national sales tax; or it may be another
 NO Felix G. Rohatyn / 155

system aimed at taxing consumption in- Public school reform, driven by higher
stead of investment such as proposed by standards, is an absolute priority. Even
Sens. Sam Nunn and Pete Domenici. though that is a state responsibility, it is

The power and dominance of global a national problem. These standards, re-
gardless of today's political conventional
capital markets in today's world would
seem to aid in the latter direction. wisdom, will ultimately be national in
scope. Access to higher education should
Lowering taxes on capital would at first
blush seem to help the already wealthy, be made available to any graduating high
current holders of capital. But whatever school senior meeting stringent national
test levels and demonstrably in need of fi-
its effect on the distribution tables, it
nancial assistance. The equivalent of the
could unleash powerful capital flows,
both domestic and foreign, that would GI Bill, providing national college schol-
lower interest rates significantly and arships to needy students, should be cre-

make investment in the U.S. even more ated and federally funded. It should be
the primary affirmative action program
competitive than it is today. At the same
time, they would maintain the strength
funded by the federal government.
of the dollar and maintain lower rates of
As part of a higher economic growth
rate, state and local governments should
inflation.
provide higher levels of infrastructure
Achieving the objective of higher investment. In addition to the creation
growth could also include the gradual of private employment, this could also
privatization of Social Security in order
provide public sector jobs to meet the
to create a massive investment pool with
work requirements of welfare reform,
higher returns for the beneficiaries and
as well as to provide the support to a
greater investment capabilities for the
high capacity modern economy. Financial
private and the pubic sector. The key to assistance from the federal government
economic success in the 21st Century will would encourage the states in that
be cheap and ample capital, high levels of endeavor. Higher growth would enable
private investment to increase productiv-
federal as well as state and local budgets
ity,high levels of education and advanced to take on this responsibility.
technology. It also includes higher lev-
A corporate safety net should be pro-
els of public investment in building a
vided in order to deal with the inevitable
national infrastructure supportive of the dislocations which corporate downsiz-
21st century economy.
ings and restructurings will continue to
If the Democrats can redefine their create. Business, labor and government
concept of fairness, Republicans, on the should cooperate to create a system of
other hand, may have to abandon their portable pensions and portable health
view of passive government. If growth care to cushion the transition from one job
and opportunity are to be the prime to another. Incentives should be provided
objectives of our society, the government for business to make use of stock grants
must play an active role in some areas. for employees laid off as a result of merg-
The first is education; the second is higher ers and restructuring. It losing one's job
levels of infrastructure investment; the creates wealth for the shareholders, the
third is the maintenance of a corporate person losing his or her job should share
safety net. in some of that wealth creation. Corpo-
156 / 8. CAN ECONOMIC GROWTH BE INCREASED BY USING MORE INPUTS?

rate pension funds, to the extent they are Some of the proposals put forth at present
overfunded as a result of the stock mar- would have very negative results for
ket boom, could be part of a process to working Americans. It is too late to
provide larger severance and retraining return to a protected American economy;
payments for laid-off employees. the only result would be to trigger a
Other than in areas such as pensions financial crisis that would harm America
and health care, it is counterproductive and our trading partners. It is impossible
to try to legislate the social side of "cor- to stop the effect of global information,
porate responsibility"; it is almost impos- technology, capital and labor. What is
sible to define. To begin with, most large important for working people, union
U.S. corporations are majority-owned by or non-union, is the creation of more
financial institutions including the pen- well-paying jobs as a result of high
sion funds of the very employees who are levels of investment and high levels
in danger of displacements. These insti- of education; to share in the profits of
tutions, drivenby their own competitive their employers through profit-sharing
requirements, were the source of the pres- and stock ownership; to share in the
sures on management which resulted in benefit potential of pension funds vastly
the dramatic restructuring of American increased by the boom in the financial
industry over the last decade. Those re- markets; to have access to permanent
structurings have made American indus- health care security and to high levels of
try highly competitive in world markets; education and training to deal with the
they must continue and we must con- 21st century requirements.
tinue the opening of world trade.
Board of directors are not blind to
the risks of political backlash. The issue Business and labor, together, should
of executive compensation, made starkly hammer out such an agenda. If we are
visible by its tie-in with the rise in stock serious about balancing the budget in
market values, will be dealt with respon- a responsible manner, the president and
sibly or boards will find themselves un- the congressional leadership could set a
der great shareholder pressure. The use national objective that the economy's rate
of profit-sharing, stock options and stock of growth reach a minimum sustainable
grants to practically all levels of the cor- level of 3% annually by the year 2000.
poration will be significantly expanded They could ask the best minds in
and should create greater common in- the country, from government, from
terests between executives, shareholders business, from labor and from academia
and employees. However, the main role to provide a set of options which could
of the corporation must remain to be com- lead to such a result. Many of these
petitive, to grow, to invest, to hire and options would be politically difficult,

to generate profits for its shareholders; a both for Democrats and for Republicans,
significant portion of employee compen- and some would probably be impossible.
sation should be related to the growing But the only way to abandon long-held
productivity of its employees. notions that may no longer apply to
The an
benefits to business in such today's world is to discuss them within
approach are obvious, but labor also has the framework of a very simple and
a large stake in such a re-examination. definite objective: higher growth.
 NO Felix G. Rohatyn/ 157

training; international trade. Most impor-

A DIFFERENT PERSPECTIVE should take place
tantly, these activities
Setting the U.S. on a path to higher within a framework in which the Demo-
growth will require coordination with concept of fair-
cratic Party redefines its
our partners in the G-7 [Group of Seven]. ness and the Republican Party redefines
The Europeans should welcome such an its concept of the role of government.
initiative since they are in greater need At present, neither is appropriate for the

for growth than we are. Nevertheless, the revolution that technology, globalization
process will be slow and it must be put and the inclusion of an additional one bil-
into motion. lion people to the global workforce will
The president's setting an objective bring about tomorrow.
of higher growth would have an im-
portant psychological impact; the econ- Ultimately, a rising tide will float all

omy is, after all, heavily influenced by ships, and both political parties can help
psychological factors. If the president bring this about. If they fail to do so,
were to set an ambitious growth objec- at a minimum the present malaise will
tive, then all elements affecting the econ- turn uglier, and it is even conceivable that
omy would be subject to review from another tide will sweep away existing
a different perspective. They would in- were to happen, arguments
parties. If that
clude fiscal and monetary policy; in- about growth or fairness will be totally
vestments and savings; education and irrelevant.
POSTSCRIPT
Can Economic Growth Be Increased Just
by Using More Inputs and Improving
Efficiency?

The Clinton administration's Council of Economic Advisers begins its dis-

cussion of economic growth by focusing on the behavior of productivity. It
documents the current slowdown in productivity growth by comparing the
period 1960-73 to the period since 1973. Annual increases in productivity in
nonfarm business averaged 2.8 percent during the first period and 1.1 percent
during the second period. The advisers state that the administration's growth
strategy is to increase physical capital, improve human capital, and improve
the overall efficiency of the economy. To increase physical capital, they want
to balance the budget: with less government borrowing more funds will be
available for business firms to borrow for investment purposes. To improve
human capital, they propose several initiatives: establish goals for education,
make higher education more affordable, and reform training programs. To
improve the overall efficiency of the economy, they recommend expansion of
the Advance Technology Program to encourage research and development,
a combination of more vigorous antitrust enforcement in some industries
and greater government regulation in others, expansion of trade, and greater
governmental efficiency.
Rohatyn argues on a more fundamental level. He begins by stating that the
economy's growth is currently constrained by a financial iron triangle. This
iron triangle consists of the commitment to balance the federal government's
budget in seven years, the acceptance of a 2.2 percent growth rate for the
seven-year period, and the impact of technology and increasing global com-
petition. In order to break out of this iron triangle, Rohatyn believes that both
Democrats and Republicans need to abandon long-held positions. He states
that the Democrats need to redefine their concept of fairness. Instead of view-
ing fairness in terms of the redistribution of income and wealth, Democrats
need to define fairness in terms of a consistently higher standard of living.
If the Democrats accept this new definition, they could lend support to a

restructuring of the tax system so that it promotes growth. Rohatyn claims

that the Republicans need to redefine their view of the proper economic role
of government. Instead of a passive role for government, Republicans need to
accept an active role for government in education, in the attainment of higher
levels of infrastructure investment, and in the maintenance of a corporate
safety net.

158
 Additional readings on the issue of economic growth include "Saving,
Economic Growth, and the Arrow of Causality," by Robert Eisner, Challenge
(May /June 1995); "True Tax Reform: Encouraging Saving and Investment,"
by Murray Weidenbaum, Business Horizons (May /June 1995); "Technology
and Growth: An Overview," by Jeffrey C. Fuhrer and Jane Sneddon Little,
New England Economic Review (November/ December 1996); "The Productiv-
ity Growth Slowdown: Diverging Trends in the Manufacturing and Service
Sectors," by Sharon Kozicki, Economic Review, Federal Reserve Bank of Kansas
City (First Quarter 1997); "Is the U.S. Economy Really Growing Too Slowly?
Maybe We're Measuring Growth Wrong," by Leonard Nakamura, Business
Review, Federal Reserve Bank of Philadelphia (March/ April 1997); and "Breaking
Down the Barriers to Technological Progress," by Preston J. Miller and James
A. Schmitz Jr., Federal Reserve Bank of Minneapolis 1996 Annual Report.

159
ISSUE 9
Is Our Current Social Security Program
Securely Anchored?

YES: Robert M. Ball, from "Keeping the Social Security Promise/' An Original
Essay Written for This Volume (1997)
NO: Sylvester J. Schieber, from "Social Security: Avoiding the Downstream
Catastrophe/' An Original Essay Written for This Volume (1997)

ISSUE SUMMARY
YES: Robert M. Ball, former commissioner of Social Security, believes that
Social Security good shape financially, and that the projected imbalances
is in
can be addressed through a series of minor adjustments.
NO: Sylvester J. Schieber, a business executive, sees a serious Social Secu-
rityfunding problem, and calls for fundamental change: movement from a
completely defined benefits program to a partially defined benefits program.

It isnot surprising, in retrospect, that an event as catastrophic as the Great

Depression of the 1930s would produce fundamental changes in the Amer-
ican economy The reality of the human suffering generated by the collapse
of one-third of the nation's banks, an unemployment rate of 25 percent, and
30 percent declines in the production of goods, services, and household net
worth led to a rush of legislation, which, in general terms, was intended to
achieve two objectives: to restore confidence in the economy and to provide
greater economic security The institutions and programs created by this leg-
islative avalanche are today familiar to almost all Americans: the Federal
Deposit Insurance Corporation (FDIC), the Securities and Exchange Com-
mission (SEC), and Social Security.
Social Security, more formally Old Age, Survivors, and Disability Insur-
ance (OASDI), was signed into law on August 14, 1935, by President Franklin
D. Roosevelt. As originally designed, OASDI provided three types of bene-
fits: retirement benefits to the elderly who were no longer working, survivor

benefits to the spouses and children of persons who have died, and disability
benefits to persons who experience nonwork-related illness or injury. The
Medicare portion of Social Security, which provides benefits for hospital,
doctor, and medical expenses, was not created until 1965.
There are many terms used to describe OASDI. It is an entitlement program,
that is, everyone who satisfies the eligibility requirements receives benefits.
Eligibility is established by employment and contributions to the system (in

160
the form of payroll taxes) for a minimum period of time. It is also a defined
benefits program; that is, the level of benefits is determined by legislation. The
opposite of a defined benefits program is a defined contributions program
where benefits are determined by contributions and whatever investment
income is generated by those contributions. OASDI is also described as a
pay-as-you-go system; this means that payments received by recipients are
financed primarily by the contributions of current workers. Still another de-
scription of OASDI is that it is an income security program. This refers to a
whole set of government programs designed to provide minimum levels of in-
come to various persons. Other income security programs include workmen's
compensation, unemployment compensation, supplemental security income
(SSI), and general assistance. Finally, OASDI is described as a social insurance
program to distinguish it from private insurance programs. The insurance fea-
ture rests on the fact that OASDI protects against certain unforeseen events
like disability or early death. The social feature arises from the fact that con-
tributions and the level of benefits are determined by legislation as well as the
fact that the contributions are mandatory (payroll taxes that must be paid).
With respect to the administration of OASDI, there are several components
to consider. One component is the Social Security and Medicare Trustees. This
six-member panel annually prepares estimates of the inflows and outflows of
funds and examines the long-term actuarial soundness of the system. A sec-
ond component is the Advisory Council, which is constituted every four years
and reviews the projections of the trustees. In the process the council may
offer suggestions for changes in the program. The third component involves
both the Congress and the president because any changes to the system, in
terms of contributions and benefits, require the passage of legislation.
All this serves as background for understanding the current issue. For the
last several years the trustee projections have indicated that OASDI trust
funds would fall below the "safe level" by the year 2030. These predictions
were widely reported by the media as the "Social Security Crisis." The Ad-
visory Council that was formed in 1994 met periodically during 1994 and
1995 to explore alternative solutions to the crisis and in early 1996 issued its
own report. But the 13-member council could not agree on a single overall
strategy to resolve the crisis; instead, it offered three different strategies.
In this issue two members Advisory Council present their views on
of the
the magnitude of the Social Security underfunding and then detail and de-
fend their strategies for dealing with it. Robert M. Ball, along with five other
members of the council, supports what has been called the Maintenance of
Benefits Option that retains the basic structure of OASDI as a completely de-
fined benefits program. Sylvester J. Schieber, along with four other members
of the Advisory Council, supports a fundamental restructuring of OASDI, in-
volving partial privatization with the creation of personal security accounts.
This is an important issue, for it affects all of us. What we do with OASDI
affects the amount of taxes we pay while we are working and our economic
well-being during retirement.

161
 Robert M. Ball
YES

SOCIAL SECURITY: KEEPING

THE PROMISE

For 60 years, the United States has had a deliberate policy of promoting in-
come security in retirement through a four-tier system: (1) a nearly universal,
wage-related, contributory, defined-benefit Social Security plan; (2) supple-
mentary employer-sponsored private pensions (now covering about one-half
of the workforce); (3) individual savings; and (4) underlying the whole, a
means-tested safety-net program, now called Supplemental Security Income
(SSI). Social Security and SSI are federally-operated and financed, and private
pensions and savings are explicitly promoted by federal tax policy.
Over 30 years ago, the Medicare program was added to this four-tier sys-
tem because it was recognized that while a cash income could meet regular
and recurring expenses, only a health insurance system could meet the un-
predictable and sometimes very heavy cost of health care in retirement and
during disability. So we now have a five-tier federally-promoted system for
retirement security, each tier with a distinct mission and complementing the
others.
Unlike Medicare, Social Security is in quite good shape financially, and
can rather easily be brought into long-range balance. It is important that
this be done promptly because what is now easy will become difficult if
unattended to. The recently released 1997 report of the Trustees is the third in
a row to report that without any changes of any kind in the program, the system
will be able to pay full benefits on time until about 2030, and that after that
date the continuing income from the payments of employers and employees
(augmented by income from the taxes on benefits) would meet three-fourths
of the [Link] with the cost of benefits rising, after 75 years these sources
of income alone would still meet about two-thirds of the cost.
Social Security is not "going broke." The long-range financing challenge is
how to cope with a shortfall. In designing a financing plan we aren't starting
from scratch after 2030 but rather with 75 percent of benefit costs already
being financed by the tax rates in current law.
Another point about Social Security financing that is greatly misunderstood
concerns the ratio of workers (those paying in) to the number of beneficiaries

Copyright © 1997 by Robert M. Ball.

162
 YES Robert [Link]/ 163

(those taking out). This ratio is drop- in one case and an increase of 1 .52 percent
ping, and the change accounts for the in- in the combined payroll tax in the other
creasing cost of Social Security in future case. As a matter of fact, if tax increases
years as the baby-boom generation re- were adopted, there would be
of this size
tires. However, this ratio has always been no need for benefit cuts and certainly no
recognized as the most important factor financial reason for basic changes in So-
in the program's long-range costs and cial Security, such as partial privatization.
has been addressed in all the long-range These tax increases alone would bring
estimates and provisions for financing. Social Security very close to the long-
There are no surprises here. Yet commen- range balance; the remaining gap would
tators routinely treat the changing ratio be 0.6 percent of payroll in one plan and
as though we had suddenly discovered only slightly more in the other. If coupled
a situation that will make it overwhelm- with a correction of about -0.2 percent
ingly difficult to meet rising costs as the in the Consumer Price Index, which gov-
baby-boomers retire. erns Social Security's cost-of-living ad-
This not the case. The current
is justments —a correction very likely to be
anticipated deficit has to do entirely with made as the result of the current reeval-
other factors. Half the new deficit is the uation of the CPI by the Bureau of La-
result of a change in actuarial methods bor Statistics — these tax increases would
and in new
sources of data, and half bring Social Security well within the def-
in changes in assumptions about the inition of close actuarial balance as tradi-
future growth of real wages, disability tionally defined, i.e., with estimated ben-

incidence, and other cost-controlling efitexpenditures falling within 5 percent

factors. (And it is entirely possible, of of estimated income. No other changes in
course, that similar adjustments resulting benefits or taxes would be needed.
in either higher orlower cost estimates But instead of relying on big tax in-
will need be incorporated in future
to creases, there are several more attractive
forecasts made over a 75-year period.) alternatives. The most important change
would be to shift from pay-as-you-go fi-
nancing to partial reserve financing so
STRATEGIES TO STRENGTHEN
that part of the increasing costs in the fu-
SOCIAL SECURITY
ture can be met from earnings on a fund
A deficit of 2.23 percent of payroll could build-up. The recent Advisory Council
be eliminated by simply raising contri- was unanimous on the desirability of this
bution rates 1.12 percentage points for And once partial reserve financing
shift.

workers and employers alike. It is doubt- isadopted, the rate of return in the funds'
ful, however, that such a big increase in investments becomes important.
taxes would be generally accepted as the government is
In Social Security, the
best way of meeting the shortfall, and it is and fund manager
the administrator
not necessary. There are other ways. Yet it of an enormous pension and group
is to be noted that the two groups of Ad- insurance plan. It collects dedicated
visory Council members advocating par- taxes which are the equivalent of the
tial privatization of Social Security call premiums in a private insurance plan and
for very large tax increases — deductions the payments into the defined benefits
of an additional 1.6 percent from earnings plan of a private corporation or state
164 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

retirement system. And it administers series ofchanges which together with

benefits which, like the dedicated tax an increase in the investment return
contributions, are spelled out in detail in would bring the program into long-range
the law. There are, of course, important balance. The items in the chart alone
differences between Social Security's eliminate about two-thirds of the long-
defined-benefit plan and the defined- range deficit and postpone the date of
benefit plans managed by the private Trust Fund exhaustion from 2030 to 2050.
sector and the states, but the broad Investing 40 percent of the fund build-up
characteristics are similar. in stocks would do the rest.
The administration of Social Security is If for it were decided
whatever reason
very efficiently handled, costing less than to keep all Trust Fund investments in
one percent of income. But the govern- government bonds, balance over the 75-
ment is not doing as well as it might in its year estimating period could still be
role as fund manager. This is not because maintained by implementing additional
of any failure on the part of those man- moderate tax increases or benefit cuts
aging the system but because Social Se- now or providing for gradual benefit cuts
curity by law is allowed to invest only in in the future by scheduling increases in
the most conservative of all investments: the normal retirement age beyond the age
long-term, low-yield government bonds. 67 provided in present law.
Trustees of private pension systems and Proposals to substitute a compulsory
managers of state pension systems who savings plan for part of Social Security
have the authority to invest much more seem undesirable for a variety of reasons
broadly would surely be replaced if they and certainly unnecessary. But before
were to pursue such an ultraconservative looking more closely at the issues raised
investment policy. by privatization, it is important to put the
To deny Social Security managers the debate in context by examining the nature
same investment opportunities available of the Social Security system —both in law
to private fund managers means that So- and by tradition.
cial Security will pay smaller benefits
than private pensions can pay for each
SOCIAL SECURITY AS
dollar of contribution (except to the ex-
tent that Social Security's low admin-
AN ENTITLEMENT
istrative costs offset the smaller invest- Social Security is an "entitlement" pro-

ment gain). This differential, caused by gram. In spite of the fact that entitle-
prohibiting investments in private secu- ments on the whole have recently been
rities, accounts for much of the pressure given a bad name, the concept is of great
to switch to a system of private savings importance to the future economic secu-
plans as a partial substitute for Social Se- rity of those covered by Social Security.
"Give me the
curity. It leads to the cry, The term deserves to be rehabilitated. In
money —
can do better on my own/'
I the case of Social Security, "entitlement"
Yet increasing the investment return means that all people without distinction
on Social Security contributions cannot of sex, race, income, or behavior receive
be the whole answer to balancing Social benefits in an amount specified by law
Security nor is it a necessary part of once they have met the objective criteria
the answer. The attached table shows a of having worked in employment cov-
 YES Robert [Link]/ 165

STRENGTHENING SOCIAL SECURITY:

RECOMMENDED STEPS FOR CONSIDERATION i

• Starting point: Over the long run (75 years), Social Security revenues are
expected to fall short of outlays by 2.23% of payroll. 2
. . .

• Goals: Preserve long-term balance without making major changes in

the program, and improve the benefit-contribution ration for younger
workers.
• Initial Steps:

Proposed Change Rationale for Change Impact on

Deficit

1. Increase taxation of benefits Benefits should be taxed to the extent -0.31

they exceed what the worker paid in,
as is done with other contributory
defined-benefit pension plans.

[Link] Cost of Living Adjustment COLA is determined by CPI, which is -0.20

(COLA) to reflect corrections to widely believed to overstate inflation;
Consumer Price Index (CPI) anticipated corrections should result
in downward adjustment of at least
0.2%.
3. Extend Social Security coverage Most state and local employees are -0.22
newly hired
to all state and local already covered; the 3.7 million who
employees are not are the last major group in
labor force not covered.
[Link] wage-averaging period for Reduces benefits for future retirees -0.28
benefits-computation purposes from an average of 3%.
35 to 38 years.

[Link] contribution rate 0.50% Future workers as well as current - 0.50

(0.25% for workers and employers and future beneficiaries should share
alike) modestly in correction of imbalance.

(Box continued on next page)

ered by the program for a specified pe- and Medi-

In the case of Social Security
riod of time and have met other objective from certain other enti-
care, as distinct
qualifications —
by reaching age 62 for re- tlement programs such as food stamps,
duced retirement benefits, or by reaching there is not only a legal entitlement, but
age 65 for full benefits, or by having a to- since the benefits grow out of past earn-
tal disability estimated to last for a long ings and contributions, they are looked
and indefinite period, or by having a rela- on as an earned entitlement. Thus, al-
tionship with a covered worker that gives though benefits and conditions for pay-
them entitlement to benefits as a widow ment can ho changed by law if the
or widower, or by being the child of an changes affect a broad category of par-
insured worker. ticipants in ways that are reasonable and
 — .

166 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

Long-term deficit remaining after implementation of above changes . .

0.75% of payroll.*
Conventional options to eliminate this remaining deficit include:
additional moderate tax increases or benefit cuts now or providing for
gradual benefit cuts in the future by scheduling increases in the normal
retirement age beyond the age 67 provided in present law. But all of these
changes have the disadvantage of making Social Security less attractive to
younger workers (by lowering the ratio of benefits to contributions),which
strengthens the case for
Investing some of Social Security's accumulating funds in equities:
Under present law, funds may be invested only in low-yield government
bonds. Passively investing 40% of these funds in stocks indexed to
the broad market would yield higher returns, closing the deficit and
improving the benefit/contribution ratio for younger workers. 4

^y Robert M. Ball, commissioner of Social Security 1962-73 and member of the Social

Security Advisory Council 1994-96. 2 1997 estimate by the Social Security trustees, expressed
as a percent of total covered payrolls: in other words, if Social Security payroll-tax rates had

been increased by 2.23 percentage points in 1997, the long-term deficit would be eliminated.
3 Adjusted for interaction of proposed changes. 4 To help maintain the program in balance even
beyond the traditional 75-year estimating period, a contribution-rate increase of 1 .6% should
be scheduled to go into effect in 2045, with the understanding that at that time, depending on
actual experience, the increase may not be needed.

nondiscriminatory, there is a consider- Social Security could mean —as it does

able reluctance on the part of Congress in —
some programs that benefit levels
or the President to reduce protection or would be determined not by long-term
make radical changes. There is good rea- considerations but by short-term budget
son for this. Social Security commitments cycles, inwhich various programs com-
are very long-term. People are contribut- pete against each other for funding. It
ing now to pay for benefits that may not —
could even mean as once was the case in
be due for more than 40 years in the fu- welfare programs and may soon be again
ture, and a high degree of stability in in some states (now that basic welfare
both contribution rates and benefit lev- policy has been turned back to the states)
els is a valued part of the Social Security —that payments could vary according
tradition —so much so that discussions of to the policies of individual administra-
possible benefit reductions or other major tors seeking to encourage or discourage
changes make participants very uneasy. certain behavior. Social insurance is de-
The opposite of an entitlement is a dis- signed to get away from all that, and the
cretionary payment, which if applied to fundamental principle that determines
 YES Robert [Link]/ 167

the character of the program is that it is titlement would be cut back and, instead
an earned entitlement. There would be little of being entitled to a full defined bene-
security in a Social Security system if ben- fit, contributors would make defined con-
efits were to be altered every few years tributions to various investment vehicles,
to adjust to short-term budget considera- with future income dependent in part on
tions. To make Social Security work, it has the success or failure of individual invest-
to be backed by long-term commitments ment strategieffTJnder one plan, individ-
— an entitlement, but an entitlement in ual investments would be limited to a
return for work and contribution, not an number of government-operated plans;
entitlement granted simply by legislative under the other, investors could chan-
fiat. nel their deductions from wages to vir-
It is important also to the concept of So- tually any generally available investment
cial Security that it have its own financing account or broker.
through earmarked contributions by par- The argument over privatization di-
ticipants. Thus, over the years, the test vides into two parts. First, why not invest
of adequate financing for Social Security part of the Social Security fund directly in
has not been short-run, as with other private stocks? This increases the return
programs, but rather whether the best on contributions and thus substantially
estimates, projected across a very long improves the benefit/contribution ratio
— —
period 75 years show an approximate for younger workers as well as helping
balance between earmarked income and with the long-range balance. The main
benefits as specified in law. fear expressed by some is that if So-
cial Security invests in stocks, Congress
would make po-
force Social Security to
WHAT PARTIAL litically motivated investments. The fear
PRIVATIZATION MEANS is that instead of following a neutral
Proponents of partial privatization on the policy of passive investment in indexed
1994-1996 Advisory Council on Social funds, Congress would steer investments
Security would significantly reduce the toward or away from particular stocks
guarantee of an entitlement by, in one according to some political agenda and
case, limiting benefits to what could be would interfere in other ways with the
supported by present tax rates and, in best interest of the participants and with
the other proposal, by substituting a low, the operations of individual companies
flat benefit. The firstapproach would re- or industries.
an average cut of 30 per-
quire, over time, Based on experience to date, this fear
cent in the guaranteed benefit, and the is unwarranted. Managers of the
entirely
second would cut the guaranteed benefit Thrift Savings Plan (TSP), a major re-
even more on average. Both plans call for tirement plan for federal employees, and
substituting, for a part of the entitlement, of the defined benefit plans of the Fed-
a compulsory savings plan that would eral Reserve System and the Tennessee
guarantee only that the worker be given Valley Authority, all of which have been
an amount taken from his or her wages investing in private securities for many
to invest, as with a 401 (k) plan, tor future years, have remained entirely indepen-
income in retirement. So there would be dent in their hind management. How-
two major changes: the Social Security en- ever, to provide additional safeguards,
168 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

it would be possible to create an orga- since no corresponding increase in So-

nization, modeled on the Board of Gov- cial Security proposed. The
protection is

ernors of the Federal Reserve System, whole objective of the IA plan is to re-
to have broad responsibility for Social duce the benefits covered by the gov-
Security Trust Fund investments. The ernment guarantee to a level where over
board would consist of experts confirmed the long run they can be financed by
by Congress and appointed for lengthy, present Social Security contribution rates,
staggered terms. By law the board would while hoping that the new Individual
be required to pursue a policy of invest- Accounts will, on average, make up for
ment neutrality, a policy buttressed by the cuts in the guaranteed Social Secu-
being required to invest in broadly in- rity plan. Since the objective is only to
dexed funds and to select private port- make up for the cuts on average, it may be
folio managers experienced in handling assumed that for many people, in spite
large indexed accounts. While under our of the increase in deductions from their
political system there can obviously be no earnings, the combined benefits of the
absolutely iron-clad guarantees against residual government plan and the sav-
attempts at political manipulation, the ings benefits will actually be substantially
record of the Board of Governors of the lower than those of the government plan
Federal Reserve makes clear that this ap- under present law. This does not seem to
proach can insulate decision-makers and be a very attractive proposition: higher
7
protect the principle of independence in deductions from workers earnings than
policy-making. under present law, but a considerable risk
Second, what, if anything, is wrong that one might be in the group that will
with shifting part of Social Security get less in benefits than the present gov-
protection over to personal savings-and- ernment guarantee.
investment accounts? There are several To be fair, in making comparisons
problems. with today's guarantees it needs to be
recognized that the present level of
Individual Accounts benefits not adequately funded for
is

First let us consider the plan of one the long run. So people will need to
group within the Advisory Council called —
choose to decide whether a menu of
"Individual Accounts" (IA). This plan, modest proposals to bring the present
it should be noted, would modify the program into balance is as onerous as
present program less than just about any having earnings reduced an additional
of the other proposals for privatization 1.6 percent coupled with lower benefits
that have been discussed both within and for those who get a less-than-average
outside of the Advisory Council, but it return from their individual account and
still seems entirely unsatisfactory. in all cases lose guaranteed defined
In discussing the IA plan, it is im- benefit protection.
portant to bear in mind that, as previ- Under the IA plan, individual savers
ously noted, the plan requires an addi- would have a limited choice of invest-
tional deduction from workers' earnings ment vehicles, perhaps five to ten in-
of 1.6 percent. I am inclined to think that dexed funds, managed and invested by
this alone might well be enough to make the federal government as in the case of
the proposal unacceptable to the public, the Thrift Savings Plan. At retirement age,
 — A

YES Robert M. Ball / 169

the retiree would be required to take out tireand convert the accumulation to an
a lifetime annuity underwritten by the annuity. But they have no control over
government with a guaranteed period of conditions in the stock market at these
payment and with protection against in- times.
flation by price indexing. The annuitant Moreover, although the intent of the IA
also would be required to take out a joint plan is to create a nationwide system of

and survivors annuity to protect the an- individual retirement accounts, with both
nuitant's spouse —unless, as is the case the principal and the income available
under the Employee Retirement Income only in retirement, very doubtful
it is

Security Act (ERISA) requirement for pri- that this objective could be preserved
vate pension plans, the spouse agrees in in practice. As with today's IRAs and
writing to waive this right. It should be 401 (k) plans, people will want to use
noted that with the government directly individual savings accounts for medical,
handling the investment of the funds in educational, housing, or other needs.
the savings accounts, this plan does not With funds going into individually-named
do much for the financial industry. The accounts, as provided for under the LA
Advisory Council assumed that the cost plan, account holders will assuredly find
of financial management would be low it unreasonable to be denied access to
only 10 basis points. their "personal" funds in an emergency
Perhaps the worst thing about this —
situation or indeed for any purpose that
plan is that it increases the risk that —
seems worthwhile and Congress and
retirement income will be inadequate. the Executive Branch can be expected
The LA plan shifts Social Security away to go along, as is already happening
from a detmed-benefit plan toward a with IRAs and 401 (k)s. As a result, the
deimed-contribution plan. This is a bad amounts that would actually be available
idea. By definition, defined-contribution at retirement under the IA plan would
plans contain no guarantees regarding almost certainly be much lower than
the amount of the benefit. With more and predicted by the plan's proponents.
more private-sector employers offering Looking at the two parts of the
only defined-contribution 401 (k) pension plan together — the part guaranteed by
plans, it is all the more important that the government plus the individual
the nation's basic plan be maintained as a savings part — the IA plan would achieve
defined-benefit plan with amounts avail- a better return on total investment
able in retirement determined by law than the current Social Security system,
rather than by the risks and uncertainties assuming pay-as-you-go increases in the
of individual investment. contribution rates to make up for the
The increased risk arises, of course, shortfall under present law. However, the
not solely from the general risk of pick- residual Social Security part of the I

ing investments that perform badly but plan, looked at separately, would not do
also from the fact that individuals arc at all well on this test— a tact that could
inevitably exposed to the risk of being lead to the unraveling of the whole plan.
forced to begin or end an investment pe- As the plan developed over time, with
riod at a bad time. Workers are required to beneficiariesdoing le>s and less well un-
startmaking the investments when they der the reduced Social Security plan com-
go to work and end them when they re- pared to individual accounts (at least m
 —

170 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

the case of the more successful investors), design of Social Security strikes me as a
there would be every reason for many serious inversion of priorities.
above-average earners to press for fur- If Congress is willing to support
ther reductions in contributions to Social a payroll tax increase of 1.6 percent
Security in order to be able to shift more of (which is to Medi-
doubtful), directing it

their Social Security contributions to their care would be postpone

sufficient to
individual accounts. Thus the IA plan is the Hi's fund exhaustion by about
inherently unstable, and would probably 15 years, thus providing a substantial
lead to further cutbacks in government- planning period in which to design and
guaranteed benefit levels. implement needed structural changes.
When combined with these changes, a
This approach to retirement security
tax rate increase of a small fraction of
raises another troubling issue. How far
enough
1.6 percent is to support the
should we go in compelling people to
present level of Social Security benefits.
save for retirement? It is not doing
The IA plan puts the whole burden of
average and below-average earners any
maintaining the present benefit level on
favors to make them save more for the
deductions from worker wages.
sole purpose of trying to increase their
income in retirement. Millions of workers
Personal Security Accounts
are living from paycheck to paycheck,
The other plan proposed by some mem-
spending whatever they have on food,
bers of the Advisory Council to privatize
clothing, shelter, schooling and other
—
immediate needs and still falling short
a part of Social Security —the "Personal
of an adequate standard of living. And
Security Accounts" (PSA) plan —would,
over time, completely abolish the present
formany workers, protecting against the
Social Security system and substitute a
unforeseeable cost of health care may be
flat benefit payment varying only by the
a higher priority than setting aside more
income for retirement. Yet the IA plan's
length of time under the system with —
full coverage, one would have a guaran-
sponsors take no note of these needs.
teed benefit of $410 a month, increased
Partial-privatization proponents sim- over time to keep up with rising wages
ply accept, as a given, that more should augmented by 5 percent of earnings in-
be deducted from workers' wages now to vested by the individual in any generally
improve their cash income in retirement. available investment vehicle.
But many workers, if asked, might pre- The combined payroll tax on employ-
fer to earmark any deductions from earn- ersand employees would be increased
ings beyond those needed to support the 1.52 percent, with the increase main-
present level of Social Security either for tained over the next 70 years or so to
current health insurance or for Medicare meet the cost of paying benefits to cur-
in their retirement. After all, Medicare is rent retirees and others with a stake in
just as important as cash benefits to the the present system while at the same time
and the dis-
financial security of retirees funding a new compulsory savings plan
abled, and the Medicare Hospital Insur- for those under age 55. This 1.52 per-
ance (HI) fund faces problems in the near cent of payroll is the so-called "transi-
term. To ignore Medicare's immediate tion" cost of switching from a pay-as-
needs in order to finance a long-term re- you-go system (Social Security today) to a
 — —

YES Robert M. Ball / 171

funded savings plan. It is a very long and benefits all fit together. Each part of
very costly "transition." For many years the plan is complicated within itself
—across the span of two generations and when combined with the others
workers must pay twice: once for their creates a situation that defies explanation.
own protection and once for the protec- The total job of administration would
and older
tion of those already retired be chaotic, expensive, and quite likely
workers with an investment under the unmanageable at any price. (It should
old system. be noted, however, that no allowance
In addition, to make the financing of has been made for administration in the
the plan work, it is necessary to borrow estimated cost of this plan except for an
very large amounts from the federal allowance of 100 basis points for the cost
government —
as much as $2 trillion in of investing.)
1997 dollars at the peak, $15 trillion in There are other problems. The PSA
nominal dollars. Borrowing on this scale plan does not provide for inflation pro-
is required because, although the payroll tection or annuitization. (Individuals de-
tax increase of 1.52 percent meets the siring annuities would have to buy them
average transition cost over some 70 years, in the private market, which necessarily
the cost is above average at first for — has to charge an extra premium to protect
about 30 years, in fact. Then, with the against the fact that those who buy an-
cost gradually declining after 30 years, it nuities ordinarily have longer than aver-
becomes possible to gradually repay the age life expectancies.) Moreover, the plan
loan out of the tax increase. does not require protection for a spouse.
This larger privatization scheme has And, although survivors and disability
all the disadvantages of the IA plan protection are continued as part of the
— plus many more. In the first place, government guaranteed plan, over time
it is doubtful whether such a plan the disability benefits would be cut about
could be administered. The government 30 percent below present law.
would need to see that 5 percent of Finally, a government system sup-
workers' earnings were deducted each ported by a wage tax but with a ben-
payday and sent to any of thousands efit unrelated to wages will clearly be

of financial institutions or brokers and a bad deal for above-average earners,

kept invested until retirement, while who are therefore likely to give the
at the same time allowing workers to government part of the PSA plan little
shift from one investment arrangement support. Thus this whole plan could eas-
to another and adding new funds each ily end up as simply a compulsory indi-

payday to the same or a different —

vidual savings plan without the present
account. It is difficult to see how this program's ability to redistribute income
would work with smaller employers from the higher-paid to the lower-paid
and an unlimited number of investment supplemented by a government safety-
opportunities. And administration also net program testing individual need (as
entails trying to make clear to people in the case o! SSI). This would represent
what their individual benefits would be: a major loss of security for many work-
how benefits are computed under the irucularty those with lower-than-
old plan, how the transitional benefits pe lifetime earnings. For society as
work, and how this new hybrid system's a whole, that loss of security would mean
172 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

greater reliance on welfare programs, benefit formula, feasible only in a system

with all their flaws, difficulty of adminis- in which nearly everyone participates,
tration, and lack of political support. not only helps to protect us all against
impoverishment but, because it is part
of a universal system, does so at much
BUILDING ON WHAT WORKS lower administrative cost than private
Whatever their attractions, partial-pri- insurance and without the stigma of a
vatization schemes have seemingly in- welfare program.
surmountable disadvantages. They are a The unique strengths of this ap-
high-cost, high-risk approach to retire- proach argue for retaining our traditional
ment security. In essence, they require multi-tier retirement system with Social
workers to contribute more of their wages Security as the foundation. Basic protec-
than at present in order to fund two dis- tion thatone can count on is particu-
tinct systems: one offering reduced ben- important in a dynamic, risk-taking
larly
efits and the other promising uncertain economy such as ours, in which long-
returns. One can imagine workers and established businesses, sometimes whole
beneficiaries choosing this approach only industries, may fade even as new ones
if they believe the present system is going are springing up. More than most, our
broke and needs to be replaced, and only economy rewards rapid adaptation to
if they are unaware of the philosophy that changing conditions; that is one reason
has made Social Security so successful for why it functions well at the aggregate
so long. level. But the more dynamic the econ-
Social Security is a blend of reward for omy, the greater the need for individuals
individual effort and, at the same time, a to be protected against economic circum-
strong affirmation of community solidar- stances beyond their control. In short,
ity. Social Security is based on the premise we need the basic security that Social
that we're all in this together, with every- Security uniquely supplies regardless of
one sharing responsibility not only for downsizing, mergers, bankruptcies, the
contributing to their own and their fam- market, and the un-
volatility of the job
ily's security but also to the security of certainty of individual investments.
everyone else, present and future. Social Security as presently constituted
There is nothing sentimental about clearly meets the test of what Lincoln de-
this approach; it is neither liberal nor scribed as the legitimate objective of gov-
conservative. It simply makes sense. ernment: "to do for a community of peo-
—
Lacking a crystal ball unable to know ple whatever they need to have done but
in advance who will succeed and who cannot do at all or cannot do so well for
will struggle unsuccessfully, who will themselves in their separate and individ-
suffer early death or disability and who ual capacities." Compulsory individual
will live long into retirement, in good savings plans do not meet this test and —
health or —we
ill pool our resources we would be well advised to keep Lin-
and are thus able to guard against the coln's wise words in mind as we consider
average risk at manageable cost to each various proposals to "individualize" our
of us. Social Security's redistributive Social Security system.
NO Sylvester J. Schieber

SOCIAL SECURITY: AVOIDING THE

DOWNSTREAM CATASTROPHE
INTRODUCTION
For more than 20 years now, the movie To Fly has been shown several times
each day at the Air and Space Museum of the Smithsonian Institution in
Washington, DC. The beginning of the movie is set in 1876 and in an early
scene a balloonist is seen floating over a very peaceful river as he notices
a trapper paddling below in a canoe. After a bit, from his high perch the
balloonist sees some dangerous white water and waterfalls down river. The
balloonist, seeing that the trapper has no clue of the pending danger, screams
down to the trapper that there is white water down river and he must get
to shore for his own safety. In the movie, the trapper paddles safely toward
shore. This scene is a good analogy for the nature and scope of the financing
problem now facing Social Security.

THE NATURE AND SCOPE OF THE

SOCIAL SECURITY FINANCING PROBLEM
This year Social Security will collect approximately $60 billion more in rev-
enues than it will incur in expenses through the Old Age and Survivors In-

surance and the Disability Insurance (OASDI) programs. Trust fund balances
in the combined programs currently exceed $500 billion. Social Security's
current funding flows and trust fund balances might encourage us to be tran-
quil about the downstream prospects of its operations. But its actuaries and
trustees have been telling us for some time that the program is significantly
underfunded for future generations of retirees. The most recent Trustees Re-
port suggests that the payroll tax would have to be about 2.23 percentage
points higher than it is today to provide promised benefits over the next 75
years. 1
Some students of the program trivialize underfunding by saying that
its

2.23 percent of covered payroll over the next 73 years is no big deal; that

current law tax rates would meet two-thirds of promised benefits even after

Copyright © 1997 by Sylvester 1 Schieber. All findings, recommendations, ind conclusions in

this paper represent the views of the luthor and do not necessarily represent those of Watson
Wyatt Worldwide or any of it> other attOC latH

173
174 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

the trust funds are depleted; and that have consistently worsened over the last
there are some very simple marginal ad- 15 years as reflected in Table 1.

justments that can rebalance the system. The table shows that since 1983 the pro-
These arguments are misleading. jected accumulation in the trust funds has
diminished significantly in virtually ev-
If the current actuarial imbalance is to ery subsequent valuation of the ongoing
be made up through a tax increase, it operations of the program. The actuarial
would represent an 18 percent increase underfunding of the program, stated as
in the program's cost over the next 75 a percentage of covered payroll over the
years. Such an increase in the tax that 75-year projection period, has also wors-
has become the largest federal tax for ened in almost every projection year since
many workers is no trivial matter. If it 1983. The year that we expect the trust
were imposed this year, it would amount fund to be depleted has also worsened
to $72 billion and it would grow at the significantly over the the projection pe-
compound rate of average wage growth riod. Finally, the projected underfunding
in the future. In addition, the 2.23 percent of the program has grown by more than
figure assumes that we could have raised $3 trillion since 1983. We have been told
the payroll tax rate 2.23 percentage repeatedly that this program is signif-
points early in 1997and "banked" the icantly underfunded downstream, and
added accumulation, or cut benefits by a each subsequent valuation tells us that
comparable amount. This assumption is the underfunding is worse than that re-
problematic for several reasons: it does vealed in the last valuation. One Cana-
not consider the deteriorating funding dian actuary characterizes the unfolding
status of the program at the end of picture as a "predictable surprise." The
the 75-year projection period; there are essence of his characterization is that the
questions about the government's ability problems we face are highly predictable,
to convert added payroll tax collections but likely that we will still be sur-
it is

into national savings; and by the time prisedwhen we finally experience them
action is finally taken, the funding gap because we have refused to deal with
will be much larger than it is currently. them.

Social Security today is no more in "cri-

BALANCING SOCIAL SECURITY
sis" than the man in the canoe described
WITHIN THE CONTEXT OF
earlier. But the man in the canoe, with
GOVERNMENT'S TOTAL
the benefit of the downstream perspec-
OPERATIONS
tive of the balloonist, realized that he
would be in danger if he did not change In 1997, total expenditures under the
his course. Our situation with Social Se- OASDI programs willbe an estimated
curity is similar to that of the man in 4.66 percent of our gross domestic
the canoe. The program's actuaries have product (GDP). By 2030, the OASDI
warned us several times that there is a sig- claim on the economy is expected to
nificant problem downstream. Not only rise to 6.57 percent of GDP and by
have they warned us repeatedly of Social 2035 to 6.64 percent. In other words,
Security's actuarial imbalance, their esti- over the next 30 to 35 years, we expect
mates of the magnitude of the imbalance Social Security's claim on the economy
 NO Sylvester J. Schieber/175

Table 1

Projected Maximum OASDI Trust Fund Accumulations in Current Dollars,

Projected 75- Year Actuarial Balance as a Percentage of Covered Payroll, and
Estimated Year Trust Funds Will Be Depleted by Year of Actuarial Estimate and
Present Values of 75- Year Surpluses of OASDI Funds Relative to Obligations

Projected Present Value

Maximum Actuarial Year of Tax Income
Trust Fund Balance Trust Fund plus Current Fund
Balance as Percent Projected to minus Obligations
Year of Estimate ($ billions) of Payroll Be Depleted (S billions)

1983 $20,750 0.02 2063 $148.3

1984 18,393 -0.06 2059 37.4
1985 11,955 -0.41 2049 -268.8
1986 12,739 -0.44 2051 -342.6
1987 12,411 -0.62 2051 -377.6
1988 11,838 -0.58 2048 -664.0
1989 11,930 -0.70 2046 -849.5
1990 9,233 -0.91 2045 -1,242.7
1991 8,020 -1.08 2041 -1,185.1
1992 5,535 -1.46 2036 -1,772.6
1993 4,923 -1.46 2036 -1.863.7
1994 2,976 -2.13 2029 -2,841.9
1995 3,275 -2.17 2030 -2,832.7
1996 2,829 -2.19 2029 -3,094.2
1997 2,834 -2.23 2029

Sources: 1983 to 1997 Annual Reports of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and Disability Insurance Trust Funds (Washington, DC: Social Security Administration) and the
Office of the Actuary, Social Security Administration.

to grow by about 2 percentage points. Figure 1 shows three-year averages

Some analysts would have us believe of the total receipts of the federal
that such a shift in national resources government as a percentage of gross
to this vital retirement program can be domestic product (GDP) starting with
achieved without significant difficulty. Fiscal through Fiscal Year
Year 1951
One of the problems that we face in 1996. Three-year averages are used here
rebalancing Social Security is that it rather than the actual annual data to
is only one of several governmental smooth the effects of economic cycles on
programs that will be affected by the tax revenues. Over the 45-vear period
aging of our society. The combination from the end of the Korean War, total
of these programs, including Social federal tax receipts have varied from
Security, Medicare, Medicaid, and other a low of 17.1 percent of GDP to a
federal retirement programs, will place a high oi 19.3 percent, only about a 2
tremendous strain on the government's percentage point variation in the claim
fiscal operations. that the tederal government has made on
176 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

Figure 1

Three- Year Averages of Total Federal Receipts as a Percentage of GDP

20

15

10

I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I

1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
Source: Historical Tables: Budget of the United States Government, Fiscal Year 1998, pp. 21-22.

taxpayers. Even looking at actual year-to- this picture thatwe should really focus
year numbers, the maximum claim in any our energies for managing entitlement
year was 19.7 percent of GDP. growth on federal medical programs in
While there is no natural limit to general and Medicare in particular. They
government's claim on the economy, claim that if we can restrain the rapid
there are clearly political forces that growth in the health care programs, we
have narrowly limited the amount U.S. can sustain projected growth in the cash
taxpayers have rendered to it over retirement programs. 2
virtually all of the last half century. If While constraining federal health pro-
government revenue claims on the
total grams for the elderly may be desirable, it
economy are narrowly limited and Social will be more difficult to do so than con-
Security is scheduled to make a bigger straining the cash programs for retirees
claim than currently, then some other for four reasons. First, old people sim-
government expenditures must shrink. It ply use more health care services than
is here that projected expansions in Social younger ones. Second, the percentage of
Security's economic claims would seem our population over age 65 is expected to
to be particularly constrained. grow by as much between 2010 and 2030
Figure 2 shows the projected increases as it had in the prior 80 years. The third
in the on the economy by
claims factor that will make it difficult to reduce
various entitlement programs
federal Medicare expenditures is the excessive
between 1996 and 2030. The graphic price inflation that persists in the health
shows the projected increasing claim of sector of our economy. The fourth factor
Social Security as discussed earlier. The that will drive up future health costs is the
projected relative growth in Medicare continued technological development in
claims expected to far outstrip that
is the health sector and increasingly inten-
of OASDI. Some analysts conclude from sive treatment of patients.3
 NO Sylvester J. Schieber/ 177

These four factors are all compounding Figure 2

up the cost of Medi-
factors that will drive
Current and Projected Levels of
care claims even in the face of program Entitlement Program Operations as
reforms. Current projections suggest that a Percent of GDP
under present law Medicare's claim on
the economy will grow from 2.5 percent
of GDP today to 7.5 percent by 2030. 20-

The underlying assumptions in that pro-

jection, however, assume that the added
price inflationary pressures and the in-
creased costs of treatment due to cost
expanding technologies will largely be
eliminated by the end of the first decade
of the next century, just as the first of
the baby boomers begin to turn age 65.
In other words, current Medicare projec-
tions assume we have an ameliora-
will Source: Congressional Budget Office, Long-Term
Budgetary Pressures and Policy Options (Washing-
tion in inflationary pressures on this pro- ton, DC: The Congress of the United States, March
gram just as the baby boomers begin to 1997), Executive Summary, Table 2.
bring on tremendous levels of new de-
mand.
promises. Thereis very little support for
The point of this discussion is that
the potential rededication of 2 percent thisoption even among the staunchest
supporters of the current system. 4 An
of GDP OASDI might be
to rebalance
tenable if were the only imbalance
that
alternative way would be to reduce
that the government were facing. But it is
benefits by a sufficient amount to live
within the current payroll tax rates. The
[Link] we look for policy options to deal
with Social Security, we have to consider Advisory Council actually considered a
rebalancing
proposal along these lines, but no one
it in the larger context of the
total federal government's claim on the
on the Council was willing to support
the proposal because of the resulting low
economy and within the context of other
levels of benefits that would be provided
must be financed out of
entitlements that
total government revenues. by the program and because of the
relatively low rates of return that future
generations of workers would receive
SOCIAL SECURITY under this approach to reform. 5
REFORM OPTIONS Given the reluctance to address the
Social Security is financed largely by shortfalls explicitly through straightfor-
the earmarked payroll tax, and promised ward tax increases or benefit reductions,
benefits are defined in current law. The number of Advisory Council members
problem of insufficient revenues to meet opted to impose a set of implicit charges
the promised benefit stream can be On workers and beneficiaries to cover the
addressed in a number of ways. One actuarial shortfalls under the auspices of
would be to simply raise the payroll tax the "Maintenance of Benefits4 (MB) op-
'

by the necessary amount to meet benefit tion. They advocated: (1) increasing the
178 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

number of years of earnings used in de- trust fund holding more than a trillion
termining benefits from 35 to 38;(2) di- dollars worth of equities in today's dol-
verting income tax revenues on Social Se- lars would be much more tempting for
curity benefits now going to the Medicare such uses than the relatively small ex-
HI fund to the OASDI funds; (3)
trust isting federal retirement funds that hold
taxing benefits above workers' own
all only a few billion dollars today. There are
lifetime nominal payroll tax contribu- many cases, from California to Kansas to
tions — i.e., their own basis in benefits; (4) New York where the investment of assets
investing 40 percent of the trust funds in in public retirement plans at the state and
the private equity markets to get a higher local levels has been influenced or dic-
rate of return than that provided by cur- tated by political rather than economic
rent investments; and (5) raising the pay- considerations. Around the world, there
roll tax rate by
percentage points in
1.6 are also cases from Singapore to Sweden
2045. While only the last of these could be where the assets in partially funded na-
characterized as an explicit tax increase, tional retirement systems have been used
each of the others would implicitly in- for social investing purposes. While the
crease taxes or reduce benefits for pro- advocates of Social Security becoming
gram participants. our economy's largest private investor
The majority of the Advisory Council dream up ways to insulate the investing
members opposed the MB option largely from political directives, there is no way
because of its last two elements. The pro- that a current Congressional limitation in
posal to invest Social Security trust funds this regard could preclude future Con-
in the private equity markets would make gresses from undoing it.

the federal government by far the largest In addition to the problems of politi-
owner of private capital in our economy. cizing investment decisions, the MB
Such a policy might result in politically proposal would also raise conflict of in-
motivated investment of such capital for terest questions as the government rec-
reasons other than the economic inter- onciled its role as a fiduciary respon-
ests of the program's participants. Even sible for protecting the economic value
as the Advisory Council's debate was un- of its portfolio while at the same time
folding, Secretary of Labor Robert Reich fulfilling its responsibility as a regula-
was advocating that some of the assets tor of businesses in the interest of pub-
in employer-based pensions should be lic welfare. Finally, it would raise issues
used for "economically-targeted invest- of corporate governance. The advocates
ment" purposes. At the height of the de- of this proposal suggest that the govern-
bate within the Advisory Council over ment would not vote its shareholder in-
this proposal, the Clinton Administration terests in proxy voting matters. Such a
actually tapped federal workers' pension policy would change the relative balance
funds to avoid debt ceiling limits that of other stockholders on proxy votes and
were being exceeded during the bud- would be contrary to the government's
get battle with Congressional Republi- own position on employer-based retire-
cans early in 1996. Concerns about the po- ment program fiduciaries voting their
litical use of retirement funds held by the ownership position for shares in their
federal government is not a pipe dream; pension programs. Some members of the
it has already been a reality. An OASDI Advisory Council found it ironic that
 NO Sylvester J. Schieber/ 179

U.S. policymakerswould be considering in the form of "Personal Security Ac-

a massive governmental buy-up of our counts" (PSAs) just as they do in the
economy's private capital as we enter the investment of individual retirement ac-
21st century while many other govern- counts and 401 (k) assets. 6 The PSA pro-
ments around the world are moving in posal raises a transitional financing is-
exactly the opposite direction because of sue because current benefits are largely
lessons learned from the U.S. experience financed by current payroll tax revenues.
during the 20th century. The majority of If workers are allowed to keep their por-

the Advisory Council members opposed tion of the payroll tax that finances retire-
the proposed tax increase in 2045 because ment benefits, added revenues would be
they felt it was patently unfair to propose required to meet current benefit commit-
tax rates on our grandchildren that we ments.
were not willing to pay ourselves.
Those Advisory Council members op-
posed to the MB proposal, 7 out of the to- Figure 3 indicates the magnitude of the
tal 13 members on the Council, proposed transition costsunder the PSA proposal
substantial reform of the current struc- if it werebe financed on a pay-as-you-
to
ture of Social Security as the means to sal- go basis through a supplemental payroll
vage the system. They recommended that tax. The top line in the figure is the
part of the solution include some funding combined employer and employee tax
of benefits through individual accounts. rates that would be required in each year
Two members developed an "Individ- of the transition. The lower line shows the
ual Account" (IA) proposal where the current law rate of 12.4 percent of covered
individual accounts would be financed payroll. If the transition is financed on
by an added employee contribution of a pay-as-you-go basis, the payroll tax
1.6 percent of covered payroll with the to support the non-Medicare portion of
accounts being held and managed by the total benefit package would have
the Social Security Administration. Al- to increase to roughly 15.9 percent of
though workers would be given some payroll shortly after the transition begins.
where the individ-
discretion in directing Under this transition approach, virtually
ual account funds would be invested un- all would be
of the transitional costs
der this proposal, the other five members paid off within the span of a regular
of the Council felt that it was inappropri- working lifetime. Workers near the end
ate tohave Social Security managing the of their careers when the plan was
funds for the same set of reasons that they implemented would incur a relatively
opposed the MB proposal. high cost for a few years at the end of
These latter five members of the Coun- their careers. Workers who were young
cil, including me, felt that the accounts when the proposal was adopted would
should be financed by the workers' share bear the full burden of the transition costs
of the payroll tax contributions now go- throughout their lives. Those entering the
ing to finance retirement benefits through work (bice near the end of the transition
Social Security —
namely 5 percent of cov- would bear little of the cost. While
ered payroll. Under our proposal work- all generations might benefit tiom this

ers would have considerable discretion proposal under the right circumstances,
in investing their retirement assets held tned untair to distribute the costs
180 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

Figure 3
Pay-As-You-Go Payroll Tax to Fund Transition to Personal Security Accounts
16

14 Transition rate

12
I Current law ra^e

10-

o
6
1

| i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i ii i i

1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Year

Source: Office of the Actuary, Social Security Administration.

of transition so heavily onto a single onerous for those caught at the early part
generation of workers. of the transition. Of course, it increases
the cost for those at the end of the transi-
To address the concerns about inter- tion,but the workers adversely affected
generational fairness, we proposed that have the most to gain from the proposal
the transition not be financed purely on a under consideration.
pay-as-you-go basis. We proposed levy-
ing a flat 1.52 percent payroll tax over
Under the PSA proposal, the transi-
tional federal borrowing would reach
roughly 70 years with transitional bor-
about 2 percent of GDP in 2007 and then
rowing when the transitional payroll tax
gradually decline to zero around 2030 or
supplement is insufficient to meet pay-as-
so. The transitional borrowing would add
you-go costs. Under this transition pro-
to formal government debt. The added
posal, the burden on any single worker
debt would peak at around 20 percent of
would not increase more than 12.3 per-
cent (i.e., 1.52 percent payroll tax supple-
GDP by 2020 and decline after that. At its
peak, the present value of the added gov-
ment divided by the base rate of 12.4 per-
ernment debt would be equal to about
cent) in any given year. This compares
$1.1 trillion. In the context of today's dol-
with the pay-as-you-go transition where
some workers would incur payroll tax in- lars, would peak at $2.4
the borrowing
[Link] added debt would be com-
creases of as much as 28.2 percent (i.e.,
pletely paid off by 2070 under the transi-
3.5 percent supplement divided by 12.4
tion program.
percent). Spreading the transition costs
over a larger number of cohorts of par- Critics of the PSA proposal argue
ticipants would make the transition less that the transitional costs are simply too
 NO Sylvester J. Schieber/ 181

great to be borne by workers and by of equities without creating significant

the government. Their arguments seek new savings in the economy. 7 Such an in-
to obfuscate the actual obligations that crease in interest rates would undoubt-
are implied by the current operations of edly carry over into increased interest
Social Security and to confuse people rates on home mortgages, consumer debt,
about the financial transactions that and other borrowing, directly affecting
would be involved in the various reform the well being of lower- and middle-
approaches. They argue that lower- and wage workers. In short, there is no magic
average-wage workers cannot afford to way to close this deficit without impos-
pay the extra cost of transitioning out ing costs on someone. The question is on
of the current system. They argue that whom we want to impose costs and how
a government striving to balance its to impose them.
budget cannot afford to take on the The confusion over the creation of
transitional debt that would be involved "federal debt" under the PSA transition
in the PSA proposal. Both arguments are proposal arises because the government
misleading. does its accounting purely on a cash
If anyone disputes the Social Security's basis. Under cash accounting the only
actuaries' estimates of the program's un- governmental debt that is recognized
derfunding, they argue that the estimates in a given year is the difference in
are overly optimistic. They point to the cash receipts and expenditures for the
continuous deterioration in the projec- year. As such debt arises, the holders of
tions reported in Table 1 to support their the debt are issued government bonds.
case. Taking the actuaries' estimates as These bonds represent a claim on future
reasonable, however, even the MB pro- revenue streams of the government and,
ponents agree that the current system is as such, they represent obligations that
underfunded over the next 75 years by will have to be met by future taxpayers.
about 20 percent. Their proposal would The cash accounting that recognizes the
basically protect almost all of the ben- government's formal debt, however, only
efits promised under current law. They recognizes part of the true operations
would have us believe that they can ac- under federal financing and expenditure
complish this without increasing the pay- programs. It does not recognize the
roll tax rate. From an economic perspec- unfunded obligations that arise under
tive though, the 2.23 percent of payroll various federal programs such as Social
actuarial deficit can only be closed by im- Security. For example, looking back to
posing a real economic cost on the econ- Table 1, the unfunded obligations in the
omy. Someone has to pay it regardless of OASDI programs have risen from zero at
whether it is borne through an explicit the end of 1984 to more than S3 trillion
tax on workers, an explicit reduction in at the end of 1996. Just as in the case

payments to beneficiaries, or some other ot formal federal debt, these obligations

hidden claim. The MB proposal would also represent a claim on future revenue
rely heavily on the latter route. Many ana- streams ot the government and, as such,
lysts believe that the MB proposal would they also represent obligations that will
lead to higher interest rates on govern- have to he met by future taxpayers. The
ment borrowing because it would have |
Only difference between them and the
the government buy up $1 trillion worth formal debt is that one i^ accounted for
182 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

and the other is not when we calculate were discussed earlier. The only way we
the annual budget flows and balances. can keep Social Security, Medicare, and
Some analysts claim that there is a other federally sponsored retirement pro-
difference in the two forms of obligations grams from making a larger claim on the
because Congress can restructure Social economy than historical levels of total
Security, thus wiping out the statutory government funding is by constraining
obligations under the program. While them. In that regard, the MB proposal and
that is technically true, the thought' of others like it are a total failure. It is likely
completely reneging on accrued benefits that wecan only accomplish the kinds
under the program has never been of reductions in costs necessary to main-
proposed by anyone. That means that tain Social Security's future viability by
much, if not most, of these statutory significantly restructuring it to meet the
unfunded obligations will be every bit needs of workers and retirees in the 21st
as burdensome to future taxpayers as the century.
servicing of the formal debt obligations
will be. Indeed, the MB proposal would
SHIFTING FROM A DEFINED
have us cover virtually all of Social
BENEFIT TO A PARTIAL DEFINED
unfunded obligations.
Security's current
CONTRIBUTION REGIME
When economic costs of
the total
the various proposals developed by The individual account approaches in-
the Social Security Advisory Council cluded in the IA and PSA plans would
are considered, the proposed borrowing change the defined benefit nature of So-
in the PSA plan can be seen in an cial Security. Once again, some people see
appropriate perspective. Table 2 shows this as an undesirable change to the ex-
the estimated present value of the 75- isting system. They raise the specter of
year total federal obligations under the individual financial risk and argue that
three proposals put forward by Council exposing workers to such risk would be
members. The PSA plan, including the bad public policy. What they fail to ad-
full cost of transition financing cuts dress in their arguments is that the cur-
by
the obligations to future taxpayers rent system is fraught with risks that are
significantlymore than either of the not accounted for in their analysis. The
other proposals. The formal debt that implications of these risks are clear when
would be created under the PSA would the last two major policy adjustments to
arise because of a restructuring of total the Social Security Act are considered.
federal obligations in a way that would During the early 1970s the Social Se-
ultimately reduce those obligations. curity system faced a severe short-term
Table 2 is quite clear that either the financing crisis because of rapid growth
PSA or IA proposals would significantly innew retirees' benefit levels. The 1977
reduce the "entitlement" obligations of Amendments addressed this problem by
the federal government through reforma- reducing by about 25 percent the benefits
tion of Social Security. While some peo- of workers who would become eligible to
ple believe that would be inadvisable pol- retire five years after the implementation
icy, they have failed to address the issues date of the Amendments. Despite the se-
raisedby the projected growth in federal vere benefit reductions they imposed, the
entitlement claims on the economy that 1977 Amendments failed to completely
 NO Sylvester J. Schieber/183

Table 2
Present Value of OASDI's 75- Year Obligations under Alternative Policy Options

Change from
Obligations current law Percent change
(dollar amount in billions)

Present law $21,345

PSA flat benefit plus transition tax 16,487 4,858 22.8
OASDI benefit under IA proposal 18,867 2,478 11.6
MB proposal 21,177 228 1.1

Source: Derived from tables prepared by the Social Security Administration, Office of the Actuary for 1994-
1996 Social Security Council.

address the short-term financing problem are significantly under- financed for the
and by the early 1980s the program faced majority of people that are contributing
trust fund insolvency. In addition, by the to the system today. While policymakers
early 1980s there was growing awareness have not been willing to address this
of the long-term financing problems fac- issue yet, those that have been willing
ing the program. The 1983 Amendments to put proposals on the table have
were meant both of these by
to address tended toward benefit reductions in
further curtailing benefits. While the 1983 their recommendations to rebalance the
Amendments supposedly "fixed" Social system. And these proposals are not
Security's financing problems for at least all coming from the end of
libertarian
the next 80 years, here we are again less the political spectrum whose devotees
than 15 years later worrying about the would like to see the current program
system's underfunding. In a little over a significantly curtailed on philosophical
decade, Social Security will begin to run grounds alone.
a cash flow deficit, and it is projected to
be facing insolvency before the youngest Contemporary proposals to reduce
members of the baby boom generation coming from
Social Security benefits are
are eligible to receive full benefits. policymakers anchored in the political
mainstream. Before he retired in 1994,
The risks that we face under the current
Representative Jake Pickle, a Democrat
system are that benefits are going to be cut
from Texas and Chairman of the Social
significantly or that the taxes on workers
Security Subcommittee of the House
are going to be increased significantly.
Ways and Means Committee, proposed to
Implicitly, if not explicitly, one or the
rebalance the system virtually completely
other has to happen because the system is
through benefit reductions. Senator Bob
20 percent out of actuarial balance today
Kerrey, aDemocrat from Nebraska, has
and is projected to be much further out of
reached across party lines to cosponsor
balance in the future.
a proposal to reduce benefits in the
If current law benefits were secure, traditional Social Security program in
we would not be carrying on a national order to finance the creation of individual
debate about how to fix Social Security. accounts that would be held by workers.
The fact is that current law benefits And as mentioned earlier, within the
184 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

Advisory Council there was virtually no operations of a free economy if it

support for a straightforward payroll tax held the large pools of private assets
increase to deliver future Social Security implied by the MB or LA proposals.
benefits definedby current law. Maybe While economic considerations were
some proposals advocating tax increases extremely important to this group, it was
to deliver currently promised benefits ultimately political considerations that
will ultimately be tabled by policymakers drove them to suggest the individual
but general reluctance to increase tax account option that they did. They simply
rates in this society suggests that such did not believe the economic goals that
proposals will face major opposition in they thought were important could be
the legislative process. achieved within our political framework
Virtually all of the members of the through any mechanism other than
Advisory Council sought to improve the individual accounts managed outside
rates of return in the Social Security government.
system for younger cohorts of workers. The creation of individual accounts,
In addition, the majority of the members of course, would expose workers to
of the Council were also concerned about greater financial market risks in the
the implications of reform proposals accumulation of their base pensions than
on national savings As Bosworth
rates. the financial market risks they currently
and Burtless point both of these
out, face. But it is not clear that their
goals can conceivably be achieved either overall risks would be any greater than
within the current defined benefit system they are in the current environment. If
or outside it through the creation of policymakers are reluctant to increase
individual accounts. 8 As they note, from payroll taxes at all to simply sustain
an economic perspective the important the current structure of benefits, the
factor in achieving the goals of improved political of the Maintain
probability
returns and higher national savings is Tax Rate Benefit (MTR), the benefit
the prefunding of benefits, not how those that could be provided to a worker
funds are held. But they also note that if benefits were scaled back to live

many people involved in the debate within the tax rate levels in current
about Social Security reform are skeptical law, approaches one. In this regard,
that the two different approaches are the Advisory Council's unwillingness to
equivalent from a political perspective. advocate a straightforward increase in
The ultimate question that we face payroll tax rates to deliver currently
is whether the government can be promised benefits is important.
the accumulator of a vast pool of The advocates of the MB plan sought
private economic wealth and can be to secure current benefit promises and
expected to invest it in a fashion that is the current benefit structure by crafting
neutral to the performance of financial a proposal that would minimize the ex-
markets and the independent operations plicit costs of doing so to workers. But as
of business. The supporters of the we pointed out earlier, there is no way to
PSA plan within the Advisory Council cover the real deficit that exists in the cur-
thought that the government could rent system without incurring real costs.
not accumulate the pools of wealth If the only way policymakers can get soci-

in question nor remain neutral in the ety to bear these costs is to hide them, the
 NO Sylvester J. Schieber/ 185

proposal itself acknowledges that there current law, these programs allow young
is tremendous political risk that the pub- and old workers alike to contribute from
lic will be unwilling to deliver on current a few dollars a week or up to nearly $200
promises. The advocates of the individual per week into them. In the aggregate,
account options developed by the Advi- workers pour more than $1 billion per
sory Council believed that policymakers week into private 401 (k) plans. Most
might be willing to explicitly increase the workers are free to direct the investment
cost of providing benefits under the pro- of their own retirement savings in these
viso that the added levies go into indi- plans, and they do so on a fully accounted
vidual accounts. they are correct, the
If basis that costs much less than 1 percent
political probability of a benefit greater per year.
than MTR increases significantly, but it Critics also argue that the PSA plan is
would only do so at the expense of the flawed because it does not require the an-
worker taking on some investment risk. nuitization of the benefit at retirement.
A simulation approach has been used While the PSA proposal did not call for
to determine benefit levels for selected forced annuitization, it did not preclude it

birth cohorts of average age workers. 9 either. Indeed, its authors suggested that
The simulation results suggest that there it might make sense to require retirees
are tradeoffs between political risks and to show that they had a lifetime annu-
market investment risks that might make ity income that would equal 1.5 times
the choice between the two difficult the poverty line, or some other similar
for the older birth cohorts, especially multiple of the poverty level income be-
the baby-boom birth cohorts. For those fore they could liquidate their PSA ac-
birth cohortsborn after the baby boom, cumulation at retirement. At some level
however, the advantages of prefunding a of income that protects taxpayers from
portion of the benefits through individual having injudicious consumers demand-
accounts are much clearer. And this ing welfare support, however, it is not the
does not take into account the added government's business how private con-
improvements in economic welfare that sumers choose to distribute their lifetime
should result from the added savings that savings.
would be stimulated by the IA or PSA Finally, critics of Social Security reform
plans. proposals that include an individual
Critics of the PSA
proposal argue that account element argue that Congress
it would be not impossible to
costly if would be unlikely to force workers to
administer. In this regard, the experience keep the money in the accounts until
of the employer-based 401 (k) system they reach retirement. They suggest that
is instructive. Although this system is our political leaders could not withstand
completely voluntary, it has experienced the pressure to allow workers to tap
explosive growth over the period since retirement savings in cases of personal
it was first made available to workers and financial hardship. The fact is that a
in the early 1980s. The system went wide range of countries around the world
from virtually nothing to accounting for have adopted Social Security reforms of
more than half the total contributions the sort recommended under the PSA
going into private employer-sponsored ;aL Such reforms have swept across

retirement programs in 1993. Under I atin America. A much larger, fully

186 / 9. IS OUR CURRENT SOCIAL SECURITY PROGRAM SECURELY ANCHORED?

funded individual account program is in the world is not incompatible with the
being phased in currently in Australia. early direction of our own Social Security
A similar approach is used in Singapore program.
and is being considered by a number of The father of the U.S. Social Secu-
other Asian countries including China. rity system, Franklin D. Roosevelt, felt
Sweden, the mother of all social welfare strongly that a significant portion of the
states, is moving toward a system very system's promises should be funded.
similar to the one recommended by the When he discovered that the original
authors of the IA proposal. The UK has proposal submitted to Congress by his
allowed workers to "contract out" of the Committee on Economic Security did not
second tier of their national retirement provide for such funding, he made the
program for some years, essentially Committee revise the legislative package
allowing voluntary PSAs in their national to include it. While his proposed funding
retirement system. The UK is beginning was included in the original Social Secu-
to discuss moving further down this rity Act, the levels of funding that FDR
path in the direction that Australia has had upon for his beloved Social
insisted
gone. A wide range of other countries Security program were never achieved,
around the world are carrying on similar largely for two reasons. The first was
deliberations. 10 If our political system Congressional worries that the accumu-
or our national policymakers are so lated funds would be used to buy up sig-
politically incontinent that they cannot nificant shares of private capital, a move
do what a wide range of countries around many in Congress thought was incom-
the world have been able to achieve, patible with the nature of our govern-
we may have a much larger problem to ment and the private ownership of cap-
resolve than figuring out how to secure ital. The second was that it was always

the retirement benefits of today's workers easier for Congress to delay tax increases
at a cost that future workers will be able that would have led to the trust fund
to bear. build-up that FDR envisaged than to bear
Possibly the most amazing aspect of the pain of imposing the necessary taxes;
what going on all around the world
is or it was more politically expedient to use
is the range of other countries that have excess tax revenues as they arose to raise
recognized the downstream perils of pay- benefits than to allow the trust fund to
roll tax financed pay-as-you-go retire- accumulate.
ment security systems. These countries FDR was right; a healthy fund back-
are paying attention to the predictable ing our national retirement system would
demographics they face and changing be good for the economy and its par-
the course of their national retirement ticipants' economic security. What more
—
programs often much older than ours than 60 years of experience has told us,
— generally by adopting some form of however, is that we can only achieve
individual account program. They are FDR's vision by significantly reforming
amending existing systems to avoid the the current system. We were among the
perils that taxpaying workers and depen- last of the countries in the Western Hemi-
dent retirees face from retirement security sphere to adopt a Social Security pro-
systems that are not sustainable for aging gram. We should not be the last to re-
populations. What is going on elsewhere form it.
 NO Sylvester J. Schieber/187

Security Reform Options and Their Implications

NOTES for Future Retirees, Federal Fiscal Operations,

1. The 1997 Annual Report of the Board of Trustees

and National Savings," a paper prepared for a
public policy forum, "Tax Policy for the 21st
of the Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds (Washington, DC:
Century," sponsored by the American Council
for Capital Formation, Washington, DC, December
US Government Printing Office, April 1997), p. 24.
1996. Copies available from the author on request.
Henry Aaron,
2. "Is a Crisis Really Coming?
7. For example, see Alan Greenspan, speech
(Social Security and . . .)," Newsweek (December 9,
at the American Enterprise Institute's Public
1996).
3. For a full discussion of those issues, see Policy Conference, January 1997, Joan T Bok et
al., "Restoring Security to Our Social Security
Roland D. McDevitt and Sylvester J. Schieber, From
Baby Boom to Elder Boom: Providing Health Care for an Program," and Edward M. Gramlich and Marc M.
Aging Population (Washington, DC: Watson Wyatt Twinney, "The Individual Accounts Plan," in The
Worldwide, 1996). Report of the 1994-1996 Advisory Council on Social
Security, vol. 1, pp. 128, 155.
4. For example, the members of the 1994-1996
8. Gary Burtless and Barry Bosworth, "Privatiz-
Social Security Advisory Council who advocated
ing Social Security: The Troubling Tradeoffs," Brook-
maintaining the current system and benefit struc-
ture to the maximum extent possible argued that
ings Policy Brief (March 1997), No. 14.
For a full discussion of the simulation ap-
9.
any increase in the payroll tax should be largely
devoted to supporting the Medicare program. See proach and the results of simulations for lower- and
Robert M. Ball, et al., "Social Security for the
higher-wage workers, see Gordon P. Goodfellow
21st Century: A Strategy to Maintain Benefits and
and Sylvester J. Schieber, "Social Security Reform:
Strengthen America's Family Protection Plan," Re- Implications of Individual Accounts on the Dis-
tribution of Benefits," Pension Research Council
port of the 1994-1996 Advisory Council on Social Se-
curity, vol. 1, Findings and Recommendations, p.
Working Paper, Philadelphia: The Wharton School,
64.
University of Pennsylvania, May 1997.

Transcript of the Public Meeting of the Social

5. 10. For a more in-depth discussion of what is

Security Advisory Council, December 14, 1995 going on in the international arena, see Sylvester

(Social Security Administration). J. Schieber and John B. Shoven, "Social Security

6. For a complete description of this proposal Reform: Around the World in 80 Ways," The
and its financing and benefits implications, see American Economic Review (May 1996), vol. 86, no.
Sylvester J. Schieber and John B. Shoven, "Social 2, pp. 373-377.
POSTSCRIPT
Is Our Current Social Security Program
Securely Anchored?

Ball believes Social Security is basically in good shape and that financing
can easily be brought into long-range balance. He identifies the sources of
the projected deficits: 50 percent from changes in actuarial methods and new
sources of data and 50 percent from changes in assumptions. The problem
is to eliminate the projected deficit of 2.23 percent of covered payroll. Ball's

solution, which would maintain the basic structure of OASDI as a completely

defined benefits program, involves six elements: increase taxation of bene-
fits, change the cost of living adjustment, extend Social Security coverage,

increase the wage-averaging period, increase the overall tax rate, and allow
the investment of trust fund balances in equities. Ball rejects the two partial
privatization proposals — individual accounts and private savings accounts
— for a number of reasons: they require too drastic a reduction in basic bene-
fits; they require too high an increase in current taxes; they increase risk; they

are too complex; they are too costly; and they are politically unstable. In con-
clusion, Ball argues that his position on Social Security reform is consistent
with community solidarity and the proper role of government in a market
economy.
Schieber, unlike Ball, believes that the projected underfunding is a very se-
rious problem that requires a fundamental restructuring of OASDI. He rejects
the solution favored by Ball; in particular Schieber rejects the investment of
trust funds in equities by government officials on the grounds that such an
arrangement will politicize investment decisions, create conflicts of interest,
and lead to problems of corporate governance. Moreover, Ball's Maintenance
of Benefits Option, because it requires a 1.6 percent increase in the payroll
tax in 2045, shifts the tax burden to future generations. As an alternative,
Schieber proposes transforming Social Security from a completely defined
benefits program to a partially defined benefits program through the partial
privatization of OASDI. In defending his alternative, the Personal Savings
Account Option, Schieber argues that it will actually reduce risk, and that it
is consistent with reforms that are occurring in a number of countries across

the globe. But, most importantly, he believes that his proposal of partial priva-
tization is the only way in which important economic goals can be achieved
within a democratic political framework.
Additional readings on this issue include "How Not to Fix Social Security/'
by Mark Weisbrot, Dollars and Sense (March/April 1997); "The Great Social
Security Scare," by Jerry L. Mashaw and Theodore R. Marmor, The American
Prospect (November/December 1996); "A Secure System," by Robert Ball,

188
The American Prospect (November/ December 1996); "Different Approaches
to Dealing With Social Security/' by Edward M. Gramlich, journal of Economic
Perspectives (Summer 1996); and "Proposals to Restructure Social Security,"
by Peter A. Diamond, Journal of Economic Perspectives (Summer 1996). Also
see three issues of Economic Commentary, Federal Reserve Bank of Cleveland:
"Should Social Security Be Privatized?" by Jagadeesh Gokhale (September
1995); "Social Security: Are We Getting Our Money's Worth?" by Jagadeesh
Gokhale and Kevin J. Lansing (January 1, 1996); and "A Simple Proposal for
Privatizing Social Security," by David Altig and Jagadeesh Gokhale (May 1,

1996).

Itt
ISSUE 10
Does the Consumer Price Index
Overstate Changes in the Cost of Living?

YES: Michael J. Boskin et al., from "The CPI Commission: Findings and
Recommendations/' American Economic Review (May 1997)
NO: Dean Baker, from "The Inflated Case Against the CPI/' The American
Prospect (Winter 1996)

ISSUE SUMMARY
YES: Michael J. Boskin et al., members of the Advisory Commission to Study
the Consumer Price Index, (the Boskin Commission), believe that changes in
the Consumer Price Index overstate changes in the cost of living by approxi-
mately 1.1 percent, and this has led to widespread overindexing of a number
of government programs.
NO: Dean Baker, an economist with the Economic Policy Institute, argues
that impossible to determine the overall direction and magnitude of
it is

bias in the Consumer Price Index because the Boskin Commission overstates
the upward biases in the index and fails to consider factors that suggest
downward bias.

Each month the Bureau of Labor Statistics releases a new estimate of the
Consumer Price Index (CPI). This release usually merits front page attention
in the nation's newspapers because changes in the CPI are interpreted as
changes in the cost of living of Americans. If nominal income does not keep
pace with increases in the cost of living, as determined by increases in the
CPI, then real income falls.
Because of this connection between changes in the CPI and changes in
the cost of living, a number of monetary arrangements in the economy are
altered when the CPI changes; that is, they are indexed. For example, some
private sector collective bargaining agreements tie wages to changes in the
CPI. If the CPI increases, then wages automatically rise by the same percent-
age. But indexing is not limited to the private sector of the economy; the
federal government has resorted to indexing in a variety of areas. In counting
the number of poor persons, the poverty thresholds (the income levels that
separate poor from nonpoor) are adjusted upward each year by the percent-
age increase in the CPI. With the individual income tax, the dollar value of
the personal exemption is adjusted to reflect changes in the cost of living as
determined by changes in the CPI. Social Security benefits are also adjusted

190
each year to reflect changes in the cost of living and the CPI. So from the
government's perspective, if changes in the CPI overstate changes in the cost
of living, then its tax receipts will be lower than they should be and its Social
Security payments will be higher than they should be. This, in tum, means
federal government budget deficits and the national debt will be higher than
they should be.
It is clearly important, then, to measure changes in the CPI and in the cost
of living accurately This issue addresses the question of the extent to which
this accuracy is achieved. As a first step in understanding this debate it is

important to understand how the CPI is calculated. The CPI, in technical

terms, is a Laspeyres fixed-weight index. Accordingly, the first step in the
—
calculation of the CPI is to determine the fixed weights the goods and ser-
vices that consumers purchase at a particular point in time known as the base
period. This is known as the market basket and is accomplished by surveys
of consumer purchasing behavior. The market basket can be considered the
expenditure pattern of the typical consumer. The market basket currently
used in the CPI was determined by surveys conducted in the early 1980s;
that is, the base period for the CPI is the 1982-84 period. The second step is
to gather information regarding the prices of the goods and services in the
market basket, and this is done every month. The price information is neces-
sary to determine the cost of the market basket. The cost of the market basket
changes as prices change, but the market basket itself does not (it is fixed).
If the cost of the market basket increases, then it costs the typical consumer

more to buy an unchanged bundle of goods and services, that is, the cost of
living has increased. The ratio of the cost of the market basket in the current
period to the cost of the market basket in the base period (multiplied by 100)
provides the current numerical value of the CPI. The percentage change in
the CPI between any two periods represents the rate of inflation in consumer
prices between those two periods and, by extension, the percentage change
in the cost of living between those two periods.
The Advisory Commission to Study the Consumer Price Index was con-
stituted by the Senate Finance Committee. The commission's final report,
"Toward a More Accurate Measure of the Cost of Living," was submitted
early in 1996. A summary of this report represents one side of the debate on
this issue —Michael J. Boskin was the chair of the commission while Ellen
R. Dulberger, Robert J. Gordon, Zvi Griliches, and Dale VV. Joigenson were
the other members. The commission's report has generated a great deal of
interest because its conclusions are so important— attesting everything from
calculation of poverty rates to efforts to balance the budget Some ot the re-
sponses by economists are highk critical ot the commission's bask finding
that the CPI overstates changes in the cost ot living. Dcm Baker provides an
excellent example of this criticism.

191
 Michael Boskin et al.
YES J.

THE CPI COMMISSION: FINDINGS

AND RECOMMENDATIONS
Measuring prices and their rate of change accurately is central to almost every
economic issue, from the conduct of monetary policy to measuring economic
progress over time and across countries to the cost and structure of indexed
spending and taxes. In the first external extensive evaluation of the nation's
price statistics since the Stigler Commission in 1961, the CPI Commission (see
Boskin et al., 1996) concluded that the change in the Consumer Price Index
(CPI) overstates the change in the cost of living by about 1.1 percentage points
per year (the range of plausible values is 0.8-1.6 percentage points). That is,
if inflation as measured by the percentage change in the CPI is running 3 per-

cent, the true change in the cost of living is about 2 percent. This bias might
seem small, but when compounded over time, the implications are enormous.
Over a dozen years, the cumulative additional national debt from overindex-
ing the budget would amount to $1 trillion. The implications of overstating
inflation for understanding economic progress are equally dramatic. Instead
of falling, average real earnings have risen, and instead of stagnating, real
median income has grown, over the last quarter century. The poverty rate
would be smaller. And because the CPI component price indexes are inputs
into the national income accounts, real GDP growth is also understated.
Why is inflation so hard to measure? Despite numerous improvements
that have been made historically and continue to be made by government
statisticians in all countries, including the U.S. Bureau of Labor Statistics
(BLS), many of them laboring under inadequate human and financial re-
source constraints, it is difficult to keep up with the dynamic change in the
economy. New products are being introduced all the time, and existing ones
improved, while others leave the market. Relative prices of different goods
and services change frequently, for example, in response to technological and
other factors affecting costs and quality, which leads consumers to change
their buying patterns. There are literally hundreds of thousands of goods
and services available in rich industrialized modern market economies. A
single supermarket may contain 30,000 differently priced items, and a Wal-
Mart store over 40,000. As we have become richer, demand has increasingly

From Michael J. Boskin, Ellen R. Dulberger, Robert J. Gordon, Zvi Griliches, and Dale W.
Jorgenson, "The CPI Commission: Findings and Recommendations," American Economic Review,
vol. 87, no. 2 (May 1977). Copyright © 1997 by American Economic Review. Reprinted by
permission.

192
 YES Michael J. Boskin et al. / 193

shifted to services away from goods, and Likewise, there has been a fundamental
to characteristics of goods and services change in the nature of retailing, perhaps
such as enhanced quality, more variety, most pronounced in the United States,
and greater convenience. Technology and but spreading virtually everywhere with
entrepreneurship provide them. But all the advent of superstores and discount
these factors, plus others, mean that a chains. The same VCR available for $200
larger fraction of what is produced and in a local appliance store may be only
consumed in an economy is harder to $160 at Circuit City. Since price data are
measure than decades ago, when a larger collected within outlets, the shift of con-
fraction of economic activity consisted of sumers to purchasing from discounters
easier-to-measure items such as tons of does not show up as a price decline, even
steel and bushels of wheat. though consumers reveal by their pur-
chases that the price decline more than
compensates for the potential loss of per-
sonal services. Thus, in addition to sub-
I. FINDINGS
stitution bias among commodities there is
How to obtain information on who is an outlet substitution bias. In the United
buying what, where, when, why, and States, this adds another 0.1 percentage
how in an economy, and then to aggre- point of upward bias.
gate it into one or a few measures of Another problem is that price data tend
price change raises a host of complex to be collected during the week. In the
analytical and practical problems. The United States, about 1 percent of price
mathematics of aggregating changes in quotes are collected on weekends, despite
the prices of different goods and ser- the secular trend of an increasing share of
vices are complex and subtle (see Irving purchases made on weekends and hol-
Fisher, 1922; Erwin Diewert, 1976). De- idays (probably reflecting the increas-
spite decades of analytical and empir- ing prevalence of two-earner couples).
ical research, some of it recently done Since some outlets emphasize weekend
in statistical agencies such as the BLS sales, there may be a "when" bias as
the statistical agencies around the world well as a "what" and a "where" bias. Re-
stillprimarily rely on fixed-weight in- cent research suggesting that prices rise
dexes which do not account for consumer less rapidly in data collected by scanners
substitution among commodities. Thus, rather than price-takers maybe partly ex-
these Laspeyres measures of inflation are plained by this phenomenon.
inherently upper bounds, and empiri- These types of problems account for
cal studies led the Commission to con- just a little under halt of the 1.1 per-

clude that this source of substitution bias centage points identified by our com-
— failing to catch that consumers substi- mission. Slightly over half results from
tute chicken for beef when beef prices go the difficulty oi Adjusting fully for qual-
up (upper-level substitution bias), or De- ltv change and the introduction of new
licious for Macintosh apples under sim- prodlM Miii^ts have known since

ilar circumstances (lower-level substitu- John Micks (1910) that the introduction oi
tion bias) — leads to an overstatement m a new product should be dealt with in

the U.S. Consumer Price Index ot about oMiving index by using its :

0.4 percentage points. 1

vation price and Including the consumer
194 / 10. DOES THE CONSUMER PRICE INDEX OVERSTATE CHANGES?

surplus attributable to the introduction of common-sense observation, estimated

the product. Noting this, our commission (we believe conservatively) a quality-
took the more cautious approach of pri- change and new-product bias in the CPI
marily including estimates of explicit di- of 0.6 percentage point per year.
mensions of quality change and the very Thus, the total bias is estimated at 1.1
late introduction of major new products percentage points per year, as detailed in
into the index. In the U.S. CPI, VCRs, Table 1.
microwave ovens, and personal comput-
ers were included a decade or more after
they had penetrated the market and their
II. RECOMMENDATIONS
prices had fallen 80 percent or more. Cel- Our commission made a variety of rec-
lular telephones will not be included in ommendations form guideposts for
that
the U.S. CPI until 1998, despite the facts statistical agencies to improve the quality
that there are more than 40 million cel- of their statistics. (Many of the world's
lular subscribers in the United States to- statistical agencies, including the BLS in
day and that well over 100 million Amer- the United States, are planning to make
icans receive calls on phones
land-line progress on at least some of these fronts
initiated on cellular phones. Jerry Haus- already.) These include changing from
man of MIT estimates that the quality- fixed-weight formulas to mathematical
adjusted price of cellular services has formulas that account for consumer sub-
declined by 90 percent since 1989. The stitution in the aggregation of prices
advent of personal communication ser- of goods and services. Also important
vices (PCS) competition and deployment are reweighting the consumption basket
of digital technology will have substan- more frequently and increasing the pace
tially occurred by the time cellular ser- of sampling so that new products enter
vices begin to get priced. Correspond- more quickly and the prices of new prod-
pace of quality change in some
ingly, the ucts, the commodity mix, and the out-
important areas, such as health care and let mix are adjusted more rapidly, and so
consumer electronics, has been breath- that the prices collected are more repre-
taking, and our statistics are not keep- sentative of current market activity. 2 Fi-
ing up. nally, more use should be made of hedo-
When economists try to define the nic statistical methods to adjust for qual-
change in the cost of living it is to ity change.
answer the question "How much more More specifically, the Commission's
income will consumers need to be just first and overarching recommendation is
as well off with the new set of prices as that the BLS should establish a cost-of-
the old?" In addition to the substitution living index as its objective in measur-
issue raised above, this clearly involves ing consumer prices. All of the other spe-
measuring quality-adjusted prices. One cific recommendations are aimed toward
would not want to count a major achieving this goal. In its publications,
improvement in quality that greatly the BLS has explicitly recognized that
enhances well-being as inflation. Hence, the CPI is not a cost-of-living-index for
the Commission examined an exhaustive decades. Still, its most common and per-
set of 27 subcomponents of the CPI, and vasive use and interpretation is as a cost-
based on empirical research findings and of-living index. We believe a more funda-
 .

YES Michael J. Boskin ct al. / 195

Table 1 lection, reorganization of activities, or

Estimates of Biases in the CPI- changes in the detail of the various
Based Measure of the Cost of Living subindexes produced by the CPI. And
(Percentage Points per Annum) third, longer-run recommendations em-
phasize topics in areas that need addi-
Sources of bias Estimate tional research and attention. . .

Upper-level substitution 0.15

Moving to a notion of a new
"basket"
Lower-level substitution 0.25 each year will allow a faster introduction
New products/quality change 0.60 of new items and new outlets. Moving
New outlets 0.10 to a national sample for most such items
Total 1.10 would allow expansion of the number of
(Plausible range) (0.80-1.60) specific items (models, varieties, types)
sampled within a particular ELI and
reduce thereby the number of forced
mentally sound cost-of-living index can substitutions. Also, this would allow
and should be developed. In order to for the use of new sources of data,
achieve this objective, the Commission such as scanner data on prices, and
recommends the publication of two in- industry-wide information on sales of
dexes: one which is published monthly specific items (for more detailed weights),
on a timely basis and is designed to main- leading to a quicker identification of new
tain the spirit of the cost-of-living index goods and their faster incorporation into
yet accommodate the inconsistent tim- the index. This is which
also the level at
ing schedules of the required informa- more extensive quality adjustmentsand
tion; and a second index which is pub- "comparable" substitutions could be
lished and updated annually and revised made, recognizing the appearance of new
historically to introduce improvements outlets and new versions of services
arising from new information and new that provide consumers, effectivelv, with
research results. The purpose of having cheaper sources for the same or similar
two indexes is to accommodate the com- items consumed previously;
plex issues that must be addressed and A number of additional specific explicit
the time delay in obtaining all of the nec- and implicit recommendations are made
essary data. in the report, such as creating a more per-
We divided our recommendations into manent mechanism for bringing outside
three time horizons. First, short-run rec- information, expertise, and research re-
ommendations include those we think sults to the BLS; converting the price of
can be implemented immediately, with durables, such as cars, to I price of an-
little in the way of additional resources nual services analogous to that tor owner-
or new data-collection initiatives. These occupied housing; Changing the treat-
center on changing the current CTI com- ment of insurance to an OK mU
consumer
putation, primarily to make it more price rather than an fit /v hased
and on computing an annually
current, measure; <\nd determining whether col-
updated and subsequently revised cost- lecting more price data Oil weekends and
of-living index. Second, the intermediate- holidays would make a diffefl
run reforms are those that are currently 1 onger-run considerations include ex-
feasible but would require new data col- amining die notifications ol theassuntp-
196 / 10. DOES THE CONSUMER PRICE INDEX OVERSTATE CHANGES?

tions of price equilibrium, developing dependent committee of experts to re-

research programs to look beyond the view progress in this area every few
current "market basket" framework, per- years, and to provide advice on the
haps eventually to be able to publish sup- appropriate interpretation of the then-
plementary information on non-market current statistics. Congress should also
issues. The BLS should also develop a enact legislation necessary for the De-
number of new data-collection initiatives, partment of Commerce and the Depart-
in particular, health status surveys to db- ment of Labor to share information in the
tain more information on various quality- interests of improving the accuracy and
of-life issues. Most importantly, efforts timeliness of economic statistics and to
should be made to gather data on time reduce the resources consumed in their
use from a large sample of consumers in development and production. In particu-
order to deal with search and related is- lar,substantial progress can and should
sues. be made in reducing the time from sur-
Of the 1.1-percentage-point bias in the vey collection to implementation in the
United States we have identified, we be- price program. Other countries appear to
lieve that about 0.4-0.5 percentage points, be able to do this in less than half the time
from the substitution bias, could be dealt that it takes in the United States.
with in relatively short order (a year or
so) by the statistical agencies. Dealing
with quality change and new products
III. CONCLUDING REMARKS
will be harder, but use of the appropriate While the CPI is the best measure cur-
statistical techniques and getting more rently available, it is not a true cost-of-
up-to-date sampling should enable the living index. It suffers from a variety
statistical agencies to get another 0.2-0.3 of conceptual and practical problems as
percentage points over the intermediate the vehicle for measuring changes in the
run of several years (although exactly for BLS up-
cost of living. Despite important
which products, when, is impossible to datesand improvements, it is likely that
say). Even with the widespread use of changes in the CPI have substantially
scanner data, it is likely that there will re- overstated the actual rate of price infla-
main an irreducible minimum of quality- tion. Moreover, revisions have not been
change and new-products bias. But the carried out in a way that can provide
overstatement can be substantially re- an internally consistent series on the cost
duced. of living over an extended span of time.
The Commission made a variety of More importantly, changes in the CPI are
recommendations to Congress, such as likely to continue to overstate the change
providing additional resources necessary in the true cost of living for the foresee-
to expand the Consumer Expenditure able future. This overstatement will have
Survey sample and the detail collected, important unintended consequences, in-
to make the Point-of-Purchase Survey cluding overindexing government out-
(POPS) more frequent, and to acquire lays and tax brackets and increasing the
additional commodity detail from alter- federal deficit and debt. If the intent of
native national sources such as indus- such indexing is to insulate recipients and
try surveys and scanner data. Congress taxpayers from changes in the cost of liv-
should establish a permanent rotating in- ing, use of the CPI substantially overcom-
 YES Michael J. Boskinetal./ 197

pensates (on average) for changes in the cost problem. They should be made first

true cost of living. and foremost in the interest of accuracy,

The and econometric re-
analytical not only for the budget and the programs,
search done over recent decades has but for the economic information upon
heightened economists' understanding which citizens depend.
of these issues. The time has come
for governments in the United States
and elsewhere to recognize these prob-
NOTES
lems and act accordingly. That involves 1. A similar bias occurs in most other countries
(although Statistics Canada has fixed about half
providing enhanced support for the sta-
of this problem, and statistical agencies in other
tistical agencies to improve the price countries are working on it.)
statistics with all deliberate speed in a 2. The United States is ahead of most countries
in its sampling procedures; some others do not yet
nonpoliticized manner. It may well re-
sample.
quire additional resources. Virtually ev-
ery major private firm in the world is

spending heavily on information tech- REFERENCES

nology (hardware, software, and human Boskin, Michael J.; Dulberger, Ellen R.; Gordon,
capital), and we should not expect better Robert J.; Gnliches, Zvi and Jorgenson, Dale W.
Toward a more accurate measure of the cost of living.
statistics from our government agencies
Final Report to the Senate Finance Committee
without a corresponding investment. from the Advisory Commission to Study the
Finally, the President and Congress Consumer Price Index. Washington, DC: Senate
Finance Committee, 1996.
must decide whether they wish to
Boskin, Michael J. and Jorgenson, Dale W. "Im-
continue the widespread overindexing plications of Overstating Inflation for Indexing
of their government programs. If the Government Programs and Understanding Eco-
purpose of the indexing is to compensate nomic Progress." American Economic Review, May
1997 (Papers and Proceedings), 87(2), pp. 89-93.
recipients of the indexed programs or Diewart, Ervvin. "Exact and Superlative Index
taxpayers for changes in the cost of Numbers." Journal of Econometrics, May 1976,
living, no more and no less, they should 4(2), pp. 113-45.
making of index numbers. Boston,
Fisher, Irving. The
move to wholly or partly adjust the MA: Houghton-Mifflin, 1922.
indexing formulas. Such changes will Gordon, Robert J. and Gnliches, Zvi. "Quality
have profound ramifications for our fiscal Change and New Products." American Economic
Review, May 1997 (Papers and Proceedings), 87(2),
futures, but these changes should be
-4-88.
made even if the budget were in surplus rlkks, lohn. "The Valuation of the Social Income."
and there were no long-run entitlement m>mka. May 1940, 7(2), pp. 105-40.
 Dean Baker
NO

THE INFLATED CASE AGAINST THE CPI

There is now the appearance of an expert consensus that the government's

most important measure of inflation, the consumer price index (CPI), seri-
ously overstates the true increase in the cost of living. This sudden enlight-
enment is less the result of new research than political convenience. A cut
in the CPI would reduce government payouts and ease the path to deficit
reduction. Even better, it would do so via a technical adjustment that left few
political fingerprints.
Tax brackets and government benefit programs such as Social Security are
indexed to the CPI. If the CPI overstates inflation by 1 percent, as the Senate
Finance Committee's Boskin panel has proposed, and the index is adjusted
accordingly, this would reduce benefits and the deficit by a cumulative total
of $634 billion over 10 years. Not bad for a technical fix.
Doubtless, the way we measure inflation requires continuous refinement.
The Bureau of Labor Statistics (BLS) takes this task seriously, and has made
myraid small adjustments over the past three decades. For years, there was a
nuanced and relatively obscure debate about how to fine-tune the CPI. Lately,
there has been a politically driven frenzy, as a small group of economists has
— —
labored to uncover and exaggerate all the ways in which the CPI might
overstate inflation. Many claims have been advanced based on very little
real evidence. There has also been virtually no effort to examine the ways in
which the CPI might understate inflation.
The immediate protagonists are the five-member panel appointed by the
Senate Finance Committee, chaired by former Bush economic advisor Michael
Boskin, to make recommendations on revisions in the CPI. Though the group
includes some eminent economists, all had previously testified on the CPI's
supposed bias. All were chosen as known quantities who could be reli-
ably counted upon to recommend a downward revision. Other eminent
economists such as former BLS Commissioner Janet Norwood, who took
the opposite view, were ignored. The panel was appointed in June 1995 and
announced its 1 percent solution in mid-September. It conducted no original
research. Instead, it used rough rules of thumb to reach its conclusions.

From Dean Baker, "The Inflated Case Against the CPI," The American Prospect (Winter 1996),
86-89. Copyright ©
1996 by The American Prospect, P.O. Box 383080, Cambridge, MA 02138.
Reprinted by permission. All rights reserved.

198
 NO Dean Baker/ 199

the switch from a traditional department

THE CASE FOR SHRINKING
store to a discount store as a price decline.
THECPI
Rather, the price differential is treated as
Five factors are usually cited by those offsetting the lower quality of service in
claiming an upward bias in the CPI. the discount store. Clearly this treatment
Each provides some basis for claiming misses a cost saving. Since discount
the index overstates inflation. However, stores have grown rapidly at the expense
the size of any resulting overstatement is of traditional retailers, many consumers
far smaller than what is being claimed, must consider the cheaper price well
and may well be offset by the sources of worth the lower quality service.
understatement in the CPI. However, the importance of this differ-
ence for the CPI has been vastly over-
Substitution Effects. This is the most stated. Only about 15 percent of the
frequently cited source of bias, perhaps index consists of goods that could poten-
because so many reporters learned about tially be sold in discount stores (primarily
it in their introductory economics classes. apparel, appliances, and household fur-
Most goods have close substitutes. If niture). The share of consumers who pa-
oranges are $1.99 a pound, consumers tronize discounters versus full-price re-
switch to apples. The CPI measures tailers simply does not change much from
the prices of a fixed basket of goods year to year. Moreover, even if the true
and services. When the price of some price difference is as much as 10 percent
goods in this basket rises temporarily, (after adjusting for differences in service
thrifty consumers shift to substitutes. By quality), this would lead to a bias of just
holding the basket fixed, the CPI then 0.015 percent a year. This compares to
overstates the true increase in the cost of a figure of 0.2 percent to 0.4 percent of-
living for most consumers. This is a fair ten cited by those claiming a substan-
criticism. tialCPI overstatement of inflation. The
However, most studies that have tried Boskin panel used a figure of 0.2 percent.
to measure the size of this bias find it
to be very small, between 0.1 percent Quality Bias. One of the largest sources
and 0.2 percent annually. (The Boskin of alleged overstatement of inflation is

panel scored it as 0.3 percent.) Moreover, the failure of the consumer price index
one might fairly argue that even a close to fully account for the improvements in
substitution "choice" dictated by a price product quality. Clearly, a $2,000 com-
rise entailsan offsetting loss to quality. puter today is a tar superior machine to
Presuming the substitute to be identical is imputer bought as recently as
like comparing, well, apples and oranges. 1994. Most products are continuously im-
proving in quality. But in fact, the con-
The Wal-Mart Effect. Over the List sumer price index already includes ex-
several decades discount stores have tensive adjustments tor product quality.
displaced many traditional retailers Afl I It may even overstate the improvement
result, consumers purchase many goods in quality m boo
at far lower prices. The CIT doe- example* the price index tor new
its local samples on where consumers cars has increased Approximately 150 per-
actually shop, but the CPI doesnoi : cent trom 1^70 to the present, although
200 / 10. DOES THE CONSUMER PRICE INDEX OVERSTATE CHANGES?

the average price of an actual new car New Products. New goods are typi-
has increased about fourfold. Based on cally not included in the index until sev-
the CPI's price adjustment, it should be appear on the
eral years after they first
possible to purchase a car today for ap- market. During this time, they often un-
proximately 2.5 times what a compara- —
dergo large price reductions which are
ble car cost in 1970. In 1970, a new Volk- not picked up in the index. The inclu-
swagen no
Beetle cost about $2,000. But sion of these price declines would lead
new car on the market today for any-
is to a lower measure of inflation. The clas-
thing close to $5,000, as would be implied sic example of this problem is the hand
by the new car index. The bottom-of-the- calculator. When it first appeared on the
linenew car available today for $9,000 is market it cost over $1,000. Within a cou-
doubtless a significantly better car than a ple of years its price had fallen to under
Volkswagen Beetle, but there are proba- $100. This huge decline in price was not
blymany consumers who would prefer picked up in the CPI.
to purchase a new Beetle at $5,000 rather But wait. Most people don't buy very
than pay more for a better car.
expensive new products. Such products
This is the general problem with the only find mass markets after their price
quality adjustments in the index. Price in- has come down dramatically. (How many
creases attributed to quality adjustments people bought thousand-dollar hand
are not counted as price increases in calculators?)
the index, even though many consumers The CPI is an "expenditure-weighted
might not pay for them if they had the index/' meaning that each dollar of con-
choice. sumer expenditure is weighted equally.
This means that if Donald Trump spends
There are also many areas where qual-
ity has plainly deteriorated. For exam- 1,000 times what the average consumer

ple, many consumers have to spend more

spends, his expenditures count 1,000
times as much as those of the average con-
time fighting with health insurance com-
sumer. Of course, it is the Donald Trumps
panies over the processing of claims than
20 years ago, but this deterioration is not who buy the expensive new products.
picked up in the index. Airline service has However, it is possible to construct the
—
declined less legroom, more changes of index in a different way, which would
planes and missed connections, fewer count each consumer's expenditures
meals, more convoluted fares. Other ex- equally. Under this system 1 percent of
amples include longer waits in traffic and my budget would count the same as 1
time spent waiting on hold or navigat- percent of Donald Trump's budget in
ing voicemail instructions. None of these determining the weighting of a particular
quality deteriorations are recorded in the item. Such an approach is clearly more
CPI. Given the very limited research on appropriate for the purposes the CPI is
quality adjustments in the CPI (the most intended for. There is no reason that
frequently cited work is now twelve years Social Security recipients should get a
out of date), it is impossible to reach any smaller cost of living adjustment because
conclusive judgment about the size, or a few wealthy people experience huge
direction, of quality bias in the present savings on hand calculators. Nor does it
index. make sense that such a bonanza for the
 NO Dean Baker/ 201

wealthy should affect wage contracts that

use the CPI as a point of reference.
A DOWNWARD BIAS?
A "person-weighted" index that count- The possibility that the CPI understates
ed each individual's expenditures equally inflation has received little attention,
would provide a much better gauge of the since it won't help cut the deficit. Indeed,
increase in the cost of living experienced if the CPI errs on the low side, then So-

—
by most of the population and it would cial Security pensioners should be get-
virtually eliminate the problem of new ting bigger checks. Consider three dis-
goods as a source of bias in the index. tinct sources of downward bias:
Here is a case crying out for a genuine
technical adjustment, but one that cuts Health Insurance Costs. The CPI does
in the opposite direction from the Boskin not include most increases in insurance
panel. premiums for individual health insur-
ance, or increases in copayments or de-
Formula Bias. This is the most techni- ductibles on employer-purchased insur-
cal issue (sorry).Suppose the price of a ance. This has been a major drain on
good rises from $1.00 to $1.10. This is a 10 household budgets in recent years, as em-
percent increase in price. Suppose it then ployers have shifted more of the cost of
falls back from $1.10 to $1.00; this is a 9 health insurance back to their employ-
percent decrease in price. If these changes ees. Nor does the CPI include increases
were just added together it would imply in required payments by beneficiaries of
a 1 percent increase in price even though government programs such as the pro-
the price had not changed at all. BLS was posed increases in the Medicare Part B
never so foolish as to construct the CPI in premium. This exclusion would lead to
such a way that it would be generally sub- an enormous understatement in the cost
ject to this [Link] there are other such of living of an elderly household. Even
technical problems. BLS has researched under the Clinton Medicare proposal, the
this issue extensively, and uncovered and premium is scheduled to rise by approxi-
corrected several such areas. It is possible mately $500 per beneficiary over the next
that problems of this sort may still exist seven years. This increase will consume
in places, but the impact is likely to be ex- nearly 5 percent of the annual income
tremely small, almost certainly less than of a couple with an income of $20,000,
0.1 percent annually. the midpoint of the income distribution
Let's give the critics the benefit of the for families over 65. Under the Gingrich
doubt. Adding all of these possible biases proposal, the total increased costs to con-
together, a plausible estimate of inflation sumers would be substantially higher.
overstatement in the CPI would be 0.4 Today's basket of health services is in
—
percent not the one full percentage many respects superior to mat of, say, two
point estimated by the Boskin panel. But decades ago — thanks to new technolo-
this is a gross adjustment, not a net and litesavmg procedures.
gies, drugs,
one: It revises only those elements of the It's under managed care,
also true that
CPI that apparently overstate inflation. many doctors aa> more harried and pa-
To be accurate, one needs to offset this tients are often rushed out of hospitals.
adjustment with factors that suggest the Some ot the higher COS! Oi today's health
CPI may be too low. Sects not betfc but dead-
202 / 10. DOES THE CONSUMER PRICE INDEX OVERSTATE CHANGES?

weight losses —the cost of claims process- derstanding the true increase in the cost
ing, risk selection, mergers, and acquisi- of living.
[Link] on health care has quin-
tupled in three decades, but it's not at all Quality of Life Factors. Many factors
clear that the quality has. It would take that affect the quality of life are not
a great deal more research to determine picked up CPI. An obvious
in the
how to net out the improvements and example is crime. people have to spend
If

degradations to quality, and then weigh more money in order to live in a safe
them against the unambiguously higher —
neighborhood say on security alarms
cost. — it is not captured by the CPI. Nor

is a deterioration in the quality of

Personal Business Expenditures. This public schools and therefore an increased
category of expenditures, which includes need for spending on private schools
items such as lawyers' and brokerage or personal tutors. Nor is the cost of
fees, has been rising at the rate of 0.2 per- joining a private exercise club because
cent a year for the past 20 years as a share the local public facility has closed or
of disposable income. This is a category become unsafe. Many of these issues
of spending that may not provide direct are quite complex and cannot be easily
benefits to consumers but rather is often quantified in any meaningful way, but
a cost of maintaining a standard of living this doesn't make them any less real.
threatened by deteriorating external cir- Anyone attempting to make conclusive
cumstances. Suppose, for example, that statements about changes in the "true"
I have to hire a lawyer in order to re- cost of living must be prepared to address
solve a dispute with my health insurance such issues.
company, because health insurers are be- Given the very limited amount of re-
coming more aggressive. Compared to a search on the biases in the CPI, im- it is

situation where the insurance company possible at this point to reach any con-
deals with me honorably, this is a need- clusive judgment about the magnitude or
less expense. I am worse off in direct pro- direction of the overall bias in the index.
portion to the amount of money that I While the claim that "the CPI overstates
have to spend on my lawyer, regardless inflation" has become a virtual mantra of
of the quantity of quality of legal services the Washington punditry, honest propo-
provided. nents of this view acknowledge that it is
Similarly, if I have to rely on a private based on very little evidence. The best
financial counselor to ensure a secure re- solution would be to provide the pro-
tirement, instead of receiving a company fessional statisticians at BLS with the re-
pension, I am worse off in direct pro- sources they need to improve the CPI.
portion to the amount of money I must This is clearly preferable to bending eco-
pay the counselor, not the fee per finan- nomic statistics in whatever direction is
cial transaction. Likewise the cost of di- politically expedient.
vorce lawyers and security consultants.
Since the CPI only measures the change
UNEXPECTED TWISTS
in the price of these services, rather than
the change in the overall need for the ser- One striking thing about this whole
vices or genuine benefit derived, it is un- debate is that conservatives try to have
 NO Dean Baker/ 203

the argument both ways. Supposedly, a just $11,215 measured in 1995 dollars.
lower CPI would cut the deficit; and In 1960, today's 70-year-olds were 35. It

cutting the deficit would stop us from is hard to justify taking Social Security
"robbing our grandchildren." But if the benefits from these people in order to
Boskin panel is right and the CPI is make the 35-year-olds of 2030 better off.
overstated by 1 percent per year, then real In addition, the critics have ignored
median wages are rising at 2 percent per the implications of a significant CPI re-
year. This means that they will double vision for monetary policy and growth.
in approximately 35 years, so that the Alan Greenspan, chairman of the Federal
average real wage will be approximately Reserve, has testified that the CPI over-
$50,000 a year (in 1995 dollars) in the year states inflation by as much as 1.5 percent.
2030. If so, our grandchildren will do just But if the official inflation rate is low-
fine and there's no need to slash the Social ered, undermines the entire rationale of
it

Security of their grandparents. Greenspan's tight money policy. So politi-

As overstated CPI also means that cizing the CPI leads to some unexpected
people had been much poorer in the implications. It would be far better to re-
recent past than we realized. If the CPI turn the question of CPI revision to intel-
was overstated by 1.5 percent in the past, lectually honest technicians, where it be-
as suggested by the Boskin Commission, longs, and to argue deficit reduction on
then the average annual wage in 1960 was its merits.
POSTSCRIPT
Does the Consumer Price Index
Overstate Changes in the Cost of Living?

The Boskin Commission states, firstly, that because of certain biases, changes
in the CPI overstate changes in the cost of living by approximately 1.1 percent.
The commission contends that this overstatement has created a number of
other problems: the national debt is higher, estimates of economic growth are
lower, and the official count of the number of poor persons is higher. The com-
mission identifies four biases. The first is upper-level substitution bias. This
bias arises because the CPI does not allow for the tendency of consumers to
switch from products that have increased in price to similar commodities that
have not, such as switches from beef to pork when beef prices increase. The
—
second is lower-level substitution bias the tendency of consumers to switch
from steak to hamburgers when the price of steak increases. The third is new
products /quality change bias; that is, the CPI does not sufficiently discrimi-
nate between an increase in the price of a product whose quality has increased
and an increase in the price of a product whose quality is unchanged. The
fourth is outlet bias. This is a reflection of a fundamental change in retail-
ing with the growth of superstores and discount outlets that has taken place
since the 1982-84 period. The CPI fails to capture this change in consumer
shopping patterns. The Boskin Commission also makes a number of recom-
mendations that it believes will lead to more accurate estimates of changes
in the cost of living. These include the introduction of a new market basket
every year, new data collection methods, and new research initiatives.
Baker begins with a charge of bias against the Boskin Commission itself:
it was composed of individuals whose views on the upward bias of the CPI

were well known; it did not conduct any new research; and it released its
findings in less than four months. With respect to the specific findings of the
Boskin Commission, Baker estimates that the upward bias of the CPI is prob-
ably closer to 0.4 percent rather than 1.1 percent. He then considers the notion
that the CPI understates changes in the cost of living. Baker believes there are
three sources of understatement. One source involves health insurance costs
—the CPI does not include most increases in health insurance premiums paid
by individuals or increases in copayments and deductibles associated with
employer-provided health insurance. A second source is personal business
expenditures. Lawyer and brokerage fees have been rising, and these expen-
ditures may not provide direct benefits to consumers. Baker claims that it
would be more appropriate to consider these increasing fees as an increasing
cost of maintaining a given standard of living. The third source of downward
bias involves quality of life factors. Baker offers several examples of quality

204
of life by the use of the CPI as a measure of the cost of living;
factors ignored
one example spending by consumers to protect themselves from crime.
is

Combining a lower estimate of upward bias and the possibility of downward

bias, he concludes that it is impossible to pinpoint the direction, let alone the
magnitude of the overall bias in the CPI.
—
Additional readings on this issue include "The Overstated CPI Can It Re-
ally Be True?" by Dean Baker, Challenge (September/October 1996); "Presto
Change-O! On the Consumer Price Index," by Audrey Freedman, Challenge
(March/April 1996); "The Downside of Bad Data," by Everett Ehrlich, Chal-
lenge (March/April 1997); "How Right Is the Boskin Commission — Interview
With Janet Norwood," Challenge (March/April 1997); "Quality Changes in
the CPI: Some Missing Links," by Charles Hulten, Challenge (March/April
1997); "The Boskin Commission's Trillion Dollar Fantasy," by Wynne Godley
and George McCarthy, Challenge (May /June 1997); and "Bias in the Consumer
Price Index: What Is the Evidence?" by Brent R. Moulton, Journal of Economic
Perspectives (Fall 1996). For additional perspectives from the members of the
Boskin Commission, see "Quality Change and New Products," by Robert J.
Gordon and Zvi Griliches, American Economic Revieiv (May 1997) and "Im-
plications for Overstating Inflation for Indexing Government Programs and
Understanding Economic Progress," by Michael J. Boskin and Dale W. Jor-
genson, American Economic Review (May 1997). For an interesting discussion
regarding the actual collection of price data for CPI computations, see "Is the
CPI Accurate? Ask the Sleuths Who Get the Numbers," by Christina Duff,
Wall Street Journal (January 16, 1997). For a discussion of the planned revision
in the CPI, see "Overview of the 1998 Revision of the Consumer Price Index,"
by John S. Greenlees and Charles C. Mason, Monthly Labor Review (December
1996).
ISSUE 11
IsThere a Need for a Constitutional
Amendment to Balance the Budget?
YES: Martin A. Regalia, from "Should the Senate Pass a Balanced Budget
Amendment to the U.S. Constitution? Pro/'
Congressional Digest (March 1997)

NO: Robert Rubin, from "Should the Senate Pass a Balanced Budget Amend-
ment to the U.S. Constitution? Con," Congressional Digest (March 1997)

ISSUE SUMMARY
YES: Martin A. Regalia, chief economist for the U.S. Chamber of Commerce,
argues in favor of a constitutional amendment to balance the budget for three
reasons: a balanced budget would have favorable economic effects; such an
amendment is appropriate for the Constitution; and the amendment would
not needlessly involve the court system in its enforcement.
NO: Robert Rubin, secretary of the treasury in the Clinton administration,
believes that an amendment to the Constitution is not an appropriate mech-
anism for the achievement of this goal because it would effectively eliminate
the ability of the government to respond to economic problems as they arise.

The Full Employment and Balanced Growth Act of 1978 lists a number of
economic goals for the federal government. Besides the familiar objectives
of full employment, price stability, and increased real income, the act specif-
ically mentions the goal of a balanced federal budget. This means that the
government is to collect in taxes an amount equal to its expenditures. Despite
this legislative call to action, the federal government has failed to balance its
budget, and recent deficits, at least in terms of dollar size, have been of record
proportions. For example, between the years 1940 and 1975, there were only
two instances when the deficit was in excess of $50 billion. For the years 1980
through 1990 the deficit averaged about $140 billion. In spite of legislative
reduce budget deficits, the deficit reached a level of $290 billion
efforts to
in 1992. Although declining since then, deficits are projected to continue at
least through fiscal Economic Report of the President 1997, the
year 2002. In its

Clinton administration projects deficits of at least $100 billion through fiscal

year 1999.
When the federal government runs a deficit it sells securities treasury —
bills, notes, and bonds. In this respect the government is just like a business

firm that sells securities to raise funds, and the public debt increases by the
amount of the deficit. The public or national debt represents the total value of

206
outstanding government securities. Accordingly, the public debt at any point
in time is a summary of all prior deficits (offset by the retirement of securities
if the government chooses to repurchase its securities when it has a budget

surplus). By September 1996 the gross federal debt was approximately $5.2
trillion. The debt is owned by (that is, the government securities have been

purchased by) different groups, including individuals, commercial banks,

pension funds, life insurance companies, federal government agencies, state
and local governments, and corporations. Some securities are also sold to
foreign individuals, businesses, and governments.
Following the elections in November 1996, there seemed to be general
agreement that the government needed to balance the budget by the year
2002. Within this consensus, there were two areas of disagreement between
the Democratic Clinton administration and the Republican Congress. One in-
volved the various changes in spending and taxes that would be necessary to
achieve the goal. The second was whether or not a constitutional amendment
was necessary to ensure the attainment of the goal and to eliminate future
deficit problems.
The balanced budget constitutional amendment considered by the 105th
Congress would have required Congress to balance the budget by the year
2002 or two years after ratification (whichever is later) and every year there-
after. A three-fifths vote of both the House and the Senate could rescind the
requirement. A waiver would also apply in times of military engagement. To
become part of the Constitution a proposal must be approved by a two-thirds
vote of both the House and the Senate and then ratified by three-fourths of
the states. The whole process came to a grinding halt, at least for 1997, when
the amendment failed by a single vote to secure the necessary two-thirds
majority in the Senate.
As just stated, theproposed amendment was not approved by the Senate
in 1997. What was agreed to by the Congress and the president in 1997 was
a series of spending and tax changes, which, if everything works according
to plan, will lead to a balanced budget by 2002. But without a constitutional
amendment, this agreement could easily unravel. For this reason there is no
doubt that there will be future efforts to pass a balanced budget constitutional
amendment. So we can expect still another debate on this issue with the
arguments following the basic points raised by Regalia and Rubin.

207
 Martin A. Regalia
YES

SHOULD THE SENATE PASS A BALANCED

BUDGET AMENDMENT TO THE
U.S. CONSTITUTION? PRO
The [U.S.] Chamber [of Commerce] strongly supports a balanced budget
amendment to the Constitution. Our members and their employees have . . .

long felt mismanagement. Large, persistent Fed-

the effects of Federal fiscal
eral deficits reduce saving and investment, stymie income and job growth,
and reduce our standard of living. They ultimately lead to increased taxes,
bigger government, and higher interest rates, all of which reduce the global
competitiveness of U.S. firms.
The balanced budget amendment would prohibit Federal outlays from ex-
ceeding revenues, unless Congress approved a deficit by a three-fifths vote
of both the Senate and House. The amendment would require the same
three-fifths vote to increase the Federal debt limit and would require a "con-
stitutional majority" —51 votes in the Senate and 218 in the House—to raise
Federal taxes.
The Chamber is convinced that the balanced budget amendment will place
renewed emphasis on fiscal discipline, forcing Congress to slow government
spending while constraining its ability to raise taxes. In restoring the proper
balance between spending and taxes, the balanced budget amendment also
would force government officials to prioritize difficult spending choices.
The balanced budget amendment has been challenged on various grounds,
including its economic effects, its appropriateness for the Constitution, and
the contention that it would needlessly involve the court system in its en-
forcement. I would like to address each of these issues, and share with the
committee the conclusions reached by the Chamber.
Critics of the balanced budget amendment contend that the negative effects
of deficits are overblown, that deficits really do not matter. Others admit
to some of the negative effects, but point to recent "improvements" in the
claiming that we have adequately addressed the problem. Still others
deficit,
acknowledge the serious long-term ramifications of deficits, but claim that
correcting this situation carries too high a social and political price.

From Martin A. Regalia, "Should the Senate Pass a Balanced Budget Amendment to the
U.S. Constitution? Pro," in "Reducing the Deficit: The Ongoing Balanced Budget Debate/'
Congressional Digest, vol. 76, no. 3 (March 1997). Copyright © 1997 by The Congressional Digest
Corporation, Washington, DC, (202)333-7332. Reprinted by permission.

208
 YES Martin A. Regalia / 209

Chronic government deficits, and the in 1996. As a share of total government

resulting accumulation of government payments on the debt
outlays, interest
debt, reduce the level of savings and have more than doubled, from about 7
investment, lower productivity growth, percent during the early 1970s to over
raise the specter of inflation, put upward 15 percent currently. That means that for
pressure on interest rates, encourage the same amount of revenue there is less
trade deficits, and lower our standard of money for other government programs,
living. whether for national defense, our court
Since the 1960s, we have
seen the system, Head Start, or environmental
net national savings fall from about 10 clean-up. No matter what the budget
percent of GDP [Gross Domestic Product] priorities are, fewer funds are available.
to consistently below 4 percent —
too low
Large persistent deficits and the accu-
to support the investment required for
mulation of debt can also have severe
high productivity growth. Because long-
consequences for future generations. To
term productivity growth is the key to
the extent that government debt is held
rising standards of living, skimping on
investment dangerous.
—
by foreigners currently about 15 per-
First,
is

chronic government borrowing

—
cent there will be a net transfer from
these future generations to foreign bond
tends to put upward pressure on interest
holders to service or retire the debt.
rates. Businesses seeking to raise capital
Even more important, shifting funds
and households applying for mortgages
from current private savings and invest-
have to compete with the Federal Gov-
ment to current government consump-
ernment in securing loanable funds. This
tion via government deficits can leave
increase in demand pushes interest rates
future generations with inadequate in-
up. Consequently, fewer loans are made
vestment, sluggish productivity growth,
to the private sector, and those that are
poor wage growth, and lower living stan-
made carry a higher interest rate. This is
dards.
known as "crowding out," since govern-
ment borrowing displaces some private Some critics charge that these nega-
borrowing. tive effects of government are largely
Second, because our economy is in- overblown and that much government
creasingly linked to the global market, spending is really investment. Some gov-
there are important international impacts ernment spending can be regarded as "in-
related to the budget deficit. Higher inter- vestment spending," meaning that funds
est rates tend to precipitate an overvalued spent now will generate stronger eco-
dollar, meaning that our goods and ser- nomic growth later. Spending on infra-
vices cost more our trading partners.
to structure — highways, bridges, dams, and
This lowers our exports and pushes up mass transit, example— and other
tor
our trade deficit. Many contend that one programs such as education are often
of the major forces behind the huge trade thought of that way because they provide
deficits of the 1980s was the Federal bud- benefits OVW I longer period or time.
But
get deficit. the bulk ot government spending goes to
Third, the amount we are paying to projects ,md programs that instead repre-
service our national debt has grown since sent "current consumption." While many
1969— from $43 billion to $240 billion ot the>e programs are desirable, we need
210 / 11. IS THERE A NEED FOR AN AMENDMENT TO BALANCE THE BUDGET?

to recognize that we should pay for them been able to agree on a statutory plan to
out of current income. balance the budget.
Many critics of the balanced budget Some commentators have argued that
amendment will acknowledge the prob- a balanced budget requirement is a mere
lem but claim that such a "drastic" so- rule of accounting, incompatible with the
lution is unnecessary. They point to the broad principles in the Constitution. It
1993 OBRA [Omnibus Budget Reconcili- is worth noting that the Constitution al-

ation Act] legislation and recent deficit re- ready contains several narrowly focused
duction as evidence that we have solved economic and fiscal provisions, includ-
the problem. Unfortunately, this is an ex- ing the Article I, Section 9 requirement
treme form of denial. We need only look of "a regular statement and account of
to history and current CBO [Congres- the receipts and expenditures of all pub-
sional Budget Office] projections to see lic money" and the Article I, Section 8
the fallacy in this argument. requirement that "duties, imports and ex-
Until about 1960 or so, running a bal- cises . [be] uniform throughout the
. .

anced budget over time was an "unwrit- United States."

ten" constitutional amendment. The U.S. Moreover, the balanced budget amend-
government ran deficits during the War ment embodies two principal themes
of 1812, the severe recession of 1837-43, of the Constitution: limitationon Fed-
the Civil War, and the Spanish- American eralpower, and protection of politically
War, to name a few episodes. But in other under-represented groups against ma-
periods, the Federal Government ran sur- joritarian abuse. Thomas Jefferson, who
pluses to reduce outstanding debt.
its perceived the inherent expansionist ten-
On the whole, only emergencies justified dency of central government, supported
running a deficit. a constitutional prohibition of Federal
But since 1960, this informal rule borrowing as a means of protecting in-
apparently has gone by the wayside. In dividual liberty.
the past 36 years, the United States has As I noted earlier, our Federal Gov-
avoided a deficit only once, when in ernment embraced the practice of hold-
1969 there was a surplus of $3 billion. ing government spending in check to
Given the chronic deficits we have grown avoid deficits, except during war or re-
to expect, it is make explicit
time to cession. In recent times, the erosion of
through a constitutional amendment the this principle has created persistent struc-
old implicit principle of government tural deficits, removed the need to limit
living within its means. and prioritize programs, and led to an
While true that a combination of
it is excessively large Federal sector. The bal-
factors has lowered the current deficit, anced budget amendment requirement
the impact is likely to be transitory. The that Federal operations be funded from
Congressional Budget Office estimates current revenues restores an important
that after bottoming out in 1966, the principle of fiscal responsibility and lim-
deficit will begin to rise once again both itedgovernment.
in absolute terms and as a percentage of Statutory attempts to impose fiscal dis-

GDP. What is even more discouraging is cipline upon the Federal Government
that despite all the rhetoric, neither the have failed, largely because Congress
Congress nor the Administration have was able to change the rules in mid-game.
 YES Martin A. Regalia / 211

The ambitious deficit-reduction targets of role for the courts in maintaining the in-
the 1985 Gramm-Rudman-Hollings law tegrity of the balanced budget require-
were repeatedly modified when they con- ment.
flicted with Congress's spending ambi-
In general, the courts have shown an
tions. Likewise, big-ticket items such as
unwillingness to interject themselves into
unemployment compensation payments the fray of budgetary [Link] New
and disaster relief are customarily desig- Supreme Court observed that "it
Jersey
nated as "emergency" spending, which which the judiciary
is a rare case. . . in
exempts them from spending caps. Be- has any proper constitutional role in
tween 1980 and 1990, each year's actual making budget allocation decisions." The
spending exceeded the targets of that judiciary has remained clear of most
year's budget resolution by an average
budget controversies.
of $30 billion (the excess was S85 billion
in 1990).
A strong framework of accounting
Each statutory response to the deficit
guidelines will emerge from implement-

has shown the same vulnerability: hard-

ing legislation. Supporters in both the

won budget rules can be waived or

House and Senate have indicated their in-
tention that implementing legislation em-
modified by a simply majority vote. Xot
surprisingly, a majority can usually be
brace stringent accounting standards that
will minimize the potential for litigation.
assembled to support more spending.
The key advantage of a constitutional Should legitimate questions arise con-
amendment is that tough budgetary rules cerning the methods by which Congress
balances the budget, these standards will
can be placed beyond the reach of simple
also provide objective criteria which meet
congressional majorities.
constitutional standards for judicial inter-
Some lawmakers and commentators
vention.
have raised questions about the enforce-
ment of a balanced budget amendment. A The implementing package is also
primary concern is that congressional ef- likely to establish guidelines for judicial
forts to meet the balanced budget require- involvement, defining those issues ap-
ment would be challenged in the courts, propriate for litigationand which par-
and the judiciary would be thrust into a tieshave standing to litigate them. State
nonjudicial role of weighing policy de- budget officers, for example, could be
mands, slashing programs, and increas- given standing to contest unfunded Fed-
ing taxes. eral mandates. These enforcement pro-
On the other hand, there is a legiti- cedures, coupled with budget process
mate and necessary role for the courts and accounting guidelines, will oper-
in ensuringcompliance with the amend- ate against a backdrop of traditional
ment. Congress could potentially circum- legal principles to rationally limit judi-
vent balanced budget amendment re- cial action. The effect should be to pre-
quirements through unrealistic revenue vent judicial over-reaching into legisla-
estimates, emergency designation- tive functions, while providing a check
budget accounts, unfunded mandates, on congressional attempts to evade the
and other gimmickry. It is our view that requirements of the balanced budget
the need to proscribe judicial policymak- amendment through procedural and nu-
ing can be reconciled with a constructive ll gimmu
212 / 11. IS THERE A NEED FOR AN AMENDMENT TO BALANCE THE BUDGET?

For most of our Nation's history, the critical principle of fiscal responsibility
growth of the Federal Government was and limited government. It will help
held in check by an implicit policy return this country to sound economic
against deficits, except during war or principles and provide for our continued
recession. In recent times, the erosion growth and prosperity.
of this principle has created persistent Finally, I would like to emphasize
structural deficits, removed the need to the Congress's role in this procedure.
limit and prioritize programs, and led Congress is not being asked to enact a
to an excessively large Federal sector. balanced budget amendment it cannot. —
Our Federal borrowing has created What we are asking is that the Congress
economic distortions that will result allow the American people the opportu-
in less investment, lower productivity, nity to adopt this provision. If sufficient
and a lower standard of living for States refuse to ratify it, the amendment
all Americans. The balanced budget will, and should, but the American
die,
requirement that Federal operations be people should be given the chance to
funded from current revenues restores a vote.
NO Robert Rubin

SHOULD THE SENATE PASS A BALANCED

BUDGET AMENDMENT TO THE
U.S. CONSTITUTION? CON

I spent 26 years on Wall Street before joining the Administration four years
ago, and I have a deep and abiding belief in the profound importance of fiscal

responsibility to our national economy. I have an equally strong conviction

that a balanced budget amendment is a threat to our economic health, will
expose our economy to unacceptable risks, and should not be adopted. I
also believe that such an amendment is not necessary to achieve the critical
objective of balancing our budget.
Throughout our history, with the exception of wartime, budget deficits
— —
when they existed at all were generally small. In the 1970s and 1980s,
they began to rise and the Federal debt grew sharply. But after experiencing
this period of fiscal indiscipline, I believe the atmosphere in Washington has
changed.
This process of change began in 1990 with the passage of the Omnibus
Budget Reconciliation Act signed into law by President Bush. We then took
an enormous step forward with the deficit reduction program enacted in 1993,
which has led to a reduction in the size of the deficit from 4.7 percent to 1.4
percent of GDP [Gross Domestic Product]. Last year, both the Administration
and the Congress proposed budgets that would eliminate the deficit by 2002,
and both are expected to do so again this year.
Not only has the atmosphere in Washington changed, but there is also a
new enforcing factor at work, which is the emergence of global markets that
are highly sensitive to a nation's degree of fiscal responsibility. A nation that
does not address fiscal matters will be severely punished by markets with
high interest rates that could impair or even severely impair its economy.
The sum total is that politically, historically, and economically, the forces
are in place to balance the budget. Now we need to get the job done.
However, there is a distinction between balancing the budget and passing
amendment. When we contemplate an action as significant
a constitutional
as amending the Constitution to require a balanced budget *W owe it to

From Robert Rubin, "Should the Senate Paai i Balanced Budget Amendment to the U.S.
Constitution? Con," in "Reducing the Deficit 1! Budget IV
Congressional Digest, vol. 76, no 3 (March 1997) Cop)
Corporation, Washington, DC printed bv pfimlMlOU

213
214 / 11. IS THERE A NEED FOR AN AMENDMENT TO BALANCE THE BUDGET?

the American people to understand ex- ticipate, and congressional action would
actly what its consequences would be. almost surely be, at the very least, months
And those consequences are serious. I late, by which time critical damage to the
believe the balanced budget amendment economy would already have been done.
proposal would subject the Nation to un- A balanced budget amendment would
acceptable economic risks in perpetuity. also prevent us from dealing quickly and
As Secretary of the Treasury I am effectively with crises, from a second
deeply concerned that a balanced budget S&L [savings and loan] crisis to a second
amendment could turn slowdowns into Hurricane Hugo to an escalating military
recessions, mild recessions into worse threat.
ones, and bad recessions into depres- For example, in September 1989, Hur-
sions. A balanced budget requirement in ricane Hugo struck the Carolinas, caus-
would make recessions
the Constitution ing billions of dollars of damage. After
longer and more painful, first by elim- President Bush declared a major disaster,
inating automatic stabilizers that pro- Congress took action by appropriating
tect people during a downturn and, sec- $2.7 billion in emergency supplemental
ond, by instead requiring measures to cut assistance to help the area rebuild. Under
spending or increase taxes during slow- the balanced budget amendment, if the
downs and recessions when the economy budget were otherwise in balance, this
is already suffering from lack of demand. could not be done until after a vote of
Since World War II, we have made im- 60 percent of both houses.
mense progress in reducing the toll of As Secretary of the Treasury, I am
the boom and bust cycle through the in- also highly concerned that limits on
troduction of automatic fiscal stabilizers our flexibility would increase the risk
and effective use of counter-cyclical fiscal of default on the Federal debt. The
policy Under current law, for example, if possibility of default should never be
unemployment rises, unemployment in- on the table. Our creditworthiness is an
surance payments rise as well, moderat- invaluable national asset that should not
ing the economic impact of recessions on be subject to question.
companies, workers, and their families. Default on payment of our debt would
The extremes of the business cycle undermine our credibility with respect
have declined sharply over the post- to meeting financial commitments, and
war period compared with the pre-era. that in turn would have adverse effects
A balanced budget amendment would for decades to come, especially when
undo this progress by turning off these our reputation most important, that
is

stabilizers and actually require measures is, when the national economy is not

that could exacerbate a recession. healthy. Moreover, a failure to pay

To take just one example, without auto- interest on our debt could raise the cost of
matic stabilizers, Treasury has estimated borrowing not only for government, but
that unemployment in 1992 might have for private borrowers, from companies
hit 9 percent instead of 7.7 percent, in ex- to homeowners making payments on an
cess of one million more jobs lost. Even adjustable mortgage.
were a three-fifths vote to waive the It isalso worth remembering that
provisions of an amendment obtainable, interest payments are only one type of
slowdowns and recessions are hard to an- obligation. If we are not able to meet
 NO Robert Rubin/ 215

our obligations, members of our armed be budget-related or related to social pol-

forces, retirees receiving Social Security, icy or any other matter —
was satisfied.
those who depend on Medicare, and Let me add that a balanced budget
many others could suffer as well. The risk amendment would also limit our abil-
of this happening must not be increased. ity to deal with national economic down-
turns in which only some regions were
The history of debt limit shows that
suffering, because most Members would
raising the statutory debt limit is never
not be experiencing the economic prob-
an easy process. We all remember the
lems, making a 60 percent waiver more
enormous difficulties that surrounded
difficult to obtain. We cannot predict the
this issue in 1995 and 1996. A requirement
political environment 10, 20, or 30 years
for a supermajority vote in both houses
from today, and we should not create
could make it far harder. Proponents
enormous minority leverage in the face
argue that the constitutional amendment
of uncertainty about future political con-
is needed to stiffen our resolve to balance
ditions.
the budget. But they also assume that,
when necessary, Congress will waive
A balanced budget amendment may
well be unenforceable. There is no way
its provisions by obtaining a three-fifths
to compel Congress and the President
majority vote.
spending or
to enact legislation to cut
It is true that 60 votes are usually re- raise taxes to balance the budget. Yet
quired for cloture in the Senate. Even there is also no way to compel enactment
more fundamentally, the Senate has long of legislation to waive provisions of the
honored the rights of a minority to ex- amendment. It is not hard to imagine a
press its views and influence legislation. which a two-fifths minority
situation in
Nevertheless, recognizing that certain es- of Congress opposes tax increases, a
sential matters should not be held up by a different minority opposes
two-fifths
minority, Senate rules permit a reconcilia- spending cuts, and another two-fifths
tion bill which can be a vehicle for passing opposes a waiver of the balanced budget
a budget or increasing the debt limit, to be amendment to raise the debt limit. The
passed by a simply majority. In contrast, amendment provides no method for
this amendment would require a three- resolving such an impasse.
fifthsmajority to increase the debt limit Some proponents have suggested that,
or obtain a waiver from its provisions and under these circumstances, the Presi-
would extend this supermajority require- dent would stop issuing checks, includ-
ment to such votes in the House. Thus, ing those for Social Security benefits. Al-
for example, 41 senators or 175 congress- ternatively, judges might become deeply
men could throw the government into involved in determining whether S
default; 41 senators could stop Social Se- Security or Medicare checks would be
curity checks from going out or could ad- stopped. The President might also im-
vance a special agenda. In effect, a minor- pound funds of his choosing. Or, the
ity in either house could put the economic amendment might just prove to be unen-
health of our Nation at risk by refusing to forceable and therefore a nullity, reducing
waive the balanced budget requirement reaped f6l the Constitution. All of these
or refusing to increase the debt limit un- potential outcomes are extremely unde-
less that minority's agenda— which could >le.
216 / 11. IS THERE A NEED FOR AN AMENDMENT TO BALANCE THE BUDGET?

Let me mention, finally, two other cuts can be made quickly, regardless of
problems. First, by requiring that a the consequences.
majority of the whole Congress approve These are just two examples of why it
a revenue increase, the amendment would be a mistake to enshrine economic
could make it more difficult to close policy in the Constitution. We have no
special interest loopholes and eliminate idea what economic conditions will be
obsolescent deductions and credits. Over like in 10, 20, 30, or 40 years, and creating
time, this would reduce the fairness and policy inflexibility is extremely unwise.
efficacy of our tax code. As I said at the beginning of my
Second, unforeseen events could lead testimony, I have a deep commitment
to a large end-of-the-year shortfall that to the importance of deficit reduction
could only be met in a very short period and fiscal discipline to our Nation's
of time. Such shortfalls happen in many economic health, and I believe that
years. In Fiscal Year 1990, for example, we can put in place balanced budget
CBO [Congressional Budget Office] re- legislation this year. But I have an equally
estimated the deficit upward by $60 strong conviction that a balanced budget
billion in the last nine months of the fiscal amendment poses real dangers for our
year. In such a case, huge cuts would be Nation's economic future and, for this
needed in those programs that happen to reason, must not be adopted.
have payments late in the year, or where
POSTSCRIPT
IsThere a Need for a Constitutional
Amendment to Balance the Budget?
Regalia structures his argument for a constitutional amendment to balance
the budget around three themes. The theme is that chronic budget deficits
first

create macroeconomic problems that can lead to lower living standards. The
second theme is the appropriateness of the amendment for the Constitution.
Regalia believes that the amendment is appropriate because it is consistent
with two constitutional themes: limiting the power of the federal government
and the protection of political minorities from abuse by the political majority.
The third theme is the extent to which the courts would become involved in
budget issues that are the responsibility of the Congress. On this point, Regalia
argues that the implementing legislation that would be passed subsequent to
the ratification of the amendment would "prevent judicial overreaching into
legislative functions."
Rubin supports the goal of a balanced budget and asserts that historical,
political, and economic forces that are now in place will lead to the attainment
of this objective. Consequently, an amendment is unnecessary. But Rubin's
opposition is more fundamental; the amendment is bad economics. In this
regard he makes several points. First, such an amendment is likely to increase
rather than decrease macroeconomic instability by eliminating automatic
stabilizers. Second, it would impede the ability of the government to respond
quickly and effectively to unexpected problems. Third, it may increase default
risk on government securities. Fourth, it might be very difficult to enforce.
Fifth, it might lead to actions that would reduce the fairness and efficacy
of the tax code. Finally, events affecting the budget can occur quickly and,
therefore, rapid response might be necessary regardless of consequences.
Although there seems to be a political consensus regarding the desirability
of a balanced budget, it remains a contentious issue among economists. Useful

information is presented in an annual series entitled The Guide to the Federal

Budget by Stanley E. Collender (The Urban Institute Press). For more Specific
discussion on the need for a constitutional amendment to balance the budget
see "The BBA: A Spent Idea," by Robert -'isner. The Nation February 24, 1997);
I I

"Balancing Act," by Stephen Moore. National 10, 1997);

and "The Balanced Budget Trap" by Karen M. Padget, 7 ;

(November/ December 1996). lor additional statements tor .md against the
amendment, see G March 1997), 1
tiption Oi the
1997 legislative plan to balance the budget til I OOOIfl 0\er Budget
Plan's Detail" by Christopher Georges, Wall \ lay 27, 1

217
ISSUE 12
Is the Federal Reserve the Cause of Poor
Macroeconomic Performance?
YES: Lester Thurow, from "The Crusade That's Killing Prosperity/' The Amer-
ican Prospect (March/April 1996)

NO: Matthew Miller, from "Grow Up/' The New Republic (May 13, 1996)

ISSUE SUMMARY
YES: Lester Thurow, an economics professor at Massachusetts Institute of
Technology, believes that two major macroeconomic problems, a disguised
high rate of unemployment and stagnating living standards, are due to Fed-
eral Reserve policies to limit economic growth to 2.5 percent or less per year.

NO: Matthew Miller, senior editor for the New Republic, believes that asking
the Federal Reserve to raise aggregate demand above the economy's potential
growth rate will create very few jobs and lead to systemic inflation.

In December 1913 the Federal Reserve Act became law. It created the Federal
Reserve System (Fed), which began operations early in 1914. The Fed was
designed as an institution that would counter the periodic financial panics
that had plagued the U.S. economy. Indeed, the financial panic of 1907 led
Congress to establish the National Monetary Commission. Following the
Commission's studies, several proposals were advanced and, after extensive
debate, the Fed was born.
As Fed had three purposes: "to give the country
originally designed, the
an elastic currency, provide facilities for discounting commercial credits, and
improve the supervision of the banking system." Over time there have been
many changes in the Fed. For example, the structure of the Board of Governors
of the Fed, whose prime function is the formulation of monetary policy, was
changed during the 1930s. Perhaps more important than changes in structure
have been changes in its goals. From the original three purposes, the Fed
has extended its purview to include "stability and growth of the economy,
a high level of employment, stability in the purchasing power of the dollar,
and reasonable balance in transactions with foreign countries." In moving
from narrow financial goals to broader macroeconomic goals, the Fed has
responded to legislative demands, primarily the Employment Act of 1946
and the Full Employment and Balanced Growth Act of 1978. While the Fed
is usually described as an independent agency of the federal government, its

218
structure, goals, operations, and, indeed, its very existence are determined
by Congress and the president.
The conventional interpretation of the Fed is that it uses its tools —open
market operations, discount rate changes, and changes in legal reserve re-
—
quirements to engage in countercyclical monetary policy. Thus, the Fed
will purchase government securities, lower the discount rate, and/or lower
legal reserve requirements to increase the money supply and lower interest
rates, in order to stimulate an economy operating at less than full employ-
ment. But this conventional interpretation has been under attack for some
time. Conservatives, led by monetarists such as Milton Friedman and Anna
Schwartz, have argued that the Fed has hurt rather than helped the cause of
economic stability. The monetarists point to a number of instances in U.S. eco-
nomic history where the Fed has made things worse and not better. The moral
of U.S. economic history, according to the monetarists, is that the economy
would be more stable if the Fed did not engage in countercyclical monetary
policy; the Fed should be passivist rather than activist.
More recently the debate has turned to the execution of activist policy.
Some liberal economists as well as some conservatives believe that the Fed
has been too concerned with inflation and has restricted eco-
in the process
nomic growth and tolerated too much unemployment. That is, the Fed has

kept the money supply too low and interest rates too high. Other economists
disagree; they believe that the Fed and other central banks cannot be all
things to all people and that it should concentrate its efforts on achieving
one macroeconomic goal: price stability. These economists think the Fed has
followed the right course. If money supply growth had been higher and in-
terest rates lower, the result would not have been higher growth and lower
unemployment, but more inflation. Both sides of this disagreement are ad-
mirably presented by Lester Thurow and Matthew Miller. Although Thurow
and Miller presented their arguments in 1996, the basic disagreement ex-
tended into 1997 when the Fed took action to increase interest rates in what
was called a "preemptive strike" against inflation.

:n
 —

Lester Thurow
YES

THE CRUSADE THAT'S

KILLING PROSPERITY

The great untold story of the American economy in the 1990s is the disguised
high rate of unemployment and its direct impact on stagnating living stan-
dards. Properly calculated, our rate of joblessness is well into double digits.
No wonder workers have no bargaining power to get their share of an in-
creasingly productive economy.
Among economists, a debate rages on why earnings inequalities began
to rise rapidly and real median wages started to fall a quarter century ago.
Some blame a technological shift that cut demand for uneducated labor while
boosting the demand for those with greater education and skills. Others iden-
tify global " factor price equalization
7'
—
in an open global economy overseas
workers with comparable skills but lower wages are forcing the wages of
Americans down.
What's left out of this lengthy, if inconclusive, debate is the role played
by the slack economic environment in which these two forces have been
operating. While each is real, their impacts would have been very different
if they had operated in an environment of labor shortages rather than one of

vast labor surplus. The U.S. economy has been celebrated for creating tens of
millions of jobs during the past two decades. But properly counted, our true
unemployment rate is no better than Europe's. And nothing keeps wages
from rising like a large pool of idle or underemployed workers.
Today's slack labor markets were produced by the war against inflation
declared in the early 1970s and still underway 25 years later. Inflation began,
with the mis-financing of the Vietnam War in the late 1960s, accelerated
with the OPEC oil shock and food shocks of the early 1970s, expanded across
the economy in the mid-1970s because of the widespread use of cost-of-living
indexes in both labor and supplier contracts, and was rekindled by the second
OPEC oil shock at the end of the 1970s.
While other remedies such as wage and price controls were initially tried,
none seemed to work. Eventually all of the world's major governments came
to the conclusion that the only cure for inflation was to use higher interest
rates and tighter fiscal policies (higher taxes or lower expenditures) to restrain

From Lester Thurow, "The Crusade That's Killing Prosperity/' The American Prospect
(March/ April 1996), pp. 54-59. Copyright © 1996 by The American Prospect, P.O. Box 383080,
Cambridge, MA 02138. Reprinted by permission. All rights reserved.

220
 —

YES Lester Thurow/ 221

prices by deliberately slowing growth to been won. The combatants have gotten
push unemployment up and to force real so used to "fighting on" that they cannot
wages down. Excess capacity and surplus even recognize that they have won.
labor became the key players in the anti- Slow growth cured inflation because
inflationary game. it directly pushed real wages down
In the end the strategy for braking creating very slack labor markets. Indi-
the world economy worked. The world's rectly, it created an environment where
real economic growth rate slid from 5 factor price equalization, a skill-intt
percent per year in the 1960s to 3.6 technological shift, and other factors
percent per year in the 1970s. The double- could generate enormous downward
digit inflation of the early 1980s led to pressures on real wages.
another round of monetary tightening, Restrictivemonetary and fiscal poli-
and growth further decelerated to 2.8 cies have produced unemployment rates
percent per year in the 1980s. Actions not seen since the Great Depression. To-
such as Federal Reserve Chairman Alan day, more than 10 percent of the Euro-
Greenspan's seven interest rate hikes pean workforce is officially unemployed
between early 1994 and early 1995 and and in three countries (Spain, Ireland,
the Bundesbank's very restrictive policies and Finland) unemployment has been
in Germany slowed the world's growth above 20 percent at some point in the
rate even further, and in the first half first half of the 1990s. Spain and Italy

of the 1990s world growth has averaged have youth unemployment rates of over
just 2 percent per year. Today the 60 percent. While it is very fashionable
Federal Reserve Board designs policies to blame Europe's high unemployment
to limit American economic growth to a rates on "rigid labor markets," which is
maximum of 2.5 percent or less. Anything to say unions and welfare state protec-
more is believed to be inflationary. In tions, the real culprit is macroeconomic
its annual policy recommendations, the austerity. Most of the same protections
Organization for Economic Cooperation existed before 1973,and coexisted nicely
and Development (OECD) subscribed to with high growth, full employment, and
the view that America's maximum non- rising wages. Japan's official unemploy-
inflationary growth rate was 2.5 percent. ment rate is near 3 percent, but Japan
essentially has a system of private un-
employment insurance where workers
Like a real war that has gone on far too who would be tired in the United States
long, all of the original reasons for the war remain on private payrolls. Even the
—the mis-financing of the Vietnam War, Japanese admit that it their films acted as
OPEC oil shocks, food shocks, indexed American firms do, their unemployment
wage and supply contracts, inflationary rate would be over 10 percent.
expectations —are long gone. As the war
continues year after year, the negative
THE REAL UNEMPLOYMENT RATE
side effects of the war, falling real wages
and rising inequalities, have become far In the tall of 1995, America's official un-
more corrosive than the original reasons employment rate was hovering around
for joining the battle. The battle continues [Cent Hut like An iceberg that is
even though the war against inflation has mostly invisible below the waterline, ot-
222 / 12. IS THE FEDERAL RESERVE THE CAUSE OF POOR PERFORMANCE?

ficially unemployed workers are just a workforce, were once in the workforce,
small part of the total number of work- are not in school, and are not old
ers looking for more work. enough to have They show up in
retired.
If we combine the 7.5 to 8 million neither employment nor unemployment
officially unemployed workers, the 5 to statistics. They have either been dropped
6 million people who are not working from, or have dropped out of, the normal
but who do not meet any of the [Link] working economy. Some we know as the
for being active in the workforce and are homeless; others have disappeared into
therefore not considered unemployed, the underground illegal economy.
and the workers
4.5 million part-time Put these three groups together and
who would like full-time work, there in the aggregate about one-third of the
are 17 to 18.5 million Americans looking American workforce is potentially look-
for more work. This brings the real ing for more work than they now have.
unemployment rate to almost 14 percent. Add in another 11 million immigrants (le-
Slow growth has also generated an gal and illegal) who entered the United
enormous contingent workforce of un- States from 1980 to 1993 to search for
deremployed people. There are 8.1 mil- more work and higher wages, and one
lion American workers in temporary has a sea of unemployed workers, under-
jobs, 2 million who work "on call/' and employed workers, and newcomers look-
8.3 million self-employed "independent ing for work.
contractors (many of whom are down- These millions of job-hunters lead to a
sized professionals who have
very few more human-scale result that everyone
clients but call themselves self-employed can understand. At 5 p.m. a midsized
consultants because they are too proud to metal-ceramic firm posts job openings for
admit that they are unemployed). Most of 10 entry-level jobs on its bulletin board.
these more than 18 million people are also By 5 a.m. 2,000 people are waiting in line
looking for more work and better jobs. To- to apply for those 10 jobs.
gether these contingent workers account
for another 14 percent of the workforce.
In the words of Fortune magazine, "Up-
WHY WAGES FALL
ward pressure on wages is nil because While the economy has been generating
so many of the employed are these 'con- about 2 million jobs per year since the end
tingent'workers who have no bargain- of the 1990-1991 recession, these gains are
ing power with employers, and payroll just barely large enough to hold even with
workers realize they must swim in the migration and the normal internal rate of
same Darwinian ocean." Like the unem- growth of the working-age population.
ployed, these contingent workers gener- However rapid, job growth cannot lead
ate downward wage pressures. to wage increase, unless it is faster than
In addition there are 5.8 million the growth rate of those looking for work.
missing males (another 4 percent of one believes even marginally in the
If

the workforce) 25 to 60 years of age. power of supply and demand, surplus

They exist in our census statistics but labor of these magnitudes has to lead to
not in our labor statistics. They have falling real wages. Wages rise roughly
no obvious means of economic support. with productivity growth only if there
They are the right age to be in the are labor shortages. Since slow growth
 —

YES Lester Thurow/ 223

throws the bottom 60 percent of the during recessions. Instead, recessions

workforce into unemployment far more would be allowed to run their course
than it does the top 20 percent, the and governments would simply wait
earnings of the bottom 60 percent should for a recovery —
or as happened in 1994
be expected to fall sharply relative to in the United States, adopt monetary
the top 20 percent in a period of high policies to actually slow what was
unemployment —as they have. already by historical standards a very
These direct negative effects on wages weak recovery.
were compounded by several indirect Knowledge that governments won't
effects. American economists used to shorten recessions radically changes ex-
talk about something called "efficiency pectations. downturns are sharper and
If

wages." One of the mysteries of the longer, business firms have to reduce
post-World War II era was wages that prices if they wish to survive. As a re-
rose even when there were unemployed sult, in the 1990s more of America's pro-
qualified American workers who would ductivity gains are showing up as falling
have been glad to do those jobs for less. prices and fewer are showing up as rising
This anomaly was explained by arguing wages. Higher labor productivity doesn't
that firms deliberately paid incumbent lead to higher labor wages as it used to.
workers above-market wages to secure a Wages can fall while productivity rises
high degree of cooperation, commitment, as has happened in the last 20 years.
and effort that they could not have gotten The best example is the computer
if their workforces could have quit and industry —an industry that pays very
easily gotten equal wages elsewhere. low wages for its production workers.
But in a world where there are Productivity is growing very rapidly, but
always millions of unemployed and all of that productivity gain shows up in

underemployed workers, firms do not lower prices or higher profits for chip-
have to pay efficiency wages. The same makers or software firms. None shows
degree of cooperation, commitment, and up as higher wages as used to occur in
effort can be achieved by using the industries such as automobiles or steel.
—
motivation factor called "fear" the fear This sea of excess labor accentuates the
of being thrown into this enormous sea of downward pressures of a skill-intensive
unemployment and underemployment. technology shift and global factor price
In the last five years examples abound equalization. Tight labor markets would
of profitable firms that simplymarched offset much if not ail of the impact
in and dramatically lowered the wages on the bottom 60 percent of the
of their existing workforces by 20 to 40 distribution, but they don't e\
percent. Workers complain but they don't A skill-intensh e technological shift
quit. should raise the wages of the skilled
Similarly, two decades of surplus and lower the wages of the unskilled,
labor have broken linkage bet but in the context of vast supplies
productivity gains and wage increases. labor the expected higher
The early 1990s demonstrated that no wages even tor skilled don't i

government would come running to the appear. The upward wagt - that

rescue with large fiscal and monetary should be seen aa> mote than ottset by
packages designed to stimulate demand the down v. . from surplus
224 / 12. IS THE FEDERAL RESERVE THE CAUSE OF POOR PERFORMANCE?

unemployed skilled laborers. For males, High school-college wage differentials,

real wages are now falling at all education for example, have always been smaller in
levels, even for those with graduate the union sector than in the nonunion sec-
degrees. For the unskilled the downward tor. As a result, with the demise of unions

wage pressures flow from this

that as a force in the American economy, wage
technological shift are magnified because differentialsshould be expected to rise.
of the surplus labor that already exists. In addition, as company worries about
unionization have waned, the gap be-
tween union and nonunion wages has
The war on inflation has also intensified doubled. Higher wages no longer need to
the downward wage pressures coming be paid in nonunion firms to keep unions
from a number of other sources. Some out.
capitalists certainly plotted to kill Amer- The attack on unions could not have
ica's labor unions. President Reagan's succeeded in an environment of tight
firing of all of America's unionized air labor markets. But in this sea of surplus
traffic controllers legitimized a deliberate labor, unions have little negotiating
strategy of de-unionization. In the pri- power to offer prospective members.
vate sector, consultants were hired who Deregulation has also led to some wage
specialized in getting rid of unions, de- reductions. In regulated industries such
certification elections were forced, and le- as trucking and airlines, workers col-
gal requirements to respect union rights lected some of the excess profits —what
were simply ignored —firms simply paid economists call "rents" —that accrued
the small fines that labor law violations from regulation. Truck driver wages and
brought and continued to violate the the wages of some airline employees fell
law. The strategy succeeded in shrink- dramatically with deregulation. In the
ing union membership to slightly more case of truck drivers, wages fell three
than 10 percent of the private workforce times as fast as elsewhere. The rents that
(15 percent of the total workforce). And had been built into their wages were
even where unions still existed they lost transferred back to the consumer or to
much of their power to influence wages corporate profits. But in a world of tight
or negotiate working conditions. Com- labor markets more of those rents would
bined with corporate compensation com- have stayed with workers.
mittees who in the past 25 years have es- Since wages in the many advanced in-
calated CEO salaries from 35 to 157 times dustrial countries are now above those in
that of entry-level workers, one could ar- the U.S., most of the factor price equaliza-
gue that the capitalists had declared class tion flowing from other First World coun-
—
warfare on labor and were winning. tries is behind us. But ahead lies the inte-
While the economics literature is incon- gration of the Second World into the First
clusive as to whether unions affect av- World and a very different Third World.
erage wages (equally productive compa- The communist countries did not run ef-
nies with and without unions tended to fective civilian economies but they ran
pay the same wages in the past), there excellent education systems. The Soviet
is no doubt that unions affect the dis- Union was a high-science society with
tribution of wages. Wage distributions more engineers and scientists than any-
are much more equal where unions exist. one other than the United States. China is
 YES Lester Thurow/ 225

capable of quickly generating hundreds April 1993 and annual rates of increase
of millions of medium-skill workers. The decelerated from 1.2 percent in 1993 to
end of communism and the success of the 0.6 percent in 1994. In 1994 and 1995
"little tiger" countries on the Pacific Rim labor costs rose at the slowest rate since
have led the Third World to junk import records had been kept and the core rate
substitution as a route to economic devel- of inflation (the rate of inflation leaving
opment, and to become export oriented. out volatile energy and food prices) was
Where countries with only a few million the lowest rate recorded since 1965.
workers used to be export oriented (Sin- Officially the rate of inflation in the
gapore, Hong Kong, Taiwan, and South consumer price index (CPI) fell from 3
Korea), Third World countries contain- percent in 1993 to 2.6 percent in 1994,
ing billions of people now want to be ex- and to 2.5 percent in 1995, but Chair-
port oriented (Indonesia, India, Pakistan, man Greenspan had himself testified to
Mexico). As a result, exports from low- Congress that the CPI exaggerated infla-
wage Third World countries are apt to tion by as much as 1.5 percentage points
be much larger in the years ahead. What- since underestimated quality improve-
it

ever one believes about how much of real ments ingoods (in computers, for exam-
wage declines and increases in wage dis- ple, it has performance rising at only 7
persion can be blamed on globalization in percent per year) and since it gives no
the past, the forces of factor price equal- credit at all for quality improvements
ization are going to grow enormously. in [Link] Boskin Commission, ap-
If they continue to operate in a world pointed by the Senate Finance Commit-
of slack labor markets inside the United tee, has estimated the upward bias in

States, the rate of decline in real wages the CPI at between 1 and 2.4 percent-
will accelerate. age points. If one is willing to assume
that the sectors where quality improve-
ments are hard to measure are in fact im-
THE REAL INFLATION RATE proving quality at the same pace as those
has already ended. But as
Inflation itself sectors where quality is easy to measure,
long as the policymakers are convinced the over-measurement of inflation may
that the ghost of inflation will at any be closer to 3 percentage points.
minute reappear, they will operate their Health care is a sector whose infla-
policies as if inflation were a real threat. tionary dynamics have little to do with
It is possible, in fact, that inflation is macroeconomic pressures. Since health
even lower than its low official rate. The care accounts for 15 percent of GDP and
broadest measure of inflation, the implicit health care prices were rising at a 5 per-
price deflator for the gross domestic cent annual rate in L9H» mathematically
product, fell from 2.2 percent in 1993 another 0.75 percentage points of infla-
to 2.1 percent in 1994, and in the third n be traced to health care (more
quarter of 1995 inflation was running at than one-third i total inflation).

the rate of 0.6 percent. Put all of these factors together and
Having during the previous
fallen .ear that the rate o! nidation in
recession, the producer's price index for where inflation is controllable
finished consumer goods in \\ ember I with slower growth is certainl)
1994 was below where it had h lOW and probably actually negative.
226 / 12. IS THE FEDERAL RESERVE THE CAUSE OF POOR PERFORMANCE?

While some economists argue that the it is equally true that ghostbusters have
CPI does not in fact overstate inflation often created a lot of realhuman havoc.
it is bizarre that Alan Greenspan is Central bankers will of course tell us
among those who think that inflation is that when they gain anti-inflationary
significantly below its officially measured credibility/' rapid noninflationary growth
rate since it undercuts his arguments for will resume. But this is a mirage shim-
contractionary monetary policy. mering in the hot desert air. If any cen-
tral bank has anti-inflationary credibil-
ity, it should be the German Bundesbank,

yet Germany has one of the industrial

Left to their own devices, those who world's lowest real growth rates. If the
operate central banks are never going Bundesbank has not yet achieved anti-
to declare a permanent victory over inflationary credibility, no central bank
inflation. The reasons are simple. If the ever will obtain this exalted status.
battle against inflation is primary, central As a result, if policies are to change it
bankers will be described as, and actually will require a change in political percep-
be, the most important economic players tions. Rising inequalities and falling real
in the game. Without inflation, they run wages have to come to be seen as more
rather unimportant institutions. important problems than the ghost of in-
It isimportant to remember that in flation when it comes to getting elected
1931 and 1932 as the United States or reelected. Social welfare programs for
was plunging into the Great Depression, the poor are not politically viable as long
economic advisers such as Secretary as the poor do not vote for the politicians
of the Treasury Andrew Mellon were who support the programs that benefit
arguing that nothing could be done them. Tight labor markets are equally po-
without risking an outbreak of inflation litically unviable unless voters reward the

—despite the fact that prices had fallen politicians who are willing to reverse the
23 percent from 1929 to 1932 and would macroeconomic policies that have been in
fall another 4 percent in 1933. The fear place for the past 25 years.
of inflation was used as a club to The long-run answer to falling wages
stop the actions that should have been is a much better-skilled bottom three-
taken. Central banks are prone to see quarters of the American workforce, but
inflationary ghosts since they love to be without a reversal in our macroeconomic
ghostbusters. While it is true that no policiesno set of human-capital invest-
human has ever been hurt by a real ghost, ment policies can hope to work.
NO Matthew Miller

GROW UP
It's no surprise in a campaign year to find a clamor for more growth and a

penchant for sloppy economic arguments. In the primaries, it was tax-cutting

supply-siders Steve Forbes and Jack Kemp egged on by their allies at TJie
Wall Street Journal's editorial page, who took up the chorus. Now it's liberal
economists Lester Thurow and Robert Eisner, Wall Street pooh-bah Felix
Rohaytn and manufacturing CEOs like Tenneco's Dana Mead and General
Electric's Jack Welch. The Federal Reserve and its chairman, Alan Greenspan,
we're told, are strangling the economy in the misguided belief that growth
in excess of 2.5 percent will spark inflation. Worse, the claim goes, because
this slow-growth conspiracy permeates officialdom —
both the Congressional
Budget Office and the Clinton administration, for example, forecast such
—
anemic growth over the next seven years it's sure to be self-fulfilling. If
the Fed would just take its foot off the brakes and lower interest rates, the
dissenters say, the economy would roar like it did in the 1960s, when we grew
more than 4 percent yearly with 2.5 percent inflation. With five consecutive
years of inflation at 3 percent or less, the Fed is chasing a ghost.

Are the Fed bashers right? To answer that question, let's first assume that
almost everyone wants more economic growth, just as almost everyone wants
world peace. Let's also admit that one powerful constituency in our midst
represents an exception: the wealthy, who are hurt far more by a little extra
inflation than by a little extra unemployment and thus flex their muscle (via
the bond markets) in favor of the latter. Whether you're a cheerleader for
growth or one of its secret opponents, the case against the Fed still comes
down to two questions. First, in the short term, is there enough slack in
the economy to allow the Fed to DOOSt Spending and increase output and
employment without triggering an inflationary spiral? Second, is there reason
over the long term to think our economy can "sustainably" grow Easter than
2 to 2.5 percent yearly— that is, without risking an OUtsized inflation thai can
be exorcised only by a repeat oi the bruising the Fed put us through
in the early 1980s?
The unhappy answer, for someone like me who's ^foqfttfefiH with our
economic performance, is that the Fed demonizera are mostl) wrong: they

From Matthew Miller. I tf) Copyright C 19% by The

;
-public inc. Reprinted by penntatond I

227
228 / 12. IS THE FEDERAL RESERVE THE CAUSE OF POOR PERFORMANCE?

overstate their case and are often inco-

herent in their arguments. This means
we'llhave to look somewhere other than But here's the point: saying we might be
the Fed to solve the wage stagnation and able to get a fraction of a percent more
growing inequality that plague us. jobs today is from implying we
different
can stamp out unemployment. It's also
To see why, take the short-term com- different from saying the economy can
plaint first. For all their squabbles, grow at 3 or 4 percent in perpetuity
economists generally agree that there's as the growth propagandists urge. Even
a rate of unemployment beneath which today's Fed bashers acknowledge there's
we can go only at the risk of accelerating a limit to how far you can push down
inflation. They call this, with typical lyri- unemployment without fueling inflation;
cism, the "non-accelerating inflation rate they simply argue, without specifics,
of unemployment," or NAIRU. Think of that it's lower than we think. But,
itas a way for the dismal science to avoid as Stanford University's Paul Krugman
saying explicitly that a certain level of hu- points out, acknowledging this limit
man misery is "natural." The intuition be- means conceding that the extra growth
hind it is straightforward. Workers lose they're screaming for can only last a year
jobs or enter the market where suitable or two at best.
new work is unavailable; because it takes Why? For the last two decades (in
time, training and even relocation to find
another empirical relationship so sturdy
their next opportunities, they may re-
it's called Okun's Law), every percentage
main unemployed for months. Pumping point the economy has grown annually
the economy beyond such "normal" lev-
beyond 2.5 percent has reduced the
els of slack has proven to be a reliable unemployment rate by half a point. You
predictor of inflation for twenty years,
can get higher growth for a while when
as the proverbial situation of "too much
you're starting from the bottom, say,
money chasing too few goods" translates of the Reagan recession, with its 10.7
Alan Blinder, the former
into price hikes.
percent jobless rate. But, even if the
Fed vice chairman who recently returned noninflationary level of unemployment is
to Princeton, calls the NAIRU theory the
as low as 4.5 percent, getting there from
"clean little secret of macroeconomics." would give you
today's 5.5 percent just
Economists peg the NAIRU today two years of 3.5 percent growth. That's
at between 5.5 and 6 percent. With [Link] believe that you can grow this
unemployment now at 5.5 percent (down you'd have to believe
fast in perpetuity,

from 7.4 percent in 1992), there's little we can get unemployment down to an
reason to hope for bold new progress. unprecedented 3 percent five years from
It's true that some economists debate now or toward zero (and beyond!) after a
whether the NAIRU is really 5.5 or a little decade. It's just not credible.
less. And getting the rate down another To be sure, even a year or two of
half a point means jobs for 600,000 an extra point of growth is nothing to
more people. There's a case be made,
to sneeze at; I'll take a $70 billion lift in GDP
therefore, that the Fed could probe a little [Gross Domestic Product] wherever we
further, inching down interest rates to see can find it. But the truth is that short-
what happens. term demand management by the Fed
 NO Matthew Miller/ 229

can't deliver millions of new jobs, nor long run capacity, we should have seen
bring us anywhere close to our golden no change in the economy's unused
days of growth or the booms enjoyed by resources, or "slack," over that year.
the Asian "tigers" today. Which brings us Instead, the "slack" tightened: measures
to the long-term question: Can anything of capacity use rose by 3 percent,
get us back to those glory days? and the unemployment rate dropped
a full point. Greenspan correctly noted
other signs of strain as well: deliveries
The economy's long-run potential rate of of materials slowed, for example, and
growth is a function of two things: the factory overtime rose.
growth of the labor force and the growth Asking the Fed to pump aggregate
in productivity (oroutput per worker). spending or demand beyond the econ-
Arguments about growth have to work omy's potential growth rate is a recipe
through one or both of these factors to be for systemic inflation. That doesn't mean
credible. Growth was faster in the 1960s, we shouldn't try to raise potential growth
for example, because our working-age through improving our infrastructure or
population was growing more rapidly, investing more in research and develop-
women were joining and
the workforce, ment; indeed the search for productivity-
productivity was more than 2
rising at boosting strategies is the heart of what

percent yearly. Countries like Taiwan and economic policy debate should be about.
Indonesia grow at enviable rates today But monetary policy is only one piece of
for similar reasons. economic policy. Its aim should be to pro-
Here, however, things have changed. mote a sustainable growth (and jobs) tra-
American women have completed their jectory that avoids the kind of price spiral
historic transition toward work outside that takes a costly recession to excise.
the home; their labor force participation In the face of this analysis —offered
rate of 38 percent in 1960 has expanded by such Democratic economists as Krug-
and finally stabilized at 58 percent in man, former Carter Council of Economic
the 1990s. Along with a post-baby boom Advisers chairman Charles Schultze and
drop in fertility rates, this helps explain Alan Blinder, whose agreement with
why our labor force overall now grows Greenspan on these matters got lost in
at just over 1 percent a year. The great the media hype over their supposed dif-
but mysterious post-1973 productivity —
ferences how does the growth chorus
slowdown, meanwhile, has left annual respond? Basically with a grab bag of
output per worker rising at a little sophistries. Since they sound good the
over 1 percent as well. Together, those first time you hear them, it's worth shoot-

rates produce today's "gloomy" view of ing down the big ones.
potential growth of 2.2 to 2.5 percent. It's

not rocket science or conspiracy. It's math. Inflatu Lester Thurow

And it isn't just theory. In argues in the current American Prospect
for example, still coming back from that "inflation Itself has already ended,"
recession, the economy grew at &5 citing, among other things, Alan Green-

percent. As Alan Greenspan testified span's own assertions that the Consumer
in February, if 3.5 percent was the Trice Index may overstate price hik>
true rate of increase in the econonn 'a up to 1.5 percent With the official CP1
230 / 12. IS THE FEDERAL RESERVE THE CAUSE OF POOR PERFORMANCE?

coming in at 2.5 percent last year, he says, Yes, some people's wages, particularly
"real" inflation may be only 1 percent, so those with less education, are falling, and
it's time the Fed stopped worrying and we urgently need to figure out how to
stepped on the gas pedal. reverse this. But, again, that's not an ar-
There's only one problem. If inflation gument that inflation is dead.
is overstated, then economic growth is

already a lot higher, since it's calcu-

lated by subtracting out inflation from Divine intervention. "Suppose God
observed nominal growth. On Thurow's came to thePentagon and said, 'There's
logic, we're already growing at 4 percent,
never going to be another war,' " Thurow
said to me, "You think the generals would
so what's his beef? Of course, at other
tell us? Now suppose God came to Alan
times Thurow is happy to use the over-
stated CPI to argue that real wages are
Greenspan and said, 'There's never go-
falling. It's hard to avoid the conclusion ing to be inflation again.' The head of

that he's trying to have it both ways the — the Federal Reserve Board will never de-
clare victory on inflation." Thurow may
tell-tale sign of a propagandist.
be right there. And the oath Greenspan
takes before testifying may not be enough
Productivity is really higher. Felix Ro-
haytn and assorted CEOs say produc- to smoke him out. now I'm com-
But for
tivity growth is higher than the official
fortable leaving thatbetween Greenspan
measure of 1 percent or so, meaning the and the Big Central Banker upstairs. The
potential growth the Fed is targeting is
Fed's institutional interest in inflation-

too low. Trie trouble with this argument

busting isn't proof that the Fed is lying.
is its reliance on anecdotes from man- Saying the Fed can't solve our growth
ufacturing firms, like the kind Rohaytn problems doesn't equal complacency
advises. It's true that manufacturing pro- about lousy economic performance. It
ductivity has undergone a resurgence, simply means that scapegoating the Fed
growing at 3.5 percent yearly since early is a feel-good diversion from the tougher

1993. But manufacturing only represents —

search for policies fixing our schools,
20 percent of the economy. funding new technologies, raising sav-
ings and investment— that would actu-
Wages are falling. Thurow rightly ar- ally boost productivity, wages and long-
gues that you can't possibly have an in- term growth. Let's agree that Greenspan
flationary threat if it's not translated into and Company could usefully probe for a
higher wages. But economy-wide wages few hundred thousand more jobs. Then
are actually rising 2 to 3 percent yearly. let's get back to the real work.
POSTSCRIPT
Is the Federal Reserve the Cause of Poor
Macroeconomic Performance?

Thurow argues that preoccupation with a war against inflation, which has
already been won, has led to substandard macroeconomic performance. That
is, the Fed's anti-inflation policy of limiting economic growth to 2.5 percent
or less per year has led to a true unemployment rate at least twice as high
as the official unemployment rate, falling real wages, and stagnating living
standards. As for differences between the official unemployment rate and the
true unemployment rate, Thurow contends that the official unemployment
rate ignores discouraged workers and involuntary part-time employment. So
even though there has been a substantial increase in the number of jobs, the
surplus labor market has prevented increases in real wages. To support his
position that the war against inflation has already been won, Thurow cites a
number of statistics and asserts that the Consumer Price Index may overstate
inflation by as much as 3 percent per year.
Miller states that attacks on the Fed's monetary policies have come from
the right as well as from the left: both ends of the political and economic
spectrum want faster economic growth. To determine whether the criticisms
of the Fed are correct, Miller poses two questions: Can the Fed accelerate
economic growth without accelerating inflation? Can the economy sustain a
growth rate faster than 2.5 percent per year? In answering the first question,
Miller argues in terms of the nonaccelerating inflation rate of unemployment
(NAIRU); he believes that the evidence is strong that faster growth will lead
to accelerating [Link] for the second question, Miller makes a number
of points: to get and sustain a growth rate of 3.5 percent would require that
the unemployment rate be down to 3 percent in five years and to zero in ten
years; both the growth rate of labor force and productivity are now lower
than they have been; and, if Thurow is right about overestimates of inflation,
the actual growth in the economy is greater than the measured growth in the
economy.
Additional reading on this issue includes "Monetary Polk and
Strategy," by Janet Yellen, Bustm July 1996); "Inflation and
-

Money Supply" by Alan Green-pan, I !.uvh 15, 1997);

'

"Low Inflation or No Inflation: Should the Federal Rl

Price Stability?" b\ ..ham Dickens, and George Perry, Clial-
lenge (September/ Octob .ind
Andrew Harles, Challenge (March /April 1997); and Productivity,
Profits Curb Inflation Despite Pa)
Street Jounul (May 21, 1997).
 —

ISSUE 13
Nonaccelerating Inflation Rate of
Is the
Unemployment a Useful Guide for
Macroeconomic Policy?
YES: Joseph Stiglitz, from "Reflections on the Natural Rate Hypothesis/'
Journal of Economic Perspectives (Winter 1997)

NO: James K. Galbraith, from "The Surrender of Economic Policy/' The

American Prospect (March/ April 1996)

ISSUE SUMMARY
YES: Joseph Stiglitz, chairman of the Clinton administration's Council of
Economic Advisers, argues that the nonaccelerating inflation rate of unem-
ployment (NAIRU), because it is useful in both understanding the causes of
inflation and in predicting changes in the rate of inflation, is also useful as a
guide for the execution of macroeconomic policy.
NO: James K. Galbraith, professor of economics at the LBJ School of Public
Affairs at the University of Texas, believes that the shocks that have increased
the rate of inflation have occurred both when the unemployment rate has been
high and when it has been low, and, therefore, the NAIRU is useless as a guide
for the conduct of macroeconomic policy.

There seems to be very little disagreement regarding macroeconomic goals

economy needs to achieve. They are (1) economic
the outcomes the national
—
growth the output of goods and services expand over time; (2) full employ-
—
ment all those seeking employment are successful in their job search; and
(3) price stability—
the average level of prices remains constant. While there
iswidespread agreement on the macroeconomic goals, there are significant
differences regarding what should be done when the national economy fails
to achieve them.
Noninterventionists believe that the macroeconomy is self-correcting and
government action is unnecessary; indeed, they argue that government action
may make macroeconomic conditions worse. Activists believe that the gov-
ernment must intervene if the macroeconomy is not performing as desired;
policy action can be useful in improving macroeconomic performance.
But the activists may not agree about everything. There are any number of
examples. Consider first the choice of government actions. One option is fiscal
—
policy changes in government transfer payments, changes in government

232
purchases of goods and services, and changes in taxes. Fiscal policy requires
the cooperation of the executive and congressional branches of government
because these types of changes require the passage of legislation. The second
option is monetary policy, which involves changes in the money supply
and interest rates. Monetary policy does not require executive-congressional
cooperation; it is entrusted to the Federal Reserve System, an independent
agency of the federal government. In this context, activists may agree that
there is a need for government action to correct a macroeconomic problem
but disagree on whether the appropriate response involves monetary policy
or fiscal policy.
A
second example of disagreement among activists is the usefulness of
the NAIRUas a guide for policy action. To understand the nature of this
disagreement, it is necessary to review some basic definitions. The rate of
inflation is the rate of increase in the average level of prices as measured
by the Consumer Price Index, for example. Over time the rate of inflation
can be accelerating (increasing from 3 percent in one year to 5 percent in the
next year); decelerating (decreasing from 3 percent in one year to 1 percent
in the next year), or nonaccelerating (constant at 3 percent in both years).
The unemployment rate is defined as the percentage of the labor force that is
—
unemployed the percentage of those who are seeking work but are unable
to find jobs.
The natural rate hypothesis suggests that there is a particular unemploy-
ment rate consistent with constant or nonaccelerating inflation; this unem-
ployment rate is the NAIRU. If the unemployment rate falls below the NAIRU
then prices begin to rise more rapidly; inflation begins to accelerate. If the
unemployment rate is above the NAIRU then prices begin to rise less rapidly;
inflation begins to decelerate. In this fashion the NAIRU can be used as a pol-
icy guide. A simple application can be stated as follows: if the unemployment
rate above the NAIRU, then engage in expansionary fiscal or expansionary
is

monetary policy action because such actions will serve to reduce the unem-
ployment rate without making inflation worse. This simple application can be
extended: once the unemployment rate reaches the NAIRU, it is appropriate
to terminate expansionary policy. Further action to reduce the unemployment
rate may lower the unemployment rate, but only at the cost of accelerating
inflation.
Both Joseph Stiglitz and James K. Galbraith can be considered activists in
the sense that both believe that government action can improve macro
nomic performance. They disagree, however on the usefulness of the NAIRU
as a guide to policy action. Stiglitz believes that it is a useful guide tor pol-
icy actions even though its actual numerical value may change over time.
Galbraith disagrees. He believes that the use of the NAIRU as a guide for
macroeconomic policy has led to more unemployment than was I

to maintain price stability. te argues that it we really want full employment

I

we need to abandon the use ot the NAIRU and adopt what he calls a full
employment policy.
 Joseph Stiglitz
YES

REFLECTIONS ON THE NATURAL

RATE HYPOTHESIS

Few concepts in economics with an acronym as unpleasant as NAIRU have

attained as much public prominence in the past 10 years. Who, 10 years ago,
would have thought that White House economic press conferences would be-
gin with a question concerning the administration's estimate of the NAIRU?
The issue typically posed is not whether there is a NAIRU, but what its level
actually is.

have become convinced that the NAIRU is a useful analytic concept. It

I

is useful as a theory to understand the causes of inflation. It is useful as an

empirical basis for predicting changes in the inflation rate. And, it is useful
as a general guideline for thinking about macroeconomic policy. But these
points are controversial within the profession
Let me begin my defense of theNAIRU by asserting that it is a very well
defined concept. In fact, the main advantage of using the somewhat ugly
term NAIRU instead of its more euphonious synonym, the natural rate, is
that each time we use the term we are reminded of its meaning. The NAIRU
is defined as the nonaccelerating inflation rate of unemployment; that is, the
rate of unemployment consistent with an unchanging inflation rate. When
unemployment is below the NAIRU, there is pressure for the inflation rate to
rise; contrarily, when unemployment is above the NAIRU, there is pressure

for the inflation rate to fall

I think of the theory behind the NAIRU essentially as a description about

how the economy behaves out of equilibrium. When unemployment is below

the NAIRU, real wage demands are greater than the amount firms are willing
to pay (at prevailing prices and price expectations) — Equilibrium —defined
in this case as inflation stable at a level equal to its expectation — only
is

achieved when unemployment rises to the NAIRU, making the behavior of

wage setters compatible with the behavior of price setters. In other words, the
natural rate hypothesis views changes in the inflation rate as a labor market

From Joseph Stiglitz, "Reflections on the Natural Rate Hypothesis," Journal of Economic
Perspectives (Winter 1997). Copyright © 1997 by Journal of Economic Perspectives. Reprinted by
permission.

234
 — ——
YES Joseph Stiglitz / 235

phenomenon whose magnitude can be history of unemployment would widen

proxied by a particular measure of labor the band somewhat
market slack: the unemployment rate.
In this paper, I want to elaborate want to go beyond these tests to
I

on three criteria for evaluating whether discuss some tentative conclusions we

the NAIRU is useful for academics and have reached in our more structural
policymakers — The following sections research at the CEA [Council of Economic
discuss the natural rate hypothesis in the Advisers], many of which are consistent
context of these three criteria: its ability with the empirical research in this area, as
to explain changes in the inflation rate, exemplified by some of the papers in this
our ability to explain why the NAIRU symposium. When we regress changes
changes, and the usefulness of these ideas in the inflation rate on past values
for policy discussions. of unemployment, regardless of the
precise specification or other variables
included, we get t-statistics on lagged
THE EMPIRICAL SUCCESS OF
unemployment on the order of 4 or 5
THE PHILLIPS CURVE
Such results make us just about as certain
The most basic implication of the natural that unemployment has predictive power
rate hypothesis is that changes in the for changes in the inflation rate as we can
inflation rate are (in large part) a labor ever be in empirical research.
market phenomenon whose magnitude
can be proxied by a particular measure of Just saying that unemployment mat-
—
labor market slack the unemployment ters, however, is not enough. To defend
rate. I believe the data support the view my thesis that the NAIRU is a useful con-
that unemployment is a good predictor cept, I need to demonstrate how much
of the direction that inflation will move. it matters. In our regressions, we find
One nonparametric way to approach that keeping the unemployment rate one
this issue is to compare the direction percentage point below the NAIRU for
of the change in inflation (as measured one year will result in the inflation rate
by the core experimental CPI) with increasing by between 0.3 and 0.6 of a
the level of demographically adjusted percentage point. That magnitude is def-
unemployment. 1
Since 1960, inflation initely large enough to command the at-
rose in 26 of the 32 quarters when tention of policymakers. Finally, our anal-
the unemployment rate was below 5 ysis indicates that at least 20 percent of
percent, but inflation fell in 24 of the 27 the variation in the inflation rate can be
quarters when unemployment was above explained by unemployment alone. This
7 percent This empirical regularity is very figure serves as a reminder that the ac-
strong. It also suggests an upper bound tual inflation process —
and the policy de-
on our uncertainty about the NAIRU: it must bo made based on it
cisions that
looks as if it has been contained within is much more complicated than a simple

5 and 7 percent for the period from link between the NAIRU and inflation,
1960 to the present. Note that this is the 'mi^ts should not read-
NAIRU for the demographically adjusted Uv surrender any parsimonious concept
unemployment rate; mapping it into a that can explain 20 percent of something

concept that we can compare to the actual important.

236 / 13. IS THE NONACCELERATING INFLATION RATE A USEFUL GUIDE?

early 1980s. I should caution, however,

WHAT DO ECONOMISTS KNOW that the uncertainty surrounding this
ABOUT CHANGES IN THE NAIRU? estimate, both the formal standard errors
The second criterion for the NAIRU and the uncertainty over whether we
being a useful concept is that we can are estimating the correct model, is very
explain why it changes over time, predict large.
those changes to some degree, and The three main forces in this decline are
possibly even identify policies that might the changing demographics of the labor
alter it. When Milton Friedman first force, the fact that productivity growth
proposed the natural rate hypothesis in has become more in line with worker
his presidential address to theAmerican expectations and the general increase
Economic Association in 1968, it sounded in the competitiveness of the labor
like royal edict had established the and product markets. Accounting for
natural rate as another one of the demographic change is straightforward.
universe's invariant constants. Today, Imagine that each demographic group
there is general recognition that if a has its own unchanging natural rate
NAIRU exists, it must be changing over of unemployment: higher for teenagers
time. than adults, higher for women than
A few years, ago the typical estimates for men, and so on. 3 Then imagine
of the NAIRU ranged from 6.0 to 6.2 per- that the only source of changes in the
cent. If this natural rate remained opera- NAIRU are changes in the proportion
tive today, the below 6 percent unemploy- of these different groups in the labor
ment from August 1994 through the latter force. If we assume that demographic
part of 1996 should have increased infla- changes had about the same effect on the
tion. if the natural rate were
For example, NAIRU as they have had on observed
6.2 percentand we assume that each year unemployment, then about one-third of
the unemployment rate is a percentage the 1.5 percentage point decline in the
point below the NAIRU inflation rises by NAIRU can be attributed to demographic
0.5 of a percentage point, then the average changes. The single most important
unemployment rate of 5.6 percent from demographic change is the aging of
August 1994 to August 1996 would have —
the baby boomers we now have a
led to a 0.6 point increase in the inflation more mature labor force, with greater
rate. Instead, inflation, as measured by representation of age groups that have
the yearlong increase in the core CPI, fell traditionally had lower unemployment
from 2.9 percent to 2.6 percent over that rates.
period. 2 The second explanation for the change
Through 1995 and 1996, inflationary in the NAIRU, which is linked to produc-
pressures have been milder than in tivity growth, can be called the "wage-
previous periods when unemployment aspiration effect/' Although neither the
was low. For adherents to the
this level or rate of change of productivity
NAIRU approach, the reason is clear: has any long-run effect on the unemploy-
the natural rate of unemployment has —
ment rate witness the fact that unem-
fallen Our own preliminary finding ployment has been about the same over
is that theNAIRU has fallen by around the course of a century of massive pro-
1.5 percentage points since its peak in the ductivity growth and large shifts in its
 ^ES Joseph Stiglitz / 237

trend growth rate —changes in the pro- home and abroad through regulatory re-
ductivity' growth rate can have tempo- form and trade-opening agreements. Al-
rary effects on the natural rate of unem- though trade is still a relatively small
ployment. The intuition is that workers' —
part of our economy around 10 percent
demands for increased real wages de- —the fact that much of the US. manu-
pend on their past rate of change, possi- facturing sector faces potential competi-
bly because of the psychological fact that tion is enough to deliver wage restraint
people get accustomed to a certain rate of Changes in labor markets, such as de-
increase in their standard of living. Thus, creasing rates of unionization, have also
growth rate,
after a fall in the productivity had some salutary effects on inflation, re-
workers will initially demand real-wage gardless of their other impacts. Although
growth based on their previous experi- quantifying these general notions of com-
ence and thus faster than the increase in petitiveness and the institutional struc-
productivity which puts upward pres- ture of the labor market is extremely dif-
sure on the inflation rate and requires ficult, it is not implausible to think that
a higher level of unemployment for the they account for the remaining 05 per-
economy But this
to stay in equilibrium. centage point decline in the NAIRL
increased NAIRU is only temporary, ei- the early 1980s.
ther because the productivity shock it-
self is temporary, or because workers will demography, wage as-
In addition to
eventually moderate their demands in re- piration and competitiveness, a fourth
sponse to permanently lower productiv- factor might currently be affecting the
ity growth. Either way, the NAIRU can NAIRU and might affect it even more
return to its preshock level. This effect, in the near future: hysteresis. The idea
called the wage-aspiration effect, surely that sustained high unemployment will
contributed to a rising XAIRU in the gradually raise the natural rate of un-
1970s and early 1980s, in the aftermath employment is perhaps most familiar in
slowdown. However,
of the productivity the European context. The intuition be-
workers have now had a lot of time to hind the claim emphasizes that high sus-
adjust their real-wage aspirations down tained unemployment decreases both the
to reflect the slower productivity growth, work and job-search skills of the unem-
which should be helping the NAIRU re- ployed (outsiders) at the same time that
bound to its earlier, lower rate. those who remained employed (insiders)
Our estimates at the CEA
. . . indicate want to maintain wages at the expense
the wage-aspiration effect has lowered anding emplovment. The reverse
the NAIRU by around 0.5 percentage of these forces might be at work in the
point since the early to mid-1980s. US. labor market today. Research has
However, I want to emphasize that there not conclusively shown that hysteresis
is a lot of uncertainty in this estimate. is one of the forces that has lowered the
The most likely suspects for the re- NAIRU American economy. But if
in the

maining decline in the NAIRU all fall it does, then high unemployment is even

under the heading of increased com- worse than we thought, because it raises
petitiveness of the product and labor the NAIRU, and lower unemployment is
markets. This is partly the consequence even better than we thought, because it
of the increased opening of mark. reduces the NAIRU.4
238 / 13. IS THE NONACCELERATING INFLATION RATE A USEFUL GUIDE?

These trends may continue to reduce subtle question, put roughly, is, "Should
the NAIRU in the future. Demography policymakers 'target' the NAIRU?" To
will continue to lower the natural rate answer that, we need to know what are
of unemployment as the current bulge of the consequences of basing policy on a
workers in the 35-49 age bracket move mistaken estimate of the NAIRU.
into the even lower unemployment 50 There is a famous dictum of Alfred
plus age bracket, although this effect Marshall that the world is continuous,
will be partly offset by the increase in and I think this applies to macroeconomic
teenagers resulting from the so-called policy as well: if the economy heads a

"baby-boom echo." If hysteresis does below the NAIRU, then we can

little

work in reverse, the current spell of low expect a little more inflation. This view
unemployment should help to generate stands in opposition to the view, more
a lower NAIRU in the next few years. common in nonacademic circles, that
The other two factors affecting the natural the NAIRU is like a precipice: take
rate are harder to predict, although one step over it, and you fall into a
the competitiveness of the economy spiral of rapidly accelerating inflation.
seems with the process
likely to increase The evidence simply does not support
of increased opening of international this view. In fact, the evidence suggests
trade and continued reforms in the U.S. that we can go even further than Marshall
regulatory structure. and say that in this case the world is
not only continuous but approximately
linear: if you hold the unemployment
THE NAIRU AND
rate below the NAIRU for a year, the
MACROECONOMIC POLICY inflation rate rises by about 0.3 to 0.6 of
The third criterion that the natural a percentage point per year. Contrary to
rate hypothesis has to pass if it is to the accelerationist view, not only does the
maintain its claim to an important place economy not stand on a precipice with —
in the analytic toolkit of economists a slight dose of inflation leading to ever-
is that it be useful for discussing and increasing levels of inflation but the —
analyzing policy even when there is magnitude by which inflation rises does
uncertainty about its current and future not increase when the unemployment
level. In a sense, hard to think
it is rate is held down for a prolonged period
about macroeconomic policy without the of time. 5 Thus, small mistakes have only
concept of the NAIRU. Clearly, we would small consequences.
like to get unemployment as low as What if macroeconomic policymakers
possible, without inflation accelerating. do make the mistake of holding unem-
If there is no clear, systematic relation ployment below the NAIRU for a period
between inflation and unemployment, of time, and inflation rises as a result?
why wouldn't policymakers simply keep What is required to reverse this type of
trying to push unemployment lower and a mistake? The traditional view was that
lower? the Phillips curve was convex — the costs
Thus, policymakers must base their ac- of a disinflation in terms of lost employ-
tions on some perceptions about the con- ment were viewed as substantially higher
sequences of changed levels of economic than the benefits of greater employment
activity on the rate of inflation. The more from a similarly sized inflation. The un-
 YES Joseph Stiglitz / 239

derlying intuition was that contractions out of the system. If the hysteresis effect
decreased output by creating more slack proves important, then these conclusions
in the economy, thus raising unemploy- are reinforced. 6
ment, while expansions ran into capacity
constraints, quickly resulting in higher
prices with little employment gain. In this
CONCLUSION
environment, a risk-neutral policymaker When I discuss the NAIRU with the press
would be averse to experimenting with or in public, I am usually asked about
the unemployment rate. In contrast, if the what I think the Federal Reserve will or
Phillips curve is linear, then experimen- should do. The answer I and other mem-
tation has zero expected cost — the cost bers of the Clinton administration give
of a deflation in terms of temporarily in- is always the same: we do not comment
creased unemployment is exactly equal on Fed policy. This stance has served
to the benefit of the lower unemployment the economy well by contributing to a
that caused the inflation in the first place. sense of confidence that our economy is
I want to go even further and sug- well managed. But there are also good
gest that there is some evidence that the economic reasons to avoid being pinned
Phillips curve might be concave. This down to a particular NAIRU. The NAIRU
concavity is consistent with the literature can be moving. Unemployment explains
on asymmetric price adjustment, which only a portion of changes in inflation, and
shows that in monopolistically compet- there are a variety of other economic goals
itive markets, producers might adjust besides simply fighting inflation. The an-
prices down
to avoid being undercut alytic framework connecting NAIRU to
by a but will be more reluctant to
rival inflation is only one of many ingredients
raise prices even in the face of generally that go into the formulation of macroeco-
rising prices. Our empirical research at nomic policy. Moreover, there are broader
the CEA
has found that when we run concerns of macroeconomic policy: if we
Phillips curve regressions allowing for can understand better the determinants
a kink at the NAIRU, we find that the of the NAIRU and the inflationary pro-
best fit is with a concave function. Al- cess, perhaps we can better design poli-
though this concavity is relatively mild, cies that reduce the NAIRU and alter the
it is statistically significant. This particu- tradeoffs.
lar nonlinearity, if in fact it holds up in The natural rate hypothesis passes all
future research, suggests that even risk- three testsI have outlined. Unemploy-

averse policymakers might want to en- ment is an empirically successtul way

gage in moderate experiments with the to predict changes in the inflation rate.
unemployment rate. If, hypotheticallv, Economists have good explanations for
they then discovered that the unemploy- the now undeniable tact that the NAIRU
ment rate had fallen 0.5 percentage points has fallen in the last 15 years, ^\nd forces
below the NAIRU for a six-month pe- like demography and hysteresis will con-
riod,then with a concave Phillips curve tinue to put downward
pressure on the
it would take less of a rise in unem- natural rate. Finally, the natural rate pro-
ployment, possibly 0.4 of a percentage useful framework for thinking
i

point above the NAIRUmonths, for six about policy questions even if there is

to wring the consequent inflation back considerable uncertainty about its

240 / 13. IS THE NONACCELERATING INFLATION RATE A USEFUL GUIDE?

magnitude. In particular, although no one 3. There are reasons why

these groups might
knows exactly where the NAIRU is, these have New entrants to
different "natural rates."
the labor force (teenagers) typically are involved
results suggest that in testing the waters, in more search, in order to find a good "match";
we do not risk need be, we
drowning. If hence, there is likely to be a higher level of frictional
can always reverse course. But by exper- unemployment.
4. In proposing the concept of the natural
imenting, and showing some hesitation rate of unemployment, Milton Friedman separated
about restraining the economy through the demand-management choices of policymakers
higher interest rates or other methods as from the constraints on those choices. While the
argument here agrees with Friedman that supply-
the NAIRU draws nigh, we might learn a side labor market factors like demography are of
more about the depth of the waters
little primary importance, the concept of hysteresis sug-
and possibly become better swimmers in gests that rather than macroeconomic policymakers
being faced with a NAIRU given to them solely by
the process. the supply side of the economy, the natural rate also
depends on the evolution of aggregate demand. In
short, Friedman's dichotomy may be overstated.
NOTES 5. One way to test this hypothesis is to estimate
accelerationist models that nest nonaccelerationism
1. The demographically adjusted unemploy-
as a restricted case. We
have found that the coef-
ment rate takes the actual unemployment rates for
ficients on the acceleration terms are insignificant;
different demographic groups and weights them by
in other words, the restricted model fits the data
their labor force shares in a given year, in this case,
almost as well as the accelerationist model. This is
1993.
true in a variety of specifications.
2. The weakness of inflationary pressures is also
6. With hysteresis effects, policymakers face a
illustrated by the fact that in August 1996, wage
complicated dynamic programming problem, in
growth was still lagging behind the sum of inflation
which policy today must take into account the im-
and trend productivity growth. As noted in the
pacts on the future NAIRU. This discussion has an-
text, inflation can be taken as 2.6 percent, and
alyzed only some of the aspects of macroeconomic
I consider trend productivity growth to be 1.1
policymaking. A fuller discussion would take into
percent, for a total of 3.7 percent. However, even
account factors such as costs of adjustment and of
after the fairly strong growth in earnings in the
variability in output and unemployment, and dy-
August 1996 unemployment report, average hourly
namic learning effects; for example, are there poli-
earnings were growing at 3.6 percent annually. The
cies that can affect the degree of uncertainty about
broader-based Employment Cost Index shows that
the value of the NAIRU or of policy tradeoffs?
compensation increased only 2.9 percent over last
year's level.
 —

NO James K. Galbraith

THE SURRENDER OF ECONOMIC POLICY

There is a common ground on economic policy that now stretches, with dif-
ferences only of degree, from the radical right to Bill Clinton. Across the
spectrum, all declare that the main job of government is to help markets
work well. On the supply side, government can help, up
by pro-
to a point,
viding education, training, infrastructure, and scientific research all public —
goods that markets undervalue. But when it comes to macro economic policy,
government should do nothing except pursue budget balance, and leave the
Federal Reserve alone.
To accept a balanced budget and the unchallenged monetary judgment of
the Federal Reserve is, by definition, to remove macroeconomics from the

political sphere. Thus, the remaining differences between Clinton and the
Congress are over details. Should we head for budget balance in seven years,
eight, or ten? Should we cut (or impose) this or that environmental regulation?
Do Head Start, the AmeriCorps, and technology subsidies justify their cost?
And so on, in long litanies that no one believes will make a fundamental
difference in American lives. Even if there were substantial gains to be made
by public investments on the supply side, the conservative fiscal consensus
precludes them by denying the resources.
We have now seen two Democratic presidents Carter and Clinton —
deeply damaged because they did not dispute this orthodoxy in good time
and therefore could not control the levers of macro policy. Macroeconomics,
not microeconomics, is the active center of power. Practical conservatives un-
derstand this. It is no accident that conservatives always seek to control the
high ground of deficit and interest rate policy, nor any surprise that liberals
defeat themselves from the beginning when they concede it.
Yet, the economics behind this consensus is both reactionary and deeply
implausible. It springs from a never-never-land of abstract theory concocted
over 25 years by the disciples oi Milton Friedman and purveyed through

From James K. Galbraith, "The Sum romfc Policy." The American P-

(March/April 1996), pp. 60-67. Copyright <D 1996 by The American Prospect, P.O. Box 38
Cambridge, MA
02138. Reprinted by permission. All rights n-M<i\

:n
242 / 13. IS THE NONACCELERATING INFLATION RATE A USEFUL GUIDE?

them to the whole profession. Liberals —whether there is any value in attempts
—and anyone else concerned with eco- to steer the economy toward the natural
nomic prosperity— should now reject this rate if happens to be, for a time,
it

way of looking at the world. either above or below it. To the strictest
natural-raters, doing nothing is always
and everywhere the right prescription,
THE RIGHT-WING CONSENSUS ON
because the economy will always return
EMPLOYMENT AND INFLATION*
to the natural rate on its own. Policy
The conservative macroeconomic creed is cannot help, and the very instruments of
built on three basic elements. They are, macro policy should be abandoned.
first, monetarism —the idea that the Fed- The self-described "New Keynesian,"
eral Reserve's monetary policy controls
a breed found throughout the Clinton
inflation, but has little effect on output
administration, believes a vestigial role
and employment except perhaps in the
for macro policy can be preserved.
very short run. Second, there is rational
Unemployment may persist above the
expectations, which is the idea, for which
natural rate because wages take more
Robert Lucas just won the Nobel Prize,
time than other prices to adjust to changes
that individual economic agents are so
in supply and demand, leading to failure
clever, so well informed, and so well edu- 7
of the labor market to "clear/ That being
cated in economics that they do not make
so, there may be no harm in policy
systematic errors in their economic deci-
sions, especially the all-important choices
—
measures a little stimulus now and then

of labor supply And third, there is market

when there is a serious recession to —
speed the return to the natural rate so
clearing: the idea that all transactions, in-
long as a "soft landing" is carefully
cluding the hiring and firing of workers,
engineered.
occur at prices that equate the elemental
forces of supply and demand. Alas, the location of the natural rate is

Taken together, these assumptions con- not actually observed. Worse, the damn
jure an efficient labor market that yields thing will not sit still. It is not only
appropriate levels of employment and invisible, it moves! This is no problem
wages. The employment level gener- for the never-do-anything crowd. But
ated by this abstraction is the core it poses painful difficulties for would-

policy concept of mainstream macroe- be intervenors, those few voices in the

conomics, known as the natural rate administration who call, from time to
of unemployment. If unemployment is
1
time, for summer jobs, public works
above the natural rate, the theory dic- programs, and lower interest rates. How
tates that prices and wages will fall. can one justify a dash to the goalposts,
If unemployment is below the natu- if you don't know where they are? New
ral rate, the theory dictates that infla- Keynesians obsessively estimate and re-
tion will rise. Sustainable, noninflation- estimate the location of the natural rate,
ary employment growth occurs only at in order to guide their policy judgments.
the natural rate. have never yet been able to
Sadly, they
Among most economists these ideas predict its which may be one
location,
are amazingly noncontroversial. The only |
reason why there has never yet been a
dispute is over a narrow point of policy successful "soft landing."
 NO James K. Galbraith/ 243

what ground and to what number. Or

WHERE IS THE NATURAL RATE?
we may leam that the Federal Reserve
To the (questionable) extent that the Fed- doesn't really have a natural rate theory
eral Reserve has any coherent macroe- anymore, but is only holding on to the
conomic theory, it tends to be implicitly rhetoric of these ideas, for want of any
New Keynesian on this issue. That is, alternative that ideological conservatives
the Federal Reserve Board is an inveter- might accept.
ate intervenor, raising interest rates when
unemployment is too low, and lowering

them, grudgingly, to end or sometimes The components of today's low inflation

to avoid recessions. And so the Federal rate are not at all consistent with the
Reserve also spends a good deal of time natural rate theory. No part of present
and effort trying to pin down the phan- inflationary pressure, such as it is, stems

tom and elusive natural rate. from wages. Wage compensation, two-
In 1994, with the natural rate estimated thirds of all costs, remains flat. The whole
by numerous astrologers at about 6 per- of today's modest inflation stems from a
cent, monetary policymakers faced an boom in profits and investment income,
interesting problem. Actual unemploy- and from the effects of this boom on
ment, now at 5.8 percent, had fallen be- commodity prices and other incidentals
low the estimated natural rate. So how of the inflation process. There has also
then to interpret the rest of the data, been some contribution from the rising
which contrary to theory showed no ev- interest costs imposed since February
idence of accelerating inflation? Did the 1994 by the Federal Reserve's own policy.
apparent lack of inflationary acceleration This problem is illustrated in "What's
mean that the natural rate had perhaps Driving Inflation?" (Figure The old
1).

fallen, and if so to what value? Or, had relationship between and labor
inflation
the barrier been broken and, in Robert costs really has busted up since Reagan
Solow's phrase, was inflation "accelera- fired the air traffic controllers and he
tion just around the comer"? Or again, and Volcker overvalued the dollar. Prices
was the whole theory rotten and fit for may be rising at 2.7 percent annually, but
the garbage? real wages are scarcely moving. Indeed
The Federal Reserve proved unwilling we find that all inflation accelerations
to change its estimate of the natural un- after I960, with the sole exception of
employment rate. So it tightened mon- that following Richard Nixon's election
etary policy from February 1994 through campaign in 1972 (when price controls
early 1995, as the economy broached the 6 were in torce), were led by prices and not
percent unemployment barrier. But then by wa.-
the Federal Reserve shifted course and
started cutting interest rates in Jul)
THE NOMADIC AIRU
even though unemployment remained
below 6 percent. Why? It will be inter- How la all of this to be reconciled
esting to leam, when the full minutes with a theory oi inflation acceleration
are released, whether the Federal ft based exclusively on the natural rate
formally changed its estimate of the nat- Of unemployment in ,\n aggregate labor
ural rate in July of 1995, and it so, on market? it can't be done it there 1st
 —

244 / 13. IS THE NONACCELERATING INFLATION RATE A USEFUL GUIDE?

Figure 1

What's Driving Inflation?

15

This graph shows that wages have lagged behind prices for more than 20 years—good evidence that labor
markets are not tight.

demand for labor, surely a good (new) unemployment to come down without
classicaleconomist must insist that real kicking off inflation. Depending on how
wages are rising. But they aren't and — you factor in the high-inflation decade
haven't been in 20 years. Something must of the 1970s, an honest estimate of the
be wrong with the natural rate model. natural rate —even if you believe it

(Good economists at the Federal Reserve might be 6 percent or much lower.

know this, and it bothers them, as it
should.) In fact, something is more than But the second graph shows how
wrong with the model. The model is junk, fruitless the search for a natural rate
as we should have known long ago. really is. The graph employs centered 12-
This is nicely shown by the two month moving averages of monthly data
graphs in Figure 2 ("Follow the Bouncing for both inflation and unemployment.
Natural Rate"). The first shows how the It illustrates that rising inflation is

unemployment which inflation

rates at essentially The shocks
unpredictable:
accelerated have changed over the last that cause it sometimes happen at
40 years. In the 1950s they were low, high unemployment, sometimes not until
in the 1970s, quite high. But recent data unemployment is quite low. There is no
rather resemble the 1950s again, which sign in recent data of rising inflation as
would indicate that there is room for unemployment falls.
 NO James K. Galbraith / 245

Figure 2
Following the Bouncing Natural Rate

14

12
; i
Inflation ' « . .

10
\ >j
> \

•
70s
NAIRU
; \

\j
'
\ Unemployment
8
6 Percent • A \/ A
N a NAIRU ,' l\ \/\
6

4
V /\ / \ -'
/ V w

I
_ - - - -
- ' ~>
-r^-,' -
'
' i

-,

'

J
^-/ .x 50s
I

I '
' '

' - »
• . / \ NAIRU / I <

Where Is
2 i'

-
1

1
now?
It

1 1

I 1

t
-2 -H-t i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i i » i
1

Year

OPEC II

•*-

-i r
10 11

Unemployment Rate

The graph at the top shows how estimates of the natural rate can change over time. Recent data resemble
the 1950s, indicating that an honest estimate of the natural rate today might be far lower than 6 percent.

The graph at the bottom shows how unpredictable shocks (like OPEC) have pushed around the relationship
between inflation and unemployment. Since a shock can hit at a high unemployment rate as well as at a
low one, why not go for full employment?
 .

246 / 13. IS THE NONACCELERATING INFLATION RATE A USEFUL GUIDE?

Indeed, the pattern of widening gyres macroeconomic issue. Low and stable in-
reversed itself after the deep recession of terest rates are essential here —more on
[Link] the rest of the 1980s, un- that later. Public investment can step in
employment fell without wage pressures where private investment will not go,
and without sharp rises in inflation. The and should be designed and pursued for
recession of 1989 hit while inflation was its imaginary indi-
direct benefits, not its
low by historic standards. And in the past rect ones. But consumption is also an im-
four years, 1992 through 1995, there has portant and much maligned policy ob-
been falling unemployment with falling jective. People should have the incomes
unit labor costs and no rise whatever in they need to be well fed, housed, and
inflation (see the horizontal ellipse). We clothed —and also to enjoy life. Public ser-
do not know where the nomadic accel- vices can help: day care, education, pub-
erating inflation rate of unemployment lic health, culture, and the arts all deserve

—
(AIRU) is today because we don't know far more support than they are getting.
when the next shock might hit us. So why
not go for full employment? . . Technology. Technological renewal
should be understood as part of a strategy
of mamtaining investment demand. It
MACRO POLICY IN A makes sense progressively to shut down
STRUCTURALIST WORLD
the back end of the capital stock, for envi-
Conservatives employ the myth of the ronmental, safety, energy efficiency, and
market to oppose political solutions to competitive reasons. Properly designed
distributive problems. But to leave things regulation can help, and this will open up
to themarket is no less a political choice investment opportunities for new tech-
than any other. nologies. At the same time, a flatter wage
Suppose the concept of an aggregate la- structure and bigger safety net, including
bor market and the associated metaphor retraining but also more generous early
of a natural rate of unemployment could retirement for older displaced workers,
be wiped away with a stroke from the would reduce the cost of job loss and the
professional consciousness (as it deserves resistance from affected workers. Again,
to be). The policy notion that control- this is an adjunct of high-growth macro
ling the reduction of unemployment is policy, not a substitute for it.

the principal means of fighting inflation

would lose its power. It would then be- Inflation. Inflation policy would not go
come intellectually possible to revive the away But the pursuit of relative price sta-
idea of giving a job to everybody who bility, rather than being the result of slug-
wants one. The issue becomes not how gish growth and tight money,would be-
many jobs but rather who to employ and come concerned with the management of
on what terms? particular elements of cost, as the econ-
omy got closer to employment. This
full
Investment and Consumption. Creat- includes wage and also ma-
pressures,
ing jobs is a matter of finding things terials prices, rent, and interest. Man-
for people to do. Investment of all kinds agement of aggregate demand an un- —
creates jobs, and stabilization of private doubted force on nonwage prices could —
investment demand is the traditional operate through channels with less ef-
 NO James K. Galbraith / 247

feet on employment (a variable tax on turnover. This is a doubly important

excess profits, for example). Since wages work, once for its direct policy relevance
are a major element in costs, inflation pol- and again because it flatly contradicts,
icy would be concerned with the institu- and deeply undercuts, standard models
tional mechanisms of wage bargaining. of the aggregate labor market.

Distribution. This exercise returns us

to the real, inevitably political questions Interest Rates. Low and stable has to
obscured by technical mumbo jumbo be the watchword. Interest rates should
about natural unemployment rates: our lose their present macroeconomic func-
overall structure of incomes and oppor- tion, which has been to guarantee stag-
tunities. What should be the distribution nation. They should serve instead to arbi-
of incomes? How much range, between trate the distribution of income between
the bottom and the top? Between capi- debtors and creditors, financial capital
tal and labor? Between skilled and not? and entrepreneurship. As a first approx-
In my view, the present course of rising imation, real rates of return on short-
inequalitymust be reversed, and liberals term money should be zero. And there
should frankly support the political steps is no reason why long-term rates of in-
required for this purpose. Trade unions terest in real terms should exceed the
should be strengthened and the aggres- long-term real growth rate of the econ-
sive new organizing campaigns of the omy. Indeed they should lie below this
AFL-CIO strongly supported. Minimum value, effecting a gradual redistribution
wages should be raised. And liberals of wealth away from the creditor and to-
should strongly defend the progressive ward the debtor class and a long-term sta-
income tax, as well as support proposals bilization of household and company bal-
for wealth taxation. ance sheets. Speculation in asset markets
Once the basic distribution of income should be heavily taxed.
has been set right, further gains in real
wages can only happen, on average, at
the rate of productivity growth. But to
Deficits. Ironically, the budget deficit
keep the distribution from getting worse hardly comes up in this discussion.
again, these gains should be broadly
During the postwar boom, we were
distributed, substantially social and only
a high-employment, low-inflation, low-
slightly industrial or individual. In other
interest-rate society with a progn
words, we need to return to the principle
tax structure. Such societies do not have
of solidarity — that the whole society Structural-deficit problems. A peacetime
advances together. would also
military budget greatly help.
Higher minimum wages are especially At any rate, the parent fixation on
important for this purpose. In their balancing the budget nonsen-
is
book, Myth and Measurement, David all serious economists should loudly
Card and Alan Krueger argue that declare.
raising the minimum wage within a
reasonable range would not cost jobs. The above, all taken together, would
In fact, higher minimum wages may tnacroeconomic pol hi tor!

increase employment by reducing The liberal microeconomic SUppl) -siders

248 / 13. IS THE NONACCELERATING INFLATION RATE A USEFUL GUIDE?

—
can do some useful things or think they
NOTES
—
can by getting a little money into ed-
ucation, training, infrastructure. But the 1. Some economists prefer the term nonacceler-
ating inflation rate of unemployment or NAIRU.
point is to raise living standards, to in- The idea is essentially the same. The natural
crease security and leisure, and to pro- rate/NAIRU was introduced to supplant the older
Phillips Curve idea of a static trade-off between in-
vide jobs that are worth having. And that
flation and unemployment, and to suggest that in-
requires us to reclaim macroeconomics as flation would not only rise, but inevitably acceler-
a major policy tool. ate, if unemployment falls too low.
POSTSCRIPT
Nonaccelerating Inflation Rate of
Is the
Unemployment a Useful Guide for
Macroeconomic Policy?
argues the NAIRU can be a useful guide in the formulation of macro-
Stiglitz
economic policy if it satisfies three criteria. The first criterion is a robust

empirical relationship between unemployment or the natural rate of unem-

ployment and changes in the rate of inflation. The second criterion concerns
the ability to explain and predict changes in the NAIRU. Stiglitz believes
that the NAIRU has been declining and that causes of this decline have been
identified as the changing labor force demographics, closer correspondence
between productivity growth and worker expectations, increased competi-
tion in product and labor markets, and sustained lower unemployment. The
third criterion involves the consequences of policy actions if an incorrect
value of the NAIRU is employed. Stiglitz believes that the consequences of
policy actions under these conditions will be minor. Therefore, because all

three criteria are satisfied, he concludes that the NAIRU is a useful guide for
macroeconomic policy.
Galbraith begins his analysis by stating his belief that macroeconomic pol-
icy hasbeen removed from the political sphere. That is, the Democratic Clin-
ton administration and the Republican Congress have reduced fiscal policy
to balancing the budget and have left monetary policy to an unchallenged
Federal Reserve. Focusing on the NAIRU, Galbraith makes two important
claims. First, since 1960 all accelerations in inflation except one were led by
prices and not wages. Second, rising inflation is essentially unpredictable.
Both of these points convince Galbraith that the NAIRU is useless as a policy
guide. He argues, instead, for a full employment macroeconomic policy.
For a series of more technical discussions of the natural rate of unemploy-
ment, see the Journal of Economic Perspectives (Winter 1997). This issue contains
the complete essay by Stiglitz as well as another essay by Galbraith attack-
ing the natural rate concept, "Time to Ditch the NAIRU." Other articles in
this issue are "The Time-Varying NAIRU and Its Implications for Economic
Policy/' by Robert J. Gordon; "The NAIRU, Unemployment and Monetary
Policy/' by Douglas Staiger, James H. Stock, and Mark \V. WatSOft; "What Do
We Know and Do Not Know About the Natural Kate of Unemployment?* by
Olivier Blanchard and Lawrence Katz; and
I theory Ahead oi angi I

in the Economics of Unemployment," by Richard RogeiSOn. Also Bee "Our

NAIRU Limit: The Governing Myth oi Econom net,
The American Prospect (Spring 1995).

249
ISSUE 14
Would Adopting Wisconsin's Welfare
Reforms End Welfare As We Know It?
7
YES: Robert Rector, from "Wisconsin's Welfare Miracle/ Policy Review
(March/April 1997)
NO: Michael Wiseman, from "Welfare Reform in the United States: A Back-
7
ground Paper/ Housing Policy Debate (1996)

ISSUE SUMMARY
YES: Heritage Foundation senior policy analyst Robert Rector claims that
Wisconsin has already won more than half the battle against Aid to Families
with Dependent Children (AFDC) dependence and is proceeding with the
other half with breathtaking speed.
NO: University of Wisconsin economist Michael Wiseman concludes that
not even the governor of Wisconsin has found the key to welfare savings
by means other than cutting benefits and active broad-based efforts at job
placement and training.

Given American society's traditional commitment to a market system and

itsfundamental belief in self-determination, Americans are generally un-
comfortable enacting social welfare legislation that appears to give someone
"something for nothing/' even if that individual is clearly in need. Thus,
when we trace the roots of the existing U.S. social welfare system back to
its origins in the New Deal legislation of President Franklin D. Roosevelt

during the Great Depression of the 1930s, we see that many of the earliest
programs linked jobs to public assistance. One exception was Aid to Families
with Dependent Children (AFDC), which was established as part of the 1935
Social Security Act. This program provided money to families in which there
were children but no breadwinner. In 1935, and for many years thereafter,
thisprogram was not particularly controversial. Two reasons explain this:
thenumber of beneficiaries was relatively small, and the popular image of an
AFDC family was that of a white woman with several young children whose
husband had died as the result of an illness or an industrial accident.
—
In the early 1960s, as the U.S. economy prospered, poverty and what to
—
do about it captured the attention of the nation. The Kennedy and John-
son administrations declared a War on Poverty: major legislative initiatives
focused social welfare programs on the plight of the poor, who represented
about one-fifth of the population and were white by a ratio of two to one. This

250
pattern is often overlooked because the incidence of poverty among African
Americans exceeded 50 percent of that community.
The policies of the Kennedy and Johnson administrations were designed
to address the needs of those trapped in "pockets of poverty/' a description
popularized in the early 1960s by Michael Harrington (1929-1989), a political
theorist and prominent socialist. Between 1964 and 1969 the number of AFDC
recipients increased by more than 60 percent, and the costs of the program
more than doubled. The number of AFDC families grew throughout the 1970s
and 1980s, and the program became increasingly controversial.
The controversy grew for several reasons: the increase in the number of
recipients, the increase in costs, and a change in perceptions. During the
Reagan years, a welfare mother was characterized as a woman in a big-city
public housing project whose children had been deserted by their father, or
as an unmarried woman who bore more children only to get more financial
assistance through welfare. By the late 1980s and early 1990s, AFDC had
become one of the most controversial social welfare programs.
Social critics used this negative image of the welfare mother to attack AFDC.
Charles Murray, for example, charged AFDC with encouraging welfare de-
pendency, teenage pregnancies, the dissolution of the traditional family, and
an erosion of the basic American work ethic. Such criticism set the stage for
the first major reforms in AFDC in 25 years. In 1988 the Family Support Act
was passed. The intent of this legislation was to develop state-run programs
that would help individuals who receive welfare assistance to break away
from their dependency through work, training, and education.
Within a few short years, most states had nearly 20 percent of their welfare
caseload either working or in a work training program. The use of waivers be-
came widespread. These waivers, which allowed states to experiment with
federal rules governing AFDC eligibility, work incentives, and work man-
dates, were either approved or pending in all but four states by mid-1996.
In the face of this sea change in public attitudes and state public policy,
President Bill Clinton pledged to "end welfare as we know it." Within eight
months of the start of his second term, Congress obliged. In a bold legislative
move it passed the Personal Responsibility and Work Opportunity Act. This
act abolished the AFDC entitlement that had guaranteed poor families a
standardized set of welfare benefits for 60 years and replaced AFDC with a
new block grant program entitled Temporary Assistance for Needy Families
(TANF), which allowed individual states far more discretion in determining
which families would be supported and how much each of these families
would get.
No pursued these options more
single state ely and with more
apparent success than the state of Wisconsin. Both Robert Rector .md Michael
Wiseman agree that Wisconsin has ended "welfare as we know it." What they
disagree on is what works and what does not in the Wisconsin waivers and
more importantlv, what the future holds tor states that tollow Wisconsin's
lead.

251
 Robert Rector
YES

WISCONSIN'S WELFARE MIRACLE

— —
Everyone wants or professes to want to "end welfare as we know it."
Despite such lofty proclamations, welfare is still thriving. [In 1996], federal
and state governments spent $411 billion on means-tested welfare programs
that provide cash, food, housing, medical care, and social services to poor
and low-income Americans. This greatly exceeded the $324 billion spent in
1993, the first year of the Clinton presidency.
At the core of America's vast, dysfunctional welfare system is Aid to Fam-
ilies with Dependent Children (AFDC). At present, nearly one out of seven

children in the United States receives AFDC, residing with a mother married
to a welfare check rather than a working husband. The typical family now on
AFDC will spend nearly 13 years in the program.
"Ending welfare" must begin with reform of AFDC. Congress enacted
major new legislation last summer that will start this process. The new law
promises three major changes. First, it eliminates the entitlement system
of AFDC funding, under which states that increased their AFDC caseloads
received automatic increases in federal funding, while states that reduced
dependence faced a fiscal penalty.
Second, the new law establishes performance standards that will require
each state to reduce its AFDC caseload, or at least, if the caseload does not
decline, require some recipients to work in return for their benefits.
Third, the law sets a new goal of reducing illegitimacy and will reward
states that reduce out-of-wedlock births without increasing the number of
abortions.
Although the new federal legislation sets the proper framework for reform
among the states, the liberal welfare establishment and its allies in the media
incessantly warn that reform will prove to be difficult, if not impossible. But
one statehas already proven the naysayers wrong: Wisconsin. Wisconsin's
experience with welfare reform provides an unparalleled model for imple-
menting reform that other states would be wise to follow.
In the last 10 years, while AFDC caseloads in the rest of the nation were
rising steeply, the caseload in Wisconsin has dropped by half. In inner-city
Milwaukee, the caseload has fallen by 25 percent, but in the rest of the state,

From Robert Rector, "Wisconsin's Welfare Miracle," Policy Review (March/April 1997). Copyright
© 1997 by Policy Review, published by The Heritage Foundation. Reprinted by permission.

252
 YES Robert Rector 7 253

caseloads have fallen by nearly 70 office with a firm commitment to reform.

percent. In 28 of Wisconsin's 77 counties, Figure 1 tells the rest of the story.
the welfare rolls have already dropped by Despite the rhetorical promises of the
80 percent or more. Family Support Act, the nationwide
And if all this weren't remarkable AFDC caseload remained constant in
enough, the pace of Wisconsin's reduc- the late 1980s and then grew by more
tion in welfare dependency is accelerat- than a third between 1990 and 1994.
ing. In Milwaukee, the AFDC caseload is The nationwide caseload has eased
now shrinking 2 percent per month; in downward over the last two years, but
the rest of the state, 5 percent. Wiscon- the majority of states still suffer higher
sin's achievements are utterly unprece- dependency than before
levels of welfare
dented in the history of AFDC. Liberal the Family Support Act became law.
welfare experts used to insist that a suc- Wisconsin has been the only clear
cessful work program might reduce wel- exception to this pattern. Upon taking
fare caseloads by 5 percent over five office, Thompson initiated a series of
years; in much of Wisconsin, the number reforms that cut welfare dependency dur-
of people on welfare is steadily falling by ing the late 1980s and blocked any resur-
that amount every 30 days. gence during the 1990-93 recession. Start-
Wisconsin has thus won more than half ing in 1994, a second round of more
the battle against AFDC dependence and sophisticated work-related reforms has
is proceeding with the other half with caused the caseload to nosedive further.
breathtaking speed. This victory is cru- But the raw figures understate Thomp-
cial, since welfare dependency severely son's achievements. As noted, welfare
hampers the healthy development of chil- rolls across the country ballooned by
dren. In the long term, the greatest bene- some 35 percent during the early 1990s.
ficiaries of Wisconsin's dramatic achieve- There is every reason to believe that,
ments in reforming welfare will be the without Thompson's reforms, Wisconsin
children themselves. would have followed this national trend.
If it had, its AFDC caseload would have

surged from around 100,000 recipients in

THE ROAD LESS TRAVELED 1987 to a peak ot 135,000 in 1993. It .

This remarkable story begins in 1987, sonable to conclude that Thompson has
when a major congressional debate on not merely cut his state's caseload m half
welfare culminated in the Family Support (from 98,295 recipients to 48,451) but has
Act (FSA). Touted as yet another "end reduced it by some two-thirds relative
of welfare," the FSA was a complete to the potential peak in dependence that
bust. The Act did, however generate the fisin would have experienced in the

expectation among voters that welt. ire early L990a m the absence ot reforot
recipients would be required to work In Many states brag about their recent
the same year a second unheralded declines m welfare dependency. In the
occurred with far greater significance tor past 21 months, tor example, Indiana
the future of welfare: Tommy Thompson iseload by 32 percent
took office as governor of Wisconsin n by 30 percent Maryland by 29
Following a gubernatorial campaign Massachusetts by 25 percent
largely about welfare, Thompson entered Oklahoma by 24 percent, and Michigan
254 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

by 22 percent. almost every

But, in to demand constructive behavior of
merely represent a
case, these successes welfare recipients and to sanction those
pruning back of the explosive surge in who were derelict.
welfare dependency of the early 1990s. The centerpiece of reform, however
In reality, other reforming states lag a was the requirement that a growing
half-decade behind Wisconsin; they are share of those on the AFDC rolls engage
only now engaging in the initial stages in employment-related activities such
of dependency reduction that Wisconsin as training and tightly supervised job
accomplished in the late 1980s. We might [Link] the 1990s, many Wiscon-
say that the reforms in most states have were operating sophisticat-
sin counties
merely blown the foam off the top ed systems aimed at pushing welfare
of the beer mug, while Wisconsin has recipients quickly into the labor market.
already drained the mug halfway to the For example, a particularly effective
bottom. program in Sheboygan County required
Having cut its caseload in half, Wiscon- most AFDC recipients to undertake
sin's reformers are now grappling with a closely supervised job search immediate-
more difficult, less employable group of applying for benefits. Individuals
ly after
welfare recipients. Skeptics argued that who employment within
failed to find
after Wisconsin weaned the most em- a few weeks were required to perform
ployable recipients off the rolls in the community-service work until they could
early stages, the decline in the caseload find a private-sector job.
would slow and then stop. Yet the oppo- Beginning in 1994, Thompson's staff
site has occurred. As new reforms have initiated a more sophisticated and suc-
been implemented over the last three cessful round of reforms. His administra-
years, the decline has accelerated sharply. tion instructed county welfare directors
Wisconsin continues to reduce depen- to de-emphasize education and job train-
dency at a rate surpassing all other states. ing in the classroom and to concentrate on
activities leading to immediate work. The
state created new incentives to guide the
REFORM INITIATIVES welfare bureaucracies: Counties would
The general thrust of welfare reform in no longer be simply allocated work, train-
the Thompson administration has been to ing, and day-care funds but would be re-
require reasonable behavior by recipients quired to earn those funds by increasing
as a condition of receiving aid. An early the number of recipients placed in jobs or
example was Learnfare. Enacted in 1987, community-service work.
the Learnfare program required welfare The governor's staff also understood
recipients to ensure that their school-age that many applicants entering the welfare
children attended school regularly, and system had other options. The easiest
reduced welfare payments to families way to break this group of the debilitating
with truant children. Although Learnfare habit of dependency was to prevent
did not reduce the AFDC rolls directly, it it from forming in the first place, by

did have a symbolic importance, sending reducing the number of new AFDC
a clear message to both the bureaucracy enrollments. The state began a pilot
and the welfare clientele that, for the first program based on this principle in 18
time, the government seriously intended counties in 1994 (gradually expanded to
 YES Robert Rector/ 255

Figure 1

AFDC Families: Wisconsin vs. the Nation

5.25 mil.

135. COO

4.75 mil.

- 125,000
The nation

4.25 mil. -

3.75 mil.

Number Number of
of U.S. - 95.000 Wisconsin
families 3.25 mil.
families
receiving receiving
AFDC 85.000 AFDC
2.75 mil.

75.000

2.25 mil.

65,000

-
1.75 mil.
55,000

1.25 mil. 1 1 1 1 1 1 1
45,000
I I

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Source: U.S. Department of Health and Human Services.

cover 60 by early 1996). The program, community-service work continues to

Work First, provided new applicants with receive full AFDC payments but must
counseling on the negative effects of work for the benefits ob tamed.)
dependence, offered short-term aid (such
as car repairs) that might eliminate the Another program called
pilot
need to enroll in AFDC, and required (WNW)
began in Januarv
most new applicants to begin working in 1995 in two counties, Fond du LftC c\nd
private-sector jobs or community-service Pierce WNW placed An absolute time
jobs almost immediately after enrolling limit of 24 months on receiving AFDC.
in welfare. (Once a recipient starts a Although this program otn iously had no
full-time job in the private sector AFDC direct impact on dependency in most oi
benefits are eliminated; however AFDC ite, it did send a strong symbolic
benefits generally continue at a reduced message to welfare recipients; Long-
level while the recipient works part term dependence would no longer be
time. By contrast, a recipient performing tolerated. (Mill, caseloads m those two
256 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

more
counties have fallen only slightly munity work he fails to perform. An in-
most other counties.)
rapidly than in dividual who
performs no work would
In December 1995, the governor's receive no AFDC or food stamps. Criti-
staff instituted a radical new system cally, the PFP principle was also applied
for rewarding good performance in to other constructive activities such as
county welfare offices. The new system class attendance or supervised job search.
employed competitive bidding for the PFP effectively eliminated the freedom
management of each county's welfare of most Wisconsin AFDC recipients
system. Governmental or private organi- to receive welfare without working.
zations currently running AFDC in each Caseloads, already in rapid decline,
county were thus threatened with com- began to plummet. In the first seven
petition and could be replaced by out- months after the implementation of Pay
side organizations. The current welfare for Performance and Self-Sufficiency First,
organizations, however could escape the the AFDC caseload dropped 14 percent
competitive bidding process if they ful- in Milwaukee and 33 percent in the rest
new performance criteria specified
filled of the state. If the trends continue, the
by the state. Chief among these criteria welfare rolls statewide will drop by an
was a requirement that each county re- additional one-third over the next 12
duce its AFDC
caseload by roughly 15 months.
to 25 percent (requirements varied by
county) over the subsequent 12 months.
REFORM SKEPTICS
Apologists for big welfare have natu-
DECISIVE NEW POLICIES rally sought some pretext for ignoring or
In April 1996, Wisconsin unveiled two trivializing Wisconsin's achievement The
more decisive reforms. Work First (re- most common ploy is to attribute the de-
named Self-Sufficiency First) went into cline in AFDC caseload to a "good econ-
effect in all counties including Milwau- omy." Although Wisconsin has enjoyed
kee, and a new Pay for Performance (PFP) low unemployment and healthy growth
system was implemented statewide. For in jobs, it is ridiculous to claim that this
decades politicians have talked about has brought about a dramatic reduction
making welfare recipients work while in caseload. After all, over the past 40
creating regulations that made this im- years states have often experienced ro-
possible. With Pay for Performance, Wis- bust economic growth without any sig-
consin closed the loopholes, creating for nificant drop in the welfare rolls, let alone
the first time a real work requirement for a drop of 50 percent.
AFDC recipients. Prior to PFP, a recipi- The limited role of economics in
ent who failed to obtain a private-sector Thompson's victory over dependence
job might be required to perform commu- can be seen by comparing Wisconsin with
nity service. If the recipient failed to actu- the 13 states that have experienced lower
allyperform this service work, however, levels of unemployment than Wisconsin
the state could only cut AFDC benefits over the past decade. In these states,
slightly. Under PFP, a recipient would see the welfare rolls, on average, actually
his welfare check reduced in direct pro- increased by some 20 percent. None
portion to the number of hours of com- produced a substantial decline in welfare
 YES Robert Rector/ 257

Table 1

Wisconsin Leads the Nation

Rank State Jan. 1987 Sep. 1996 Change in Caseload
1. Wisconsin 98,295 49,930 -49.2 : o
2. Michigan 214,273 167,210 -22.0%
3. Iowa 39,697 31.010 -21.9%
4. Louisiana 85,047 66,540 -21.8%
5. Mississippi 57,082 44,840 -21.4%
6. Alabama 47,817 40.640 -15.0%
7. South Dakota 6,620 5.670 -14.4%
8. Nebraska 16,246 13.950 -14.1%
9. Maryland 66,248 57,130 -138%
10. Ohio 227,035 201.950 -11.0%
11. Illinois 240,764 217.130 -9.8%
12. New Jersey 117,694 106.500 -9.5%
13. North Dakota 5,069 4.660 -8.1%
14. Kansas 25,256 23,390 -7.4%
15. Indiana 53,156 49,500 -6.9%
16. Massachusetts 87,195 81,260 -6.8%
17. South Carolina 45,640 42.640 -6.6%
18. Wyoming 4,640 4,340 -6.5%
19. Oregon 30,368 28.530 -6.1%
20. Pennsylvania 187,946 179.880 -4.3%
21. Arkansas 22,797 22.060 -3.2%
22. Montana 9,410 9.490 0.9%
23. Maine 19,329 19.700 1.9%
24. Utah 13,720 14,030 2.3%
25. West Virginia 36,485 37.470 2.7%
26. Minnesota 54,699 57.150 4.5%
27. Virginia 56,751 60,340 6.3%
28. Oklahoma 32,653 35.230 7.9%
29. Colorado 31,079 33.550 8.0%
30. Vermont 7,678 8,660 12.8%
31. New York 358,083 412.720 15.3%
32. Missouri 67,690 78.980 16.7%
33. Kentucky 59,579 69,840 17.2%
34. Dist. of Col. 19,988 25.140 25.8%
35. Washington 75.697 96.800 27.9%
36. Rhode Island 15,843 20.420 28.9%
37. Delaware 7.810 10.450 33.8%
38. Idaho 6.215 8.500 36.8%
39. Georgia 87,329 120.520 38.0%
40. Tennessee 65,296 90.520 38.6%
41. Connecticut 38.919 57.040 46.6%
42. California 585.321 870.230 48.7%
43. Hawaii 14,498 21,890 51.0%
44. Texas 153,934 238.340 54 8%
45. North Carolina 67.360 107.480 59.6%
46. Alaska 7.163 12.320 72.0%
47. New Mexico 18.207 32.970 81.1%
48. Florida 102.013 200.290 96.3%
49. New Hampshire 4.329 8.920 106.1%
50. Arizona 29.114 61.790 112.2%
51. Nevada 5.575 13.120 135.3%

U.S. Total 3,735.386 4,267,926 14.3%

Change in number of families receiving Aid to Families with Dependent Children, January 1987 through
September 1996. by state.
Source: U.S. Department of Health and Human Services.
258 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

caseloads. Although a robust economy years. This philosophy regards depen-

has undoubtedly helped Wisconsin to dence and idleness as harmful to the wel-
reduce welfare dependency, it is far from fare recipient and insists that he perform
the principal cause. useful labor in exchange for benefits he
Another common dodge of the skep- receives.
tics is to claim that reform has raised Thus a serious work requirement pro-
welfare costs. This charge no surprise;
is vides not only a sound moral foundation,
defenders of the status quo have al- but also performs a crucial gatekeeping
ways claimed that taxpayers must "in- function. A key problem for rational char-
vest" more funds in order to "end wel- ity isseparating those who truly need aid
fare." But Wisconsin's reforms did not from those who do not but are willing to
result in increased spending in either the take a free handout if one is offered. Work
short or long term. Although the state has requirements serve that purpose. For ex-
increased its outlays on welfare adminis- ample, in the 19th century, religious or-
tration, job training, and day care, these ganizations throughout the United States
expenditures have been more than offset provided food and shelter to persons who
by the rapidly shrinking caseload. Wis- would today be called "homeless." Be-
consin spends more per family on welfare fore providing a free meal and a bed,
now than in 1987, but it has half the num- however, the shelter would require the
ber of families on welfare. The greatest man seeking aid to perform some useful
expenditure increase has been for welfare chore such as chopping firewood. Charity
administration; although day-care costs workers had discovered that such a re-
have also increased modestly, they still quirement greatly reduced the numbers
constitute only 6 percent of the total. To- seeking aid. This "work test" winnowed
day Wisconsin's aggregate spending on out those who did not need aid and al-
AFDC benefits, administration, training, lowed the philanthropists to focus lim-
and day care, in current dollars, is some ited resources on the truly needy.
5 to 10 percent lower than in 1986, the With one out of seven children enrolled
last year before Thompson became gov- in AFDC, the current system is so large
ernor. But in the rest of the nation, sim- that serious reform will be impossible.
ilar expenditures have nearly doubled The initial task in transforming welfare
in the same period: Clearly, Wisconsin's is to shrink the AFDC caseload to
reforms have produced huge de facto manageable proportions. Culling those
savings, not higher costs. In inflation- who do not truly need aid from the
adjusted terms, Wisconsin's spending is welfare rolls will allow the system to
actually down by a third since 1986. focus its efforts on those who have the
most difficulty becoming self-sufficient,
and will free up resources and energy
LESSONS LEARNED
needed to deal with the underlying
The Wisconsin experience provides a cor- problems, such as educational failure
nucopia of lessons for the rest of the na- and illegitimacy, that promote future
tion. In reforming welfare, Wisconsin has dependence.
rediscovered a philanthropic philosophy Wisconsin's example provides nine
once ubiquitous in American charities, clear rules on how to sharply reduce
but largely abandoned over the past 40 dependency:
 YES Robert Rector / 259

1. Set the right goal. If the ultimate aim 4. Use work requirements to reduce

of reform is to reduce
dependence, the welfare applications. The most impor-
official goal must be to reduce the welfare tant effect of a work requirement is to re-
caseload. A large drop in caseload duce dramatically the number of persons
entails dramatic administrative change who apply for welfare. This is called the
and threatens the financial self-interest of "dissuasion" effect of work requirements.
the welfare industry. Ingenious welfare By operating programs such as Self-
bureaucrats will thus propose other Sufficiency Firstand by requiring most
performance criteria that allow them to new applicants to find private-sector em-
claim success in reducing dependence ployment or perform community-service
while caseloads continue to rise. Such work shortly after enrolling in welfare,
ersatz benchmarks generally include: Wisconsin has cut the number of new
the length of time spent on welfare; AFDC entrants almost in half over the
the number of recipients in training, last two years.
part-time employment, or make-work 5. Require continuous activity. In the
jobs; or the number who leave welfare. private sector, employees are expected
Decisionmakers should not be fooled: It to work continuously, not intermittently.
is the size of the caseload that matters. This principle must be duplicated in wel-
2. Focus on the size of the caseload, not fare. Once a recipient begins supervised

welfare exits. Measuring the number of job search, training, or work, some ac-
recipients who leave welfare — or "exits" tivity should be required without inter-
— is misleading. Large numbers of "exits" ruption or lessened intensity until the re-
from welfare will occur even when cipient leaves AFDC. In order to reduce
welfare caseloads are rising. States with welfare recidivism, the work obligation
liberal welfaresystems may have larger should resume as soon as a forme:
numbers of exits because they encourage fare recipient returns to the AFDC rolls.

highly employable persons to enroll in 6. Establish a pay-after-performance

welfare. By contrast, a serious work benefits system. Welfare should be based
requirement may actually reduce welfare on "pay-after-performance": Recipients
exits since it will discourage the most will not receive the welfare check until
employable persons from enrolling in after theyhave performed work or other
welfare in the first place. required activity. If they fail to perform
[Link] education and training. Gov- the required number oi hours of activity,
ernment training and remedial education the welfare check must be reduced on a
programs in general do not increase re- pro-rata ba
cipients' wage rates and do little to reduce Use community-service "workfare"
7.

dependence. A recent Labor Department as an enforcement mechanism. Upon

study of the government's largest train- applying for welfare, employable recip-
ing program, the Job Training Partner- ients Should be required to begin a su-
ship Act QTPA), found that the pn pervised search for emplovment. It thev
had littleor no effect on the have not found a prh r job within

trainees: The average hourly wage i six weeks, thev should be required to
female trainees rose 3.4 percent, while the Dl communitv-siTVice WOll

hourly wages of males did not inai COUnei the real goal ot reform is to see
all. that recipients obtain private-sector em-
260 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

ployment, not to push them into make- periods, clogging up the system. When
work jobs. But in a conventional welfare highly employable recipients, by con-
system, large numbers of recipients will trast, are faced with the prospect of per-
claim they cannot find private-sector jobs. forming community-service work, most
If such "unsuccessful job seekers" are per- willrespond by quickly leaving AFDC,
mitted to remain idly on the rolls, reform freeing the work slots for others, who will
will fail. Instead, all individuals who fail in turn leave the rolls. Through this re-
to obtain private-sector jobs should be volving process, the caseload will begin
placed immediately in community ser- to shrink quickly. (A variant of this prin-
vice slots on a pay-for-performance basis. ciple is to focus work requirements on re-
This effectively eliminates any recipi- cent applicants who are, in general, more
ent's chance of receiving a welfare income employable than the rest of the caseload.)
without working, and pushes recipients 9. Establish bureaucratic incentives
into private-sector jobs while dissuading
and competition. Throughout the United
other individuals from entering welfare.
States, most of the welfare industry is
Mandatory community service is thus the liberal, regards welfare recipients as vic-
crucial backstop to a serious work re- tims of social injustice, and is threat-
quirement. Of course, this does not mean
ened by reforms that will sharply reduce
that large numbers of recipients will end
its welfare clientele. In order to ensure
up in make-work community service. In the faithful and efficient implementation
Wisconsin few do, but the threat of com-
of conservative reforms, decisionmakers
munity work is the key to propelling re-
must establish precise performance crite-
cipients into the private sector.
ria linked to rewards and sanctions for the
8. Impose work requirements on the
welfare bureaucracies. In Wisconsin, wel-
most employable recipients first. The fare officeswere forced to compete with
initial goal of welfare reform should be to
one another to earn funding, and ulti-
restrictwelfare to those who truly need it
mately each county office faced the threat
and to eliminate from the rolls those who of elimination if it failed to meet high per-
do not. In order to accomplish this goal formance standards set by the governor.
and to shrink welfare caseloads, work
requirements should be focused on the
most employable welfare recipients first.
LOOKING TOWARD THE FUTURE
These would include two-parent families
(10 percent of the caseload in a typical The lessons from Wisconsin greatly
state) and mothers who do
not have influenced the national welfare reform
preschool children (typically 50 percent). enacted in Washington [in 1996]. The new
This strategy may seem counterin- federal law encourages states to pursue
tuitive, but it is essential to reduc- work policies similar to Wisconsin's.
ing dependence. The number of crucial Among the specific features of the new
community-service work slots (where the federal law drawn from Wisconsin are the
recipient is required to work for benefits) federal performance standards based on
in the first phases of reform will be quite caseload reduction, the use of workfare
small in relation to the overall caseload. to "dissuade" new applicants, and a
If the least employable recipients occupy requirement that states set up pay-for-
these slots, they will remain there for long performance systems.
 YES Robert Rector/ 261

Tommy Thompson has shown that status quo. Among the venerable myths
stategovernments can overcome AFDC debunked by Wisconsin are the follow-
dependency. The greatest benefit will ac- ing: Recipients really want to work but
crue to children. In the past, liberals jobs are not available; the lack of day care
have been mesmerized by the belief that makes employment impossible; educa-
"poverty" somehow harms and
children tion and training are the key to reducing
that welfare, by "combating poverty" dependence; and it costs more to reform
is therefore good for kids. Hence they than to continue the status quo. Thomp-
are timid, if not outright adversarial, in son has not only rewritten the rule book
their attitude toward serious efforts to on fighting dependence; he has invented
reduce welfare dependency. But studies a new language in which future rules will
that compare children on welfare with be written.
poor children not on welfare show that
Perhaps the most surprising aspect of
it is actually welfare dependency, not
Wisconsin's story is the extraordinary
poverty, that harms children. A child-
outcomes produced by mundane poli-
hood of welfare dependency lowers chil-
cies. There isnothing radical about ini-
dren's IQs, increases their likelihood of
tiatives like Self-Sufficiency First or Pay
academic failure, and diminishes their fu-
for Performance. Indeed, these policies are
ture earnings as an adult. Welfare is a
much what most voters have in
pretty
system of child abuse; by radically re-
mind when they hear talk of making
ducing dependence, Wisconsin's reforms
welfare recipients work. It is true that
will improve the future well-being of chil-
in the fall of 1997, Thompson will in-
dren.
augurate a new set for reforms termed
There is, however, one very impor-
Wisconsin Works, or W2. This will abol-
tant shortcoming to Wisconsin's welfare
ish AFDC entirely and replace it with
achievement: The current reforms have
a pure employment-based system of as-
not cut the state's illegitimate birth rate.
sistance. Although great things are ex-
Illegitimacy does much more harm to
pected of W2, its arrival should not over-
children's development than does wel-
shadow the fact that the current reforms
fare dependency. The ultimate goal of re-
will have already eliminated a vast por-
form must be not only to reduce depen-
tion of the Wisconsin AFDC caseload be-
dency but to rebuild marriage. One can
fore W2 even begins.
only hope that over the next decade, Wis-
consin's reformers will tackle the prob- Other states that are in early stages
lem of out-of-wedlock births with the in- of reform need not leap as far as
genuity and diligence they have already W2. Any state that will enact Pay for
applied to the question of dependence. i First, and
Throughout his tenure as governor, follow the nine principles outlined above,
Tommy Thompson has routinely EM will dramatically reduce the welfare
plished what the welfare industry de- dependency of its citizen*, Wisconsin has
clared impossible. He has demolished shown the way; it is now up to rest of the
many of the fables buttressing the welfare nation to apply the lessons learned
 Michael Wiseman
NO

WELFARE REFORM IN THE UNITED

STATES: A BACKGROUND PAPER

INTRODUCTION
. . . This article surveys the major issues surrounding welfare reform, outlines
the competing proposals for reform, reviews PRWORA
[Personal Respon-
sibility and Work Opportunity Reconciliation and comments on the
Act],
outlook for further reform. I argue that the likely outcome of the coming
struggle over welfare reform is, at least over the next few years, increased
hardship for the poor. Contrary to popular wisdom, however, I also argue
that the new legislation is likely to produce a larger federal role in welfare and
more difficulty for governors than would have been the case given continua-
tion of the programs ended by welfare reform. Because so many poor families
using public assistance are located in central cities, many of the consequences,
both positive and negative, of the reform effort will be concentrated there.
Welfare reform is in essence an urban policy issue
By convention, the term welfare is applied to programs of public assistance
that give aid to individuals or families on the basis of need and means.
There are many such programs in the United States, including locally funded
and state-funded general relief; various housing assistance programs; the
Low-Income Home Energy Assistance Program; school lunch and breakfast
programs; and the Special Supplemental Food Program for Women, Infants,
and Children (WIC). The four means-tested programs most important to the
national welfare reform debate are Aid to Families with Dependent Children
(AFDC), food stamps, supplemental security income (SSI), and Medicaid.
AFDC gives cash to needy families with children; food stamps are special
coupons that indigent families and individuals can use to purchase food; SSI
provides income to needy aged, blind, and disabled persons; and Medicaid
provides health care for the poor. PRWORA replaced AFDC with block grants
to states for Temporary Assistance for Needy Families (TANF) and altered
eligibility standards for food stamps and SSI. The TANF block grant allows
states to sustain the AFDC program for at least the coming fiscal year, and
as a result the changes have yet to affect either programs or caseloads sig-

From Michael Wiseman, "Welfare Reform in the United States: A Background Paper," Housing
Polio/ Debate (1996). Copyright © 1996 by Housing Policy Debate. Reprinted by permission. Notes
and references omitted.

262
 NO Michael Wiseman 7 263

nificantly. Thus I begin with discussion had important consequences for welfare
of welfare before PRWORA. I then turn politics in the 1990s.
to predictions of how states will change A number of observations can be made
the welfare system under block grants by examining constant-dollar expendi-
I choose 1993, the year between the tures on AFDC, food stamps, SSI, and
election of President Clinton and the Medicaid for 1980 through 1995:
landmark congressional election of 1994,
1. Effort has increased. It is difficult to ar-
as point of reference.
gue that the national antipoverty ef-
fort has diminished since President
Caseload trends. concern about
Political
Carter's last year of office. In addition
welfare has been driven in part by excep-
to outstripping the rate of growth in
tionally rapid recent caseload growth. Be-
the AFDC caseload over this interval,
tween 1980 and 1989, the AFDC caseload the 116 percent growth in overall real
grew by about 5.5 percent (figure 1). Be- outlays for public assistance substan-
tween 1989 and 1993, the caseload grew tially exceeded growth in population
by 33 percent. Part of this acceleration (13 percent), in real gross domestic
is attributable to the recession of 1990
product (36 percent), and in the num-
to 1992. However, the economic down- ber of poor children (29 percent). The
turn at the beginning of this decade was rate of growth accelerated after 1985.
by most measures no more severe than
2. Medicaid is the villain. While national
that of 1980 to 1982, when the caseload
effort at public assistance may not
response was much less.
have decreased, it has been redirected.
These trends produced a substantial Most (80 percent) of the increase in
mcrease in the proportion of American assistance outlays is attributable to
children living in families at least partly rising costs of Medicaid. In 1980, Med-
dependent on welfare. In a typical month icaid accounted for 45 percent of out-
in 1980, about 1 child in 10 lived in
lays in the four categories identified
a family receiving AFDC; by 1993 the here; by 1993 this share had grown
odds had increased to 1 child in 8. to 63 percent and was continuing to
Almost 14 percent of American families n>e. While approximately 36 percent
with children received AFDC during of Medicaid recipients are in AFDC
an average month in 1993; a higher households, group accounts for
this
proportion received such benefits at some only about 30 percent of Medicaid
time during the year. outlays. members of other
served groups (the elderly the dis-
Welfare costs. Between 1980 and 1993, abled) aa1
typically much greater.
the welfare caseload grew by 39 percent. 3, the share of pay-
Over the same interval, real outlay ments on behalf o! lpientsin I

the "big four" transfer programs Medicaid costs tell, between 1988 and
by 116 percent, and the composition \ the share crew b\ 25 percent.

of welfare outlays changed in ways Thus, while AFDC-related Medicaid

that affect both the state and federal B Slightly less than a third of

share of outlays and the effect of the Medicaid outlaws, the growth of this
system on povt e changes have men! during the period leading up
 —
264 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

Figure 1

AFDC Caseload, United States, 1980-1995 (Monthly Average)

6.0

1980 1982 1984 1986 1988 1990 1992 1994

1981 1983 19Q5 1g87 198g 1991 19g3 1g95
Year

Note: Data for 1995 are preliminary.

Source: U.S. House Committee on Ways and Means (1994).

to the Contract with America was ex- 4. SSI lost, too. The basic SSI benefit

ceptionally rapid. is wholly federally funded. The law

3. AFDC is Outlays for AFDC
the loser.
permits (and, in some instances, re-

benefits grew more slowly than the

quires) states to supplement the fed-
number of AFDC recipients from eral payment. Currently, all but eight
1980 to 1993 (a 14 percent increase states provide some type of supple-

compared with a 33 percent increase). ment to the federal benefit. However,

Thus, real cash benefits received by over time state SSI supplements have
individual families declined. States
not kept up with inflation, while the
set the level of AFDC benefits.
federal benefit has. The result is that
the direct federal share in overall SSI
Between January 1985 and January
1994, the maximum AFDC grant for
costs has increased and food stamp
a family of three in the median state
benefits paid to SSI recipients have
(based on benefits) fell from $461 also gone up. This too has increased
the federal share of the costs of aiding
to $367 (a 20 percent decrease) in
the SSI target population.
constant (January 1994) dollars
The bottom line is that "spendable" 5. The state share remains unchanged. The
welfare (i.e., food stamps and AFDC) federalization of spendable welfare
has become increasingly federalized cited above would be expected to
over the past 13 years as states have increase the federal share in overall
lowered AFDC benefits while food assistance payments. In fact, the
stamp benefits have been sustained. federal share of the cost of AFDC, food
 — — —
NO Michael Wiseman / 265

stamps, SSI, and Medicaid combined

did not change at all over the
THE PROBLEM OF REFORM
1980-95 interval. The culprit has
. . . The litany of indictments suggests that
already been identified. Medicaid the U.S. welfare system is a ripe target
outlays grew much faster than food for government reinventing. The lesson
stamp and SSI benefits combined. The of recent American history is that welfare
federal government still pays only reform is hard to accomplish, and as bad
slightly more than half the costs of as some problems are, the system can be
Medicaid. The rapid growth in total made worse by ill-considered fixes. There
Medicaid outlays kept the overall are several reasons for this.
federal share at slightly less than two-
thirds Poverty Is Complex
The welfare system in part mirrors the
complexity of poverty in general. Simple
In sum, despite cutbacks, states have
solutions for many, if not most, poverty
not found substantial fiscal relief in
issues are elusive, and the enthusiasm
public assistance policy. Although the
of even the most zealous reformer
states were clearly attempting to reduce
often dims as special case after special
their fiscal contribution to social welfare
case is identified. In general, the less
costs, the rapid increase in Medicaid
experienced the author is with poverty
offset the attempt so that as late as
and welfare operation and the farther the
1995 the states' apparent share was
author is from the nearest welfare office,
virtually the same as it had been 13
the simpler the solution proffered
years earlier. Given the failure of national
health insurance reform, it was likely
that states would seek fiscal relief in WELFARE REFORM IN THE STATES
other ways. The fact that states do
respond strategically to the incentives Vie Bash initiative. ... In 1991, the Bush
created by federal assistance policy is administration made a strategic decision
important, because PRWORA changes to encourage state welfare demonstra-
state incentives substantially. tions [or experiments] as a means of es-
tablishing an initiative in this area at min-
imal federal cost.

Welfare and poverty. At the same time In his 1992 State of the Union Address,
that outlays for public assistance were President Bush encouraged states to con-
increasing, so too were poverty rates. In tinue efforts to "replace the assumptions
1980, 18 percent of all children lived in and help reform the
oi the welfare state
families with reported incomes below the welfare system" and promised to make
federal poverty standard (approximately the waiver proa and quicker."
r

$12,000 in current dollars for a family of The response was switt .md substantial.
three); by 1993, the proportion was 23 Between the Mate ot the I'mon nit
percent. The 1995 poverty rate among all and the end ot the Bltth administration
persons, children and adults, wafl the following January, 22 state applica-
percent; in 1980, it was 13 percent, and waivtrbastd welfare lefotm
it has not fallen below that level since were received. Of t
266 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

14 were approved and the remaining 8 approved waivers for 43 states and the
proposals were carried over to the Clin- District of Columbia.
ton administration. None were denied. These state initiatives featured an ex-
Following precedents established by traordinary collection and combination
of interventions, ranging from benefit
the Reagan administration's Interagency
reductions to cash incentive schemes
Low-Income Opportunity Advisory
for encouraging inoculation of children
Board, the Bush administration applied
two standards in dealing with these ini- against disease. Objective evaluation of

To be approved, waiver-based
tiatives.
this avalanche of novelties is difficult.

demonstrations had to be cost neutral A defensible summary is that few will

and rigorously evaluated. A demonstra- ever produce any results usable in the
process of policy development. In gen-
tion was cost neutral if it would not add
eral, the interventions were too poorly
to federal welfare outlays. Rigorous eval-
uation meant, for the most part, evalu- planned, the number of program changes
too large, and the evaluation schemes too
ation by random assignment. The two
limited in scope to encompass the range
criteria were linked: A demonstration's
of possible program effects. In some ways
effects on costs were assessed by compar-
ing costs between control and experimen-
this outcome was politically desirable. In
state welfare reform initiatives, the polit-
tal groups. States were obligated to cover
the difference between federal per-case icalpayoff from demonstration activism
costs for the controls and federal per-case may be more important than the modest
gain in knowledge that might be attained.
costs for recipients in the experimental
group. Content did not play a major role
Moreover, in most cases the political pay-
in waiver strategy.
off seems to come early, while assessment
is postponed virtually indefinitely.

Clinton policy. Since the ambitious TJte waiver leader: Wisconsin. A prime
waiver program was largely a Republican example of the difference in timing be-
initiative, one might have expected the tween political attention and demonstra-
new Democratic administration to cur- tion outcomes is provided by Wisconsin's
tail waiver-based welfare demonstration Work Not Welfare initiative. Proposed in
activity. Instead, two weeks after his in- early 1993 following President Clinton's
auguration, President Clinton promised address to the National Governors' As-
the National Governors' Association that sociation, Work Not Welfare is an exper-
his own administration would continue iment designed to test the impact of a
to support state demonstrations, as long time limit for welfare receipt. The pro-
as the results were "honestly evaluated." gram was approved by HHS [U.S. De-
The result was rapid growth in the num- partment of Health and Human Services]
ber of waiver applications and waiver- in November; it began in two small Wis-
based demonstrations approved. In the consin counties in January 1995 with a
interval between Clinton's inauguration target number of experimental cases un-
and the 1994 congressional elections, the der 1,000. The final report is scheduled
administration approved 21 more waiver for the year 2006.
demonstrations in 20 states. By mid-1996, Work Not Welfare is one of nine Wis-
on the eve of PRWORA's passage, it had consin welfare reform demonstrations
 NO Michael Wiseman / 267

initiated since Governor Tommy Thomp- tunities and Basic Skills] is a product of
son took January 1987. Overall,
office in FSA, not the waiver process.
Thompson's record on welfare has been Since 1994, both Wisconsin's unem-
extraordinary: Between his inauguration ployment rate and its welfare caseload
and January 1994, the AFDC caseload have continued to decline. The state has
in Wisconsin fell by 21 percent. The launched two additional initiatives Self —
Thompson administration is understand- Sufficiency First and Pay for Performance
ably willing to attribute this decline to — intended to increase efforts by local op-
the welfare reform initiatives. However, erating agencies to move persons apply-
most of the reduction was accumulated ing for assistance into employment and
before the state's waiver-based initiatives to facilitate penalizing recipients who
were under way, and like Work Not Wel- fail to participate in JOBS programs. Be-
fare, some of the more celebrated of the tween December 1994 and mid-1996, the
Thompson initiatives have involved only AFDC caseload fell an additional 29 per-
a small proportion of the caseload. Con- cent. The state is conducting an evalu-
trary to the image of the Thompson ad- ation of these initiatives based on com-
ministration beyond the state's borders, parison of outcomes for cases subject to
a significant proportion of the Wisconsin the Self Sufficiency First-Pay for Perfor-
waiver-based demonstrations have actu- mance initiative with outcomes for a set
ally increased the generosity of the wel- of cases selected at random to be exempt,
fare system by improving services and but results are not yet available. The eval-
extending eligibility to two-parent fami- uation may be terminated as the state
lies without application of the 100-hour moves to its latest initiative, Wisconsin
rule. It is the Thompson administration's Works, to be discussed later.
benefit strategy and income tests that
have been restrictive. Conclusion: Image and reality. Perhaps
the most important conclusion to be
While definitive assessments are com- drawn from the plethora of state initia-
plicated, appears that at least through
it tives is that no one, not even Thompson,
1994 the overall Wisconsin achievement has really found the key to welfare sav-
is attributable to the combination of a ro- ings by means other than cutting bene-
bust economy (the September 1994 un- fits and active and broad-based efforts

employment rate in Wisconsin was 4.5 at job placement and training. As polit-
percent, compared with 5.9 percent for ically significant as the state initiatives

the nation), a gradual tightening through may be, both the content and the scale of
inflation of the welfare eligibility stan- implementation of most have been mod-
dard in the state, a freeze on welfare ben- est, and .states like Wisconsin that have

efits, and aggressive use of the hinds for undertaken more ambitious efforts have
recipient job assistance provided h\ done so in an exceptionallv favorable
[Family Support Act of 1988]. In 1994, Ru- economic context Governors know that
Com-
ing Tide, the Republican National political hyperbole is one thing, budget
news magazine, reported that
mittee's consequences another. An index of real
Thompson considered the JOBS pn state commitment to welfare-to-work ef-
his "favorite" in the welfare arena. Rising forts is provided by the JOBS program
Tide failed to note that JOBS [Job Oppor- While most states appeared eager to pur-
 —
268 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

sue welfare demonstrations, as of March the 1992 presidential campaign than with
1996 only 12 states (including Wisconsin) the substance of the program.
had claimed all federal funds available
for the JOBS operation, even though such
funds required very little in state match-
ing expenditure. The Time Limit
The record of the Thompson adminis- Prior to assuming national office, Pres-
trationand the panoply of state initiatives ident Clinton was actively involved in
spawned by Bush and Clinton waiver welfare reform, both in Arkansas and as
policy were important elements of the part of a task force of the National Gov-
aftermath of the
politics of welfare in the ernors' Association. During the presiden-
1994 election. Wisconsin's achievement tialcampaign, Bruce Reed (then a volun-
was generally cited as representative of teer speech-writer) brought the work of
what states could do when not hampered Harvard scholar David Ellwood to Clin-
by federal regulation. In 1995, Thompson ton's attention. With the support of the
became chairman of the National Gover- Ford Foundation, Ellwood had recently
nors' Association, and he used this po- published a book, Poor Support (Ellwood
sition to promote award of even greater 1988), that offered a plan for welfare re-
latitude to states to structure their wel- form.
fare programs. This gubernatorial effort
might have been cast as the leading Poor Support called for a divide-and-
alternative to the strategy set forth in conquer antipoverty strategy that com-
the Clinton administration's WRA [Work bined a substantial increase in services
and Responsibility Act], were it not for and payments to the poor with different
the emergence on the stage of welfare re- approaches to be fashioned for differ-
form of a third set of players, the House ent subgroups (recall the "tagging is ap-
Republicans, led by Speaker Newt Gin- propriate" welfare reform principle). Ell-
grich. Since the congressional Republi- wood argued that with such a strategy
can initiative was originally aimed at the in place, the nation might limit welfare
Clinton reform, it is the Clinton plan that payments to a period ranging from 18 to
is discussed first. 36 months; adults still without jobs by
the end of that period could be required
to accept some form of public employ-
THE CLINTON PLAN
ment. Ellwood's time-limit proposal was
Welfare politics caused the Clinton ad- based in part on his earlier research with
ministration's WRA
to be pitched as a Harvard colleague, Mary Jo Bane, on
"ending welfare as we know it." This the duration of spells of welfare receipt.
characterization was disingenuous, since That research indicated that a substantial
much of the proposal was a continuation share (in the original version almost half)
of the reform trajectory established by of welfare cases close within two years
FSA. What was new, of course, was the of opening. If this was correct, the
result
time limit. But the significance of even implication was that more costly inter-
this centerpiece, as proposed by Clinton, ventions could be avoided for many re-
should not be exaggerated. Its billing had cipients by waiting for nature to take its
more to do with the political strategy of course
 — .

NO Michael Wiseman/ 269

Work and Responsibility Act of experience, including that of Governor

As released, WRA on the strat-
built Reagan in California in the early 1970s, is
egy established by FSA by increas- that subsidized employment is difficult to
ing federal and state efforts to obtain do, and no state experiment with welfare
child support from noncustodial par- work requirements has yet to attain the
ents, changing JOBS, continuing the pro- scale contemplated by WRA. But while
cess of eliminating the distinction be- certainly difficult to implement, a work
tween the regular (single-parent) and the assignment incorporated as a scheduled
unemployed-parent (two-parent) sub- feature of JOBS case management had
programs in AFDC, and developing many There is some
attractive features.
national performance standards for agen- evidence that work experience increases
cies involved in delivering welfare ser- the chances that recipients will obtain un-
vices. The legislation went beyond FSA subsidized employment. A work require-
in developing a National TeenPregnancy ment is a way out of the problems posed
Prevention Initiative to "encourage re- by the design of financial incentives for
sponsible behavior." The act responded work. A common work requirement pro-
to the recommendations of the Welfare vides more leeway for unifying the treat-
Simplification and Coordination Advi- ment of single- and two-parent families
sory Committee by proposing streamlin- in AFDC; WRA offered states the option
ing of eligibility procedures and stan- of eliminating the 100-hour employment
dards across the AFDC and Food Stamp restriction for two-parent families. Above
programs. State flexibility in welfare pro- all, a timed work requirement might as-
gram design was to be increased to allow sist in making the entire welfare-to-work
states greater latitude in setting program process "time conscious." . .

parameters without waivers. In particu-

lar, states were to be allowed to vary work

incentives incorporated in payment com- Summary

putation and to eliminate welfare bene- WRA was a creditable effort at welfare
fit increases for children conceived after reform. The problem is that there was
theirmothers began receiving assistance. little in it that would not have been there

Finally,new state demonstrations were had the same task force produced draft
proposed in such areas as payment pro- legislation a year earlier. By delaying, the
cedures for the EITC [earned income tax administration fueled expectation that
credit],methods of job search assistance, something entirety different was in the
and effects of state assumption of respon- wings, an expectation that WRA did not
sibility for ensuring that child support fulfill. By appearing to deliver its own

awards are paid on schedule. Thus while initiative stillborn, the administration
WRA increased state latitude in welfare devalued it, thus opening the held tor less
program operation, it also took steps to- thoughtfully constructed congressional
ward establishing an agenda for reform- and state Alternatives, At least when
oriented experimentation viewed in terms ot media attention,
The welfare reform group recogni/ed states have been lesponsibk tor tar move

that the WORK innovation could be action on the Welfare reform tront imCf
costly and could be difficult to implement 1992 than the federal government, and
on an adequate scale. Indeed, the U the administration'! delay enooui
 —
270 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

Congress, governors, and, apparently, lation followed the original PRA in ban-
voters to fill the gap. ning cash payments for children born to
families already receiving assistance, to
unwed mothers under 18 years of age,
REPUBLICAN ALTERNATIVES
and most noncitizens. The Senate leg-
to
The major Republican congressional re- islation banned no children from assis-
sponse to the Clinton administration's tance and let states determine whether
failure to deliver welfare reform was the aid was to be given to noncitizens. The
Personal Responsibility Act (PRA). Wis- House bill ended the JOBS program; the
consin produced the boldest of the plans Senate kept JOBS, but in modified
bill
advanced by Republican governors. form. The House
bill gave states the op-

tion of operating a simplified Food Stamp

Personal Responsibility Act program using the same eligibility rules
Originally championed by the new that are applied under TANF. In con-
Speaker of the House, Representative trast, the Senate bill did not address the
Newt Gingrich of Georgia, PRA was a Food Stamp program. Both the House
follow-up on the promise of welfare re- and Senate bills left Medicaid eligibility
form included in the Republican Contract untouched. Indeed, eligibility for Medi-
with America introduced in August 1994 caid would continue to be evaluated on
and was built on a reform scheme pro- the basis of the rules applied in the old
posed in November 1993 by 160 House AFDC program
Republicans. As originally formulated, These differences were hardly insur-
the plan tackled WRA and the underlying mountable. But before they could be ad-
administration strategy for welfare re- dressed, welfare reform was sidetracked
form virtually point by point. Everything by conflict between the White House
was made tougher; the most important and Congress over the federal bud-
provisions involved the JOBS /WORK get. When Congress reconvened early
program, time limits teen pregnancy, il- in 1996, the outlook for welfare reform
legitimacy, program consolidation, fed- was clouded by the presidential cam-
eral and state financing, and aid to immi- paign. In the meantime, the number
grants of states involved in waiver-based wel-
farereform demonstrations continued to
Legislative Changes grow.
Many of the changes incorporated in the
original PRA
were modified during the Wisconsin Works
first sixmonths of the new Congress. The most ambitious of the state initia-
The House of Representatives version tives was produced in Wisconsin as a
of the law (H.R. 4) was passed in follow-up to the two-year time limit ex-
March 1995 and retained the "Personal periment described earlier. To conduct
Responsibility Act" title. The Senate his Work Not Welfare experiment, Gov-
Finance Committee passed a substitute ernor Tommy Thompson needed to ob-
bill, the Family Self-Sufficiency Act, later tain approval from the Wisconsin state
in the year legislature as well as from the federal
Despite substantial conformity, impor- government. The legislature approved
tant differences arose. The House legis- the initiative but attached a provision
 NO Michael Wiseman / 271

calling for the state's social service agency W-2 is a strategy realized in a program.
tosubmit by 1995 "a proposal for welfare The strategy has six major features:
reform in this state" that would replace
1. Virtually all cash assistance is linked
most public welfare programs by 1999.
tosome form of employment.
The proposal was to guarantee income
2. The variety of situations and capabil-
support to needy persons who could not
ities of persons seeking public assis-
work, guarantee employment to those
tance is addressed by tagging and case
who could work but could not find jobs,
management.
and assure low-income persons "afford-
3. The connection between benefits and
able child care" and "affordable health
dependence is reduced by decoupling
care."
cash assistance from access to health
The legislature's "end welfare" re- insurance and child care assistance.
quirement was a boon to Governor 4. State administrative control and in-
Thompson. In the context of the national centives for efficiency are enhanced
debate over welfare reform, the require- by allowing public and private agen-
ment allowed him to use state resources cies to compete for designation as lo-
to develop and advertise a comprehen- cal program operators.
sive reform scheme. The Hudson Insti- 5. The change in the orientation of pub-
tute, a conservative policy analysis or- lic assistance as well as agency culture
ganization, set up an office in Madison is dramatized by a shift in responsi-
and organized foundation funding for bility for public assistance from the
technical support for a task force ap- state's social service agency to the em-
pointed to draft a plan. The proposal, ployment service agency, the Depart-
called Wisconsin Works and nicknamed ment of Workforce Development.
W-2, was completed in early spring of 6. The "end of welfare" is taken seri-
1995. It was formally announced by Gov- ously: The state is committed to rapid
ernor Thompson on August 3 of that year, and complete implementation, with
following a Vermont meeting of the Na- all components in place by September

tional Governors' Association. Enabling 1997.

legislation was passed by the state legis-
... In sum, W-2 is dramatic in ambi-
lature in March 1996.
tion, scope, and Once
detail. again, Gov-
Viewed from both state and national ernor Thompson challenged the Clinton
perspectives, W-2 is an extremely im- administration, this time by demonstrat-
portant development. It is the first fully ing that a state could develop a com-
articulated plan for what a state wel- prehensive welfare reform package in far
fare system might look like in an era less time than had been required for the

of block grants. For citizens concerned WRA. If implemented, W-2 would gen-
about the direction of public assistance uinely end welfare, as Wisconsin's legis-
policy under something like PRA, Wis- lature had required. Moreover, like most
consin Works provides a picture of one of the state's initiatives, W-2 involved
direction that states might go should they considerable tinancial commitment, es-
be freed of the program restrictions pre- pedally given the state's promise of uni-
viously contained in the Social Security versal meana tested child care
Act. and insurance tor families with children.
272 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

The program appears to be a dramatic to Congress: Send me a bill that honors

refutation of the arguments of some that these fundamental principles; I'll sign it

states would respond to the fiscal incen- right away. Let's get the job done."
tives produced by a change to block grant The president congratulated Wisconsin
funding with a "rush to the bottom." W-2 for adding momentum to the "quiet
seems to be better characterized as a rise revolution" in welfare reform with the
to the challenge. W-2 proposal, which "has the makings
Drama in scope and ambition notwith- of a solid, bold welfare reform plan." He
standing, the W-2 announcement at- then appeared to endorse the plan by
tracted little public attention outside the pledging that his administration "would
state,perhaps partly because the media work with Wisconsin to make an effective
had become inured to years of Wiscon- transition to a new vision of welfare
sin welfare reform hyperbole. Few ap- based on work." This endorsement was
preciated the difference between W-2 and extraordinary given that the state had
earlier programs. More important, how- not even applied for waivers for W-2.
ever, was the shift of national attention Governor Thompson's staff scrambled to
to the struggle between Congress and the complete a waiver proposal, which the
president over the budget. It began to ap- governor delivered personally to HHS.
pear that action on welfare reform would This episode was a clear short-term vic-
await another election. For Thompson, tory for the president on the welfare re-
this outcome was galling. W-2 was not form issue. If Congress did not act, the
intended as just another waiver-based president would respond to any Repub-
demonstration. Given the breadth of the lican campaign challenge on welfare pol-
proposal, something akin to the autho- icy by claiming that it was Congress,
rization contained in PRA was believed and not he, that had prevented the ac-
essential. By spring 1996 it began to ap- complishment of welfare reform in 1996.
pear that resolution would await the out- Congress did indeed respond, and after
come of the coming presidential election. reconciliation of House and Senate ver-
sions of reform legislation, the result was
President Clinton's Announcement and PRWORA (Public Law 104-193). Despite
the End of the Impasse last-minute protests from various mem-
However, the politics of welfare reform bers of his administration and others, the
took a new turn the following May when president signed the bill in August.
President Clinton used his weekly ra-
dio address to claim credit for state wel-
PERSONAL RESPONSIBILITY
fare reform initiatives and to challenge
Congress to act on welfare reform. "There
AND WORK OPPORTUNITY
RECONCILIATION ACT
are bipartisan welfare reform plans sit-
ting in the House and Senate right now," PRWORA is the most substantial welfare
he said, "that do what the American peo- reform legislation since establishment
ple agree welfare reform must do: They of the SSI program and revision and
require welfare recipients to work; they expansion of the Food Stamp program in
limit the time people can stay on welfare; the 1970s. The most significant change is
they toughen child support enforcement the termination of entitlement by families
and they protect our children. So I say to cash assistance provided under Title
 .

NO Michael Wiseman / 273

IV-A of the Social Security Act (the work and marriage, prevent and reduce
authorizing legislation for AFDC). In out-of-wedlock births, and "encourage
place of the matching grant program, the formation and maintenance of two-
PRWORA creates block grants to cover parent families." In general, how states
TANF and related services. The new law are to do this is left open, but the law
or eliminates provision of public
restricts includes certain restrictions and perfor-
assistance to most noncitizens, families mance requirements. States are required
that have received aid for more than to sustain spending of state funds on the
five years, and children previously made replaced programs plus child care at 75
eligible on certain criteria for SSI. The percent of the spending done in fiscal
law contains major new policies aimed year 1994. Eligibility for federally funded
at reducing the rate of nonmarital births TANF is denied families with members
as well as substantial revisions in the who have received assistance for five
Federal-State Child Support Enforcement years or more (states are allowed to ex-
Program, in the Food Stamp program, empt 20 percent of their caseloads from
and in child nutrition programs. this requirement).
The heart of PRWORA is replacement As in the original Clinton plan, adults
of AFDC, JOBS, and Emergency Assis- receiving TANF assistance must "engage
tance with a block grant for TANF. (The in work" after two years (or less at state
Emergency Assistance program provides option). The criteria for satisfying the
matching funds for use by states to sup- work engagement requirement are left
port families with children at immedi- to states to define. However, in addi-
ate risk of destitution or homelessness.) tion to the two-year work engagement
Each amount based
state receives a fixed requirement for individuals, the law fol-
on payments received for the
federal lows PRA by requiring states to have a
three supplanted programs in fiscal year specific and increasing fraction of their
1994, payments for fiscal year 1995, or entire caseload involved in certain work
the average for fiscal years 1992 to 1994, activities identified by the legislation. The
whichever is [Link] that for most required level of participation for single
states caseloads have declined (see Fig- parentsis 25 percent in 1997 and rises five

ure 1), the TANF block grant results in a percentage points a year to 50 percent
net increase in federal funds over what in 2002. For adults in two-parent fam-
would have been received under pre- ilies, the required participation rate be-
PRWORA regulations. The TANF block gins at 75 percent in 1997 and jumps to 90
grant is supplemented with a substan- percent in 1999. "Participation" initially
tial increase in federal funding for child means 20 hours per week for single par-
care. A
contingency fund is established ents; for parentswith no children under
for support of states with exceptional un- six, the requirement rises to 30 hours by

employment rates, and states with either 2000. Adults in two-parent families must
exceptional population growth ral work 35 hours per week. States are al-
very low benefits are eligible for supple- lowed BOOM variation in these standards,
mental grants. but the end result will still be a much

TANF funds are to be used to help higher level of activity required from re-
needy families with children, assist par- tipienta and more monitoring to enforce
ents in moving to self-support th- R quirements than under AFDC. . .
 — —
274 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

REFLECTIONS
states in impact. In contrast, PRA pro-
posed allocation of funds across states
Put another way, PRWORA has initiated based on trends in population and num-
change, but we are uncertain of the bers of poor households. It is likely that
direction before long losers under the new system
will demand redress.
Seeing Consequences Will Be Difficult
... One possible consequence of the Large-Scale Workfare Will Be Costly
elimination of entitlement by TANF is As politically attractive as they may be
that states will attempt to cut costs by in the abstract, welfare employment pro-
making it more difficult toapply for grams are costly to operate and difficult
aid. Wisconsin is already experimenting to manage. The reasons are clear: Even
with a system, Self Sufficiency First, that bad jobs require capital and some man-
requires persons seeking assistance to agement (at minimum, rakes and straw
complete 60 hours of employment search bosses), and unlike "real" employment,
before the state even begins processing welfare employment programs encour-
their aid applications. Other states may age high turnover. The skills required for
practice more subtle means of dissuasion, management of effective workfare opera-
and it is likely that some people in need tion are quite different from those sought
will lose access to assistance altogether. elsewhere in government, and they do
This "entry effect" will never be captured not come cheaply. PRWORA requires an
by agency information systems because unprecedented level of participation in
such systems cover only the status of work and work-related activities, and the
persons approved for assistance. Under funds for meeting these standards come
AFDC, persons meeting standards of out of the same aggregate appropriation
need but denied access to assistance as basic benefits. The consequence may
could and did seek legal aid. Careful be expanded state costs, reduced bene-
attention needs to be paid to the way fits, or both

state systems come to accommodate, or

dissuade, applicants. The Bottom Still Looms
Regardless of motivation or dedication
Equity Is a Problem of governors, PRWORA creates substan-
Under AFDC, federal assistance was dis- tial incentives for reduction in benefits.

tributed to states on the basis of state ex- While the law includes some safeguards
penditure effort, per capita income, and for maintenance of effort, the standard
—
need that is, the number of eligible fam- is set low (75 percent of 1994 expendi-

ilies applying for assistance. While the tures if the state meets the work partici-
details of the formula actually used may pation requirement) and the range of ex-
be difficult to justify, the principle seems penditure states are allowed to count as
sound. The lion's share of PRWORA part of "effort" is broad. Moreover, states
funds will be distributed for the next five are permitted to set aside any amount of
years on the basis of circumstances at the their TANF grants they like in a contin-
beginning of the decade. These circum- gency fund to meet demand in the event
stances were established in part by a re- of a recession or other development that
cession that varied substantially across increases need. For every state, the shift
 NO Michael Wiseman / 275

from AFDC to TANF at least doubles the excess of this amount will increase the
cost to the state's general fund of financial federal share in social assistance, and
assistance to the poor. such effects will be magnified if benefit
In the near term, the expansion of reduction leads to greater costs for food
funds provided by caseload decline and stamps. The nearly inevitable outcome
the new block grant is likely to prevent will be a greater federal fiscal role at
any retreat on benefits. By the next the same time that federal administrative
budget cycle, however, the extent of control is curtailed.
reduction permitted under maintenance-
of-effort requirements and the range of Cities Are Where Much Will Happen
outlays that can be tallied to establish For reasons rooted in the Constitution,
effort will be well understood. At this negotiations over welfare reform have
point, legislators will begin to appreciate been almost exclusively a matter between
the new terms of trade between public states and Washington, DC. This empha-
assistance and other state activities that sis on states obscures the likely concentra-
PRWORA establishes. Likewise, the cost tion of effects of welfare reform in urban
of meeting activity requirements will be areas. A rough sense of this concentration
better understood. Pressure will be felt to can be gained from a recent study of pub-
reduce welfare expenditures and shift the lic assistance receipt by the U.S. Bureau of
expenditure level that is sustained in the the Census (1995). In 1991, 29 percent of
direction of supporting work programs. the U.S. population lived in central cities
Spendable income for welfare recipients of metropolitan areas. In contrast, 44 per-
will, under this scenario, decline. cent of recipients of AFDC, General As-
Earlier I argued that interstate varia- sistance (public assistance without fed-
tion in welfare benefits has in the past eral contribution), and SSI did. PRWORA
been reduced by incentives created by restrictions have their greatest effect on
the matching grant formula. Those incen- long-time recipients. The same study re-
tives are eliminated, or at least reduced, ported the geographic distribution of per-
by PRWORA. Disparity in benefit levels sons who reported receipt of public assis-
is therefore likely to grow as some states tance for every month over the 1991-92
drop benefits faster than others. This interval. Halfoi all persons reporting con-
in turn may create incentives for high- tinuous receipt of AFDC lived in central
benefit states to reduce outlays to dis- cities. This allocation of population does

courage migration. It should be empha- not match the allocation of employment,

sized that these effects are hypothetical, so agencies charged with assisting peo-
but such predictions are not unwar- ple to find the employment required by
ranted. As evidence already cited indi- TANF will have to reach beyond city and
cates, states do respond to the incentives S3 county borders.
created by grant allocation procedure
Again, the outcome of this pi Many of the Poor Are Indeed Needy
remains to be seen. But if CBO project ions It easy tO generate political support
is

are accepted, PRWORA will result in only for abstractions like "eliminating fraud
a 3V2 percent decline in federal outlays and al illegal immigrants." But

on public assistance between 1997 and most polls indicate continuing public
2003. Any decline in state outlays in support tor go\ eminent assistance to
 — —
276 / 14. WOULD ADOPTING WISCONSIN'S WELFARE REFORMS END WELFARE?

people who really look needy those — mented without waivers, for the proposal
who appear to make valiant efforts at involves changes in Medicaid and food
self-support but, because of bad fortune stamps, as well as changes in treatment
or other circumstances, fail. Inevitably, of child support payments in benefit com-
the restrictions imposed by states because putation, that are not permitted under the
of PRWORA will produce and publicize new law. Despite the president's commit-
tragic cases of deprivation because of ment to " work with Wisconsin to make an
government fiat. People who lose welfare effective transition to a new vision of wel-
afterrunning up against the time limit, fare based on work/' the state's proposal
children abandoned, aliens claiming risk has been rejected, and its offer to work
of death or worse at home all will — with the federal government to develop
attract media attention, and all will a satisfactory evaluation scheme has been
be state responsibilities. PRWORA does largely ignored. State budgeting for W-2
not preclude aiding such folk; in some was in part based on claims established in
instances it just precludes using federal prior years on federal savings generated
dollars to do so. To the extent that by earlier innovations. It is now the fed-
such cases, when given faces, reveal true such claims have been
eral position that
need, local and state government will feel superseded by the TANF block grant
pressure to respond

Medicaid Is Still a Problem

CONCLUSION
Despite the importance of Medicaid
to state budgets, welfare reform left Here, then, is where we are. The nation
the program largely untouched. Indeed, has achieved interim relief for states for
eligibility for Medicaid continues to be public assistance expenditures. This relief
determined on the same basis as before. has been accomplished in substantial
Congress thereby avoided a bruising part by restricting access to welfare.
battle with the health care industry, but The federal share of public assistance
it also left untouched one of the principal expenditures has been increased, while
problems in the social assistance system. the federal role in managing the core
of the program, now called TANF, has
Wisconsin Waits been reduced. The problem of developing
The new law gives states the option of and implementing a research agenda
continuing operation of welfare demon- for studying program management and
strations operated under federal waiver. effects has yet to be addressed. The
Initial reports indicate that many will consequences of PRWORA are difficult
not do so, in part because of disinter- to predict because they involve response
est in sustaining evaluation programs to the program by both states and actual
based on random assignment and be- and What
potential assistance recipients.
cause some program features previously is certain is new legislation
that while the
permitted only under waivers are allow- may have ended AFDC, it has most
able under new federal law. Ironically, the certainly not ended the struggle for
W-2 program still cannot be fully imple- welfare reform.
 —

POSTSCRIPT
Would Adopting Wisconsin's Welfare
Reforms End Welfare As We Know It?
The public policy we adopt to address the needs of those who have been left
outside the economic mainstream will dramatically shape the world in the
near future. Will the new work incentives and disincentives associated with
staying on welfare create a whole new generation of middle-income families,
or are we in the process of creating anew generation of dropouts who will
live in the dark shadows of society?
It must be remembered that we are dealing with a large number of lives. The

latest statistics on poverty indicate that more than 36 million persons suffered
the effects of poverty in 1995. Although this poverty rate for white Americans
was lower than any other racial group, the vast majority (67 percent) of poor
people are white. What is even more startling is the fact that more than one
in five children live in poverty, and if we look at children in single-parent
families, the rate soars well above 50 percent.
Consequently, whether the post-AFDC era is a boom or a bust has im-
mediate implications for those who are least able to defend themselves
children who live in poverty. One place to start reading in this area is an es-
say by Daniel R. Meyer and Marian Cancian entitled "Economic Well-Being
of Women and Children After AFDC," La Follette Policy Report (Winter 1997).
Meyer and Cancian are colleagues of Wiseman at the University of Wisconsin.
Another policy analyst who warns of the dire prospects associated with the
new welfare reform is Peter Edelman. Edelman has long been a vocal critic
of the AFDC system, yet when President Clinton signed the new welfare
bill Edelman resigned in protest from his position of assistant secretary for

planning and evaluation at the Department of Health and Human Services.

See his article "The Worst Thing Bill Clinton Has Done," The Atlantic Monthly
(March 1997).
For the opposing viewpoint see M. Tanner, S. Moore, and D. Hartman, "The
Work vs. Welfare Trade-off," Cato Policy Analysis (1995). See also William
A. Niskamen's article "Welfare and the Culture of Poverty," Cato Journal
(Spring/Summer 1996). " For a very strong indictment of antipoverty pro-
grams, read Walter E. Williams'i The Economics oi Poverty/ Vision and
Values (January 1997).
Discussions of welfare reform are found in numerous places, from pol-
icy journals —
see Gary Burtless and Kent Weaver, "Reinventing Welt..
Again," The Brookings Review (Winter 1997)—to articles in popular magazines
such as Adam Cohen's, "The Great American Welfare Lab," Time (April 21,

1997).

2"
On the Internet

European Union (EU)

This site of the. European Union in the United States has
[Link]
everything from history to current status, as well as Web
links and a search capability.
h ttp://www. [Link]

OECD Online
The Organization for Economic Cooperation and Devel-
opment resulted from the need to rebuild Europe after
World War II, but it expanded to become truly interna-
tional, with policies designed to expand world trade on
a multilateral, nondiscriminatory basis.
h ttp://www. [Link]

International Monetary Fund (IMF)

The home page of the IMF links to Information About Its
Purpose and Activities, Special Drawing Rights, What's
New, the 1997 Annual Meeting, and to other organiza-
tions and publications.
h ttp://www. imf. org/

International Trade Administration

The U.S. Department of Commerce is dedicated to help-
ing U.S. businesses compete in the global marketplace,
and at this site it offers assistance through many Web
links under such headings as Trade Statistics, Cross-Cut-
ting Programs, Regions and Countries, and Import Ad-
ministration.
h ttp://www. ita. [Link]/

Social Science Information Gateway (SOSIG)

Project of the Economic and Social Research Council
(ESRC). It catalogs 22 subjects and lists more URL ad-
dresses from European and developing countries than
many U.S. sources.
h ttp://sosig. esrc. bris. a c. uk/

World Bank
At this home page of the World Bank you can click on
News, Topics in Development, Countries and Regions,
Doing Business with the Bank, and more, as well as use
its search feature.
[Link] [Link]
 PART 3
The World Around Us

For manyyears America held a position of dominance in international

trade. That position has been changed by time, events, and the
emergence of other economic powers in the world. Decisions tliat are
made in the international arena will, with increasing frequency,
influence our lives. In the global marketplace trade relations are
influenced by swings in the economies of trading partners. The
environment is also a major concern for economists and other analysts

today.

Should the United States Protect Domestic Industries from

Foreign Competition?

Does Free Trade Make the Poor, Poorer?

Does Global Warming Require Immediate Government

Action?

Should Pollution Be Put to the Market Test?

Has the North American Free Trade Agreement Been a

Success?
ISSUE 15
Should the United States Protect
Domestic Industries from Foreign
Competition?
YES: Robert Kuttner, from "The Free Trade Fallacy," Vie New Republic (March
28, 1983)

NO: Michael Kinsley, from "Keep Free Trade Free," Tlie New Republic (April
11, 1983)

ISSUE SUMMARY
YES: Columnist Robert Kuttner alleges that David Ricardo's eighteenth-
century view of the world does not "describe the global economy as it actually
works" in the twentieth century He says that, today, "comparative advan-
tage" is determined by exploitative wage rates and government action; it is
not determined by free markets.
NO: Social critic Michael Kinsley replies that we do not decrease American
living standards when we import the products made by cheap foreign la-
bor. He claims protectionism today, just as it did in the eighteenth century,
weakens our economy and only "helps to put off the day of reckoning."

The basiclogic of international trade has not changed over time. The villains
change, the winners and losers change, but the theory remains the same.
Thus, do not be alarmed that the readings that follow refer to 15-year-old
editorials that appeared in the WallStreet Journal, the New York Times, or
the Village Voice. The pleadings made in these articles are almost identical
to those that are now being made in the newspapers of the 1990s. As the
saying goes, "The more things change, the more they stay the same." It is
because of the timelessness of the free trade versus protectionism debate that
we have included the Kuttner/ Kinsley selections, even though these essays
first appeared in print over a decade ago. Not only does the basic logic of

international trade not change over time, it is indistinguishable from domestic

trade: Both domestic and international trade must answer the fundamental
economic questions: "What to produce?" "How to produce it?" and "For whom
to produce?" The distinction is that the international trade questions are
posed in an international arena. This is an arena filled with producers and
consumers who speak different languages, use different currencies, and are
often suspicious of the actions and reactions of foreigners.

280
 If markets work the way they are expected to work, free trade simply
Increases the extent of a purely domestic market and, therefore, increases
the advantages of specialization. Market participants should be able to buy
and consume a greater variety of inexpensive goods and services after the
establishment of free trade than they could before free trade. You might ask,
Then why do some wish to close the borders and deny Americans the benefits
of free trade? The answer to this question is straightforward. These benefits
do not come without a cost.
There are two sets of winners and two sets of losers in this game of free
trade. The most obvious winners are the consumers of the less expensive
imported goods. These consumers are able to buy the low-priced color tele-
vision sets, automobiles, or steel that is made abroad. Another set of winners
are the producers of the exported goods. All the factors in the export industry,
as well as those in industries that supply to the export industry, experience
an increase in their market demand. Therefore, their income increases. In the
United States, agriculture is one such export industry. As new foreign mar-
kets are opened, farmers' incomes increase, as do the incomes of those who
supply the farmers with fertilizer, farm equipment, gasoline, and other basic
inputs.
On the other side of this coin are the losers. The obvious losers are those who
own the factors of production that are employed in the import-competing
industries. These factors include the land, labor, and capital that are devoted
to the production of such items as U.S.-made color television sets, U.S.-
made automobiles, and U.S.-made steel. The less expensive foreign imports
displace the demand for these products. The consumers of exported goods are
also losers. For example, as U.S. farmers sell more of their products abroad,
less of this output is available domestically. As a result, the domestic prices
of these farm products and other export goods and services rise.
The bottom line is that there is nothing "free" in a market system. Com-
— —
petition whether it is domestic or foreign creates winners and losers. His-
torically, we have sympathized with the losers when they suffer at the hands
of foreign competitors. However, we have not let our sympathies seriously
curtail free trade. Robert Kuttner argues that we can no longer afford this
policy. He maintains that U.S. workers face "unfair foreign competition"
and that the international rules of the game have changed. Michael Kinsley
replies that this is pure, unadorned protectionism. He concludes that "each
job 'saved' will cost other American workers far more than it will bring the
lucky beneficiary."

281
 Robert Kuttner
YES

THE FREE TRADE FALLACY

In the firmament of American ideological convictions, no star bums brighter

than the bipartisan devotion to free trade. The President's 1983 Economic
Report, to no one's surprise, sternly admonished would-be protectionists.
An editorial in The New York Times, midway through an otherwise sensibly
Keynesian argument, paused to add ritually, "Protectionism might mean a
few jobs for American auto workers, but it would depress the living standards
of hundreds of millions of consumers and workers, here and abroad."
The Rising Tide of Protectionism has become an irresistible topic for a light
news day. Before me is a thick sheaf of nearly interchangeable clips warning
of impending trade war. With rare unanimity, the press has excoriated the
United Auto Workers for its local content legislation. The Wall Street Journal's
editorial ("Loco Content") and the Times's ("The Made-in-America Trap")
were, if anything, a shade more charitable than Cockburn and Ridgeway
in The Village Voice ("Jobs and Racism"). And when former Vice President
Mondale began telling labor audiences that America should hold Japan to a
single standard in trade, it signaled a chorus of shame-on-Fritz stories.
The standard trade war story goes like this: recession has prompted a spate
of jingoistic and self-defeating demands to fence out superior foreign goods.
These demands typically emanate from overpaid workers, loser industries,
and their political toadies. Protectionism will breed stagnation, retaliation,
and worldwide depression. Remember Smoot-Hawley!
Perhaps it is just the unnerving experience of seeing The Wall Street Journal
and The Village Voice on the same side, but one is moved to further inquiry.
Recall for a moment the classic theory of comparative advantage. As the
English economist David Ricardo explained it in 1817, if you are more efficient
at making wine and I am better at weaving cloth, then it would be silly for
each of us to produce both goods. Far better to do what each does best, and to
trade the excess. Obviously then, barriers to trade defeat potential efficiency
gains. Add some algebra, and that is how trade theory continues to be taught
today.
To bring Ricardo's homely illustration up to date, the economically sound
way to deal with the Japanese menace is simply to buy their entire

From Robert Kuttner, "The Free Trade Fallacy," The New Republic, vol. 188, no. 12 (March 28, 1983).
Copyright © 1983 by The New Republic, Inc. Reprinted by permission of The New Republic.

282
 YES Robert Kuttner/ 283

—
cornucopia the cheaper the better. If dered whether the putative efficiencies
they are superior at making autos, TVs, of trade necessarily justified the loss of
tape recorders, cameras, steel, machine national autonomy. Today nearly half of
tools, baseballs, semiconductors, com- world trade conducted between units
is

puters, and other peculiarly Oriental of multinational corporations. As Keynes

products, it is irrational to shelter our predicted, most basic products (such as
own benighted industries. Far more sen- steel, plastics, microprocessors, textiles,
sible to buy their goods, let the bracing and machine tools) can be manufactured
tonic of competition shake America from almost anywhere, but by labor forces
its torpor, and wait for the market to re- with vastly differing prevailing wages.
veal our niche in the international divi- With dozens of countries trying to
sion of labor. emulate Japan, the trend is toward
But this formulation fails to describe worldwide excess capacity, shortened
the global economy as it actually works. useful life of capital equipment, and
The classical theory of free trade was downward pressure on wages. For in a
based on what economists call "factor en- world where technology is highly mobile
—
dowments" a nation's natural advan- and interchangeable, there is a real risk
tages in climate, minerals, arable land, or that comparative advantage comes to be
plentiful labor. The theory doesn't fit a defined as whose work force will work
world of learning curves, economies of for the lowest wage.
scale, and floating exchange rates. And it In such a world, it is possible for
certainly doesn't deal with the fact that grow nominally more pro-
industries to
much "comparative advantage" today is ductive while the national economy
created not by markets but by govern- grows poorer. How can that be? The
ment action. If Boeing got a head start factor left out of the simple Ricardo
on the 707 from multibillion-dollar mil- equation is idle capacity. If America's

itary contracts, is that a sin against free autos (or steel tubes, or machine tools) are
trade? Well, sort of. If the European Air- manufactured more productively than
bus responds with subsidized loans, is a decade ago but less productively
that worse? If only Western Electric (a than in Japan (or Korea, or Brazil),
U.S. supplier) can produce for Bell, is that and if we practice what we preach
protection? If Japan uses public capital, about open trade, then an immense
research subsidies, and market-sharing share of U.S. purchasing power will go
cartels tolaunch a highly competitive to provide jobs overseas. A growing
semiconductor industry, is that protec- segment of our productive resources
tion? Maybe so, maybe not. will lie idle. American manufacturers,
Just fifty years ago, Keynes, having dis- detecting soft markets and tailing profits,
sented from the nineteenth-century the- will decline to invest. Steelmaker-
ory of free markets, began wondering buy oil companies. Consumer I

about free trade as well. In a 1933 I to superior foreign products will not
in the Yale Review called "National Self- wily compensate for the decline
Sufficiency/' he noted that "most mod- in real income and the idle resources.
em processes of mass production can be Nor is there ,inv guarantee that the
performed in most countries and climates new industrial countries will use their
with almost equal efficiency." He won- oning income trom American sales
 —
284 / 15. SHOULD THE U.S. PROTECT DOMESTIC INDUSTRIES?

to buy American capital equipment (or trade to our allies the way the biggest kid
computers, or even coal), for they are all on the block calls for a fair fight.
striving to develop their own advanced, The basic GATT treaty, ratified in 1947,
diversified economies. requires that all member nations get the
Against this background of tidal same tariff treatment (the "most favored

change in the global economy, the con- nation" doctrine), and that tariffs, in the-

ventional reverence for "free trade" is just

ory at least, are the only permissible form
not helpful. As an economic paradigm, Governments are supposed to
of barrier.

it denies us a realistic appraisal of sec-

treat foreigngoods exactly the same as
ond bests. As a political principle, it leads domestic ones: no subsidies, tax prefer-
liberals into a disastrous logic in which ences, cheap loans to home industries,

the main obstacle to a strong American

no quotas, preferential procurement, or

economy is decent living standards for inspection gimmicks to exclude foreign

the American work force. Worst of all, a [Link] can producers sell below cost
simple-minded devotion to textbook free (dumping) in foreign markets
In classical free trade theory, the only
trade in a world of mercantilism assures
permissible candidate for temporary pro-
that the form of protection we inevitably
tection is the "infant industry." But Japan
get will be purely defensive, and will not
lead to constructive change in the pro- and its imitators, not unreasonably, treat

tected industry.
every emerging technology as an infant
industry. Japan uses a highly sheltered
The seductive fallacy that pervades domestic market as a laboratory, and as a
the hand-wringing about protectionism
shield behind which to launch one expprt
is the premise that free trade is the norm winner after another. Seemingly, Japan
and that successful foreign exporters should be paying a heavy price for its pro-
must be playing by the rules. Even so tectionism as its industry stagnates. Poor
canny a critic of political economy as Japan! This is not the place for a detailed
Michael Kinsley wrote in these pages recapitulation of Japan, Inc., but keep in
that "Very few American workers have
mind some essentials.
lost their jobs because of unfair foreign
The Japanese government, in close col-
trade practices, and it is demagogic laboration with industry, targets sectors
for Mondale and company to suggest
for development. It doesn't try to pick
otherwise." But what is an unfair trade
winners blindfolded; it creates them. It
practice? The Common Market just filed
offers special equity loans, which need be
a complaint alleging that the entire
repaid only if the venture turns a profit.
Japanese industrial system is one great It lends public capital through the Japan
unfair trade practice! Development Bank, which signals pri-
To the extent that the rules of liberal vate bankers to funds flow. Where our
let

trade are codified, they repose in the government offers tax deductions to all
General Agreement on Tariffs and Trade businesses as an entitlement, Japan taxes
(stay awake, this will be brief). The GATT ordinary business profits at stiff rates and
is one of those multilateral institutions saves its tax subsidies for targeted ven-
created in the American image just tures. The government sometimes buys
after World War II, a splendid historical back outdated capital equipment to cre-
moment when we could commend free ate markets for newer capital.
 —
YES Robert Kuttner/ 285

The famed Ministry of International try is in deep trouble. Then we build it

Trade and Industry has pursued this es- half a bridge.

sential strategy for better than twenty There is no better example of the
years, keeping foreign borrowers out of lethalcombination of protectionism plus
cheap Japanese capital markets, letting in market-capitalism-as-usual than the steel
foreign investors only on very restricted industry. Steel has enjoyed some import
terms, moving Japan up the product lad- limitation since the late 1950s, initially
der from cheap labor intensive goods through informal quotas. The industry
in the 1950s to autos and steel in the is oligopolistic; it was very slow to
1960s, consumer electronics in the early modernize. By the mid-1970s, world
1970s, and computers, semiconductors, demand for steel was leveling off just as
optical fibers, and just about everything aggressive new producers such as Japan,
else by 1980. The Japanese government Korea, and Brazil were flooding world
also waives antimonopoly laws for devel- markets with cheap, state-of-the-art steel.
opment cartels, and organizes recession As the Carter Administration took of-
cartelswhen overcapacity is a problem. fice, the American steel industry was pur-

And far from defying the discipline of the suing antidumping suits against foreign
market, MITI encourages fierce domestic —
producers an avenue that creates prob-
competition before winnowing the field lems for American diplomacy. The new
down to a few export champions Administration had a better idea, more
consistent with open markets and neigh-
The Japanese not only sin against the
borly economic relations. It devised a
rules ofmarket economics. They convert
"trigger price mechanism," a kind of floor
sin into productive virtue. By our own
price for foreign steel entering American
highest standards, they must be doing
markets. This was supposed to limit im-
something right. The evident success of
port penetration. The steelmakers with-
the Japanese model and the worldwide
drew their suits. Imports continued to in-
rush to emulate it create both a diplo-
crease.
matic crisis for American trade negotia-
So the Carter Administration moved
tors and a deeper ideological crisis for
with characteristic caution toward a min-
the free trade regime. As Berkeley pro-
imalist industrial policy. Officials in-
fessors John Zysman and Steven Cohen
vented a kind of near-beer called the Steel
observed in a careful study for the Con-
and
Tripartite. Together, industry, labor,
Economic Committee last
gressional Joint
government would devise a strategy for a
December, America, as the main defender
competitive American steel industry. The
of the GATT philosophy, now faces an
eventual steel policy accepted the indus-
acute policy dilemma: "how to sustain
try's own agenda: more protection, a soft-
the open trade system and promote the
ening of pollution control requirements,
competitive position of American indus-
wage restraint, new tax incentives, and a
try" at the same time.
gentlemen's agreement to phase out ex-
Unfortunately, the dilemma is com- ipacity. What the policy did not in-

pounded by our ideological blinders. clude was either an enforceable commit-

Americans believe so fervently in tree ment or adequate capital to modernize
markets, especially in trade, that we shun the industry By market standards, mas-
interventionist measures until an indus- sive retooling was not a rational course,
 . .

286 / 15. SHOULD THE U.S. PROTECT DOMESTIC INDUSTRIES?

because the return on steel investment try after industry, the costs to the econ-
was well below prevailing yields on other omy as a whole can easily outweigh the
investments. Moreover, government of- benefits. As Wolfgang Hager, a consul-
ficials had neither the ideological man- tant to the Common Market, has written,
date nor adequate information to tell the "The cheap [imported] shirt is paid for
steel industry how to invest. "We would several times: once at the counter, then
sitaround and talk about rods versus again in unemployment benefits. Sec-
and none of
plate versus specialty steel, ondary losses involve input industries . .

us in government had any knowledge machinery, fibers, chemicals for dyeing

of how the steel industry actually oper- and finishing products."
ates/' confesses C. Fred Bergsten, who As it happens, Hager 's metaphor, the
served as Treasury's top trade un- official textile industry, is a fairly successful ex-
der Carter. "There has never been a gov- ample of managed trade, which combines
ernment study of what size and shape a dose of protection with a dose of mod-
steel industry the country needs. If we're have been
ernization. Essentially, textiles
going to go down this road, we should removed from the free-trade regime by
do it right, rather than simply preserving an international market-sharing agree-
the status quo." . . ment. In the late 1950s, the American tex-
The argument that we should let "the tile industry began suffering insurmount-

market" ease us out of old-fashioned able competition from cheap imports.

heavy industry in which newly indus- The United States first imposed quotas
trialized countries have a comparative on imports of cotton fibers, then on syn-
advantage quickly melts away once you thetics, and eventually on most textiles
realize that precisely the same nonmar- and apparel as well. A so-called Multi-
ket pressures are squeezing us out of the Fiber Arrangement eventually was nego-
highest-tech industries as well. And the tiated with other nations, which shelters
argument that blames the problem on the textile industries of Europe and the
overpaid American labor collapses when United States from wholesale import pen-
one understands that semiskilled labor etration. Under M.F. A., import growth in
overseas in several Asian nations is pro- textiles was limited to an average of 6
ducing advanced products for the U.S. percent per year.
market at less than a dollar an hour. Who The consequences of this, in theory,
really thinks that we should lower Amer- should have been stagnation. But the
ican wages to that level in order to com- result has been exactly the opposite.
pete? The degree of protection, and a climate
In theory, other nations' willingness to of cooperation with the two major
exploit their work forces in order to pro- labor unions, encouraged the American
vide Americans with good, cheap prod- textile industry to invest heavily in
ucts offers a deal we shouldn't refuse. modernization. Eharing the 1960s and
But the fallacy in that logic is to measure 1970s, the average annual productivity
the costs and benefits of a trade transac- growth in textiles has been about twice
tion only in terms of that transaction it- the U.S. industrial average, second only
self. Classical free-trade theory assumes to electronics. According to a study done
full employment. When foreign, state- for the Common Market, productivity
led competition drives us out of indus- in the most efficient American weaving
 YES Robert Kuttner/ 287

operations is 130,000 stitches per worker lion. Ifan industry competes vigorously
—
per hour twice as high as France and domestically, it can innovate and keep

three times as high as Britain. Textiles, prices low, despite being sheltered from
surprisingly enough, have remained an ultra- low-wage foreign competition —or
export winner for the United States, with rather,thanks to the shelter. In fact, stu-
net exports regularly exceeding imports. dents of the nature of modem managed
(In 1982, a depressed year that saw capitalism should hardly be surprised
renewed competition from China, Hong that market stability and new investment
Kong, Korea, and Taiwan, exports just go hand in hand.
about equaled imports.) The textile case also suggests that the
But surely the American consumer sunrise industry/sunset industry distinc-
pays the bill when the domestic market is tion is so much nonsense. Most of Amer-
sheltered from open foreign competition. ica's major industries can be winners or
Wrong again. Textile prices have risen at losers, depending on whether they get
only about half the average rate of the sufficient capital investment. And it turns
producer price index, both before and out that many U.S. industries such as
after the introduction of the Multi-Fiber and shoes, which conventionally
textiles
Arrangement. seem destined for lower-wage countries,
Now, it is possible to perform some can survive and modernize given a rea-
algebraic manipulations and show how sonable degree of, well, protection.
much lower textile prices would have What, then, is to be done? First,
been without any protection. One such we should acknowledge the realities
computation places the cost of each pro- of international trade. Our competitors,
tected textile job at several hundred thou- increasingly, are marketeers
not free
sand dollars. But these static calculations in our own [Link] to let
It is

are essentially useless as practical policy foreign mercantilist enterprise overrun

guides, for they leave out the value over U.S. industry in the name of free
time of maintaining a textile industry in trade. The alternative is not jingoist
the United States. The benefits include protectionism. It is managed trade, on the
not only jobs, but contributions to G.N.P., model of the Multi-Fiber Arrangement.
to the balance of payments, and the fact If domestic industries are assured some
that investing in this generation's tech- limits to import growth, then it becomes
nology is the ticket of admission to the rational for them to keep retooling and
next. modernizing.
Why didn't the textile industry stag- It is not necessary to protect every

nate? Why didn't protectionism lead to industry, nor do we want an American

higher prices? Largely because the tex- MITI. But surely it is reasonable to
tile industry is quite competitive do- fashion plans for particular key sectors
mestically. The top five manufacturers like steel, autos, machine tools, and
have less than 20 percent of the market. semiconductors. The idea is not to close
The industry still operates under a 1968 U.S. markets, but to limit the rate oi
Federal Trade Commission consent or- import growth in key industries. In
der prohibiting any company with sales exchange, the domestic industry mu>t
of more than $100 million from acquir- invest heavily in modernization. And as
ing one with sales exceeding $10 mil- part ot the bargain, workers deserve a
288 / 15. SHOULD THE U.S. PROTECT DOMESTIC INDUSTRIES?

degree of job security and job retraining assumption that they cannot. The highly
opportunities. when a little protec-
practical question of
Far from being just another euphe- tion is justified is ruled out ex ante, since
mism for beggar-thy-neighbor, a more neoclassical economicsassumes that less
stable trade system generally can be in the protection always better than more.
is

interest of producing countries. Univer- Because applied industrial economics

sal excess capacity does no country much is not a mainstream concern of the

of a favor. When rapid penetration of trie economics profession, the people who
U.S. color TVmarket by Korean suppliers study it tend to come from the fields
became intolerable, we slammed shut an of management, industrial and labor
open door. Overnight, Korean color TV relations, planning, and law. They are
production shrank to 20 percent of capac- not invited to professional gatherings of
ity. Predictable, if more gradual, growth economists, who thus continue to avoid
in sales would have been preferable for the most pressing practical questions.
us and for the Koreans. One economist whom I otherwise admire
Second, we should understand the in- told me he found it "seedy" that high-
terrelationship of managed trade, indus- wage autoworkers would ask consumers
trial policies, and economic recovery. to subsidize their pay. Surely it is seedier
Without a degree of industrial planning, for an $800-a-week tenured economist to
limiting imports leads indeed to stagna- lecture a $400-a-week autoworker on job
tion. Without restored world economic security; if the Japanese have a genuine
growth, managed trade becomes a nasty comparative advantage in anything, it is
battle over shares of a shrinking pie, in- in applied economics.
stead of allocation of a growing one. And Fourth, we should stop viewing high
without some limitation on imports, the wages as a liability. After World War
Keynesian pump leaks. One reason big II, Western Europe and North America

deficits fail to ignite recoveries is that so evolved a social contract unique in the
much of the growth in demand goes to history of industrial capitalism. Union-
purchase imported goods. ism was encouraged, workers got a fair
Third, we should train more econo- share in the fruits of production, and
mists to study industries in the partic- a measure of job security. The transfor-
ular. Most economists dwell in the best mation of a crude industrial production
of all possible worlds, where markets machine into something approximating
equilibrate, firms optimize, the idle re- social citizenship is an immense achieve-
sources re-employ themselves. "Microe- ment, not to be sacrificed lightly on the
conomics" seldom the study of actual
is altar of "free trade." It took one depres-
industries; most often a branch of ar-
it is sion to show that wage cuts are no route
cane mathematics. The issue of whether to recovery. Will it take another to show
governments can sometimes improve on they are a poor formula for competitive-
markets is not a fit subject for empirical ness? Well-paid workers, after all, are
inquiry, for the paradigm begins with the consumers.
NO Michael Kinsley

KEEP FREE TRADE FREE

Free trade is not a religion — it has no spiritual value —and Bob Kuttner is

right to insist, as he did in TNR two weeks ago, that if it is no longer good
for America in practical terms, it is not a sensible policy for liberals anymore.
He and I would good for
also agree that a liberal trade policy ought to be
working people in particular (including people who would like to be working
but aren't). The question is whether free trade is just a relic from two happier
eras —
the period of liberal clarity two centuries ago when Adam Smith and
David Ricardo devised the theories of free enterprise and free trade, and the
period of American hegemony after World War II when we could dominate
—
world markets or whether it is still a key to prosperity.
Kuttner argues that Ricardo's theory of "comparative advantage" that all —
nations are better off if each produces and exports what it can make most
efficiently —
no longer applies. Local factors such as climate and natural re-
sources don't matter much anymore. As a result, "most basic products . .

can be manufactured almost anywhere" with equal efficiency. This means,

Kuttner says, that the only ways one nation (e.g., Japan) gains compara-
tive advantage over another (e.g., us) these days are through low wages or
"government action." Either of these, he says, makes nonsense of Ricardo's
theory. In addition, Kuttner says, Ricardo didn't account for the problem of
"idle capacity" —
expensive factories sitting unused.
"Idle capacity" is an argument against any competition at all, not just from
abroad, and has a long history of being carted out whenever established com-
panies (the airlines, for example) want the government bo prevent newcomers
from horning in on their turf. If you believe in capitalism at all, you have to
believe that the temporary waste of capital that can result from the turmoil of
competition is more than outweighed by the efficiency of competition in keep-
ing all the competitors on their toes. A capitalist who builds a plant knowing
(or even not knowing) that it than a rival abroad deserves what-
is less efficient
—
ever he gets. As for older plants that are already built that capital is sunk. If
the cost of running those plants is higher than the cost of buying the same out-
put from abroad, keeping them running is more wasteful than letting them sit

idle.

From Michael Kinslev, "Keep Fnv Bade Free," ThcNc

Copyright © 1983 by The New Republic, Inc Reprinted by pfrmiMton ol The .v

2S9
290 / 15. SHOULD THE U.S. PROTECT DOMESTIC INDUSTRIES?

This brings us to the real problem; not even adding a dollar's worth to the
sunk capital but The middle-
sunk lives. economy. Protectionism is, in effect,
class living standard achieved by much a "make work" jobs program but a —
of the United States working class is one ridiculously expensive one, both directly
of the glories of American civilization. and indirectly. The direct cost, in this
Yet Kuttner says, "semi-skilled labor example, $9 an hour. The indirect
is

overseas is producing advanced products cost is in reducing the efficiency of

for the U.S. market at less than a dollar *an the economy by preventing international
hour. Who really thinks that we should specialization.
lower American wages to that level in If the disparity between American

order to compete?" and foreign wages is really that great,

We shouldn't, of course. But importing Americans just shouldn't be making
the products of cheap foreign labor widgets. We could pay widget workers
cannot lower American living standards at $8 an hour to do nothing, and still be
as a whole, and trade barriers cannot raise better off. We could put them to work
living standards. This is not a matter of at their current wage doing anything
morality: it is a matter of mathematics. worth more than a dollar an hour. We
If widgets can be imported from Asia could spend the equivalent of $9 an
for a price reflecting labor costs of $1 hour on retraining. And we owe it to
an hour, then an hour spent making widget workers to try all these things if
widgets adds a dollar of value to the necessary, because they are the victims of
economy. This is true no matter what a change that has benefited all the rest of
American widget makers are being paid. us by bringing us cheaper widgets (and
If foreign widgets are excluded in order because, as Lester Thurow points out,
to protect the jobs of American widget doing these things will discourage them
makers getting $10 an hour, $1 of that $10 from blocking the needed change). To
economy
reflects their contribution to the protect them while they keep on making
and $9 coming out of the pockets of
is widgets, though, is insane.
other workers who have to pay more These suggestions are, of course, overt
for widgets. Nice for widget makers, but tax-and-spend government programs,
perfectly futile from the perspective of compared to the covert tax-and-spend
net social welfare. program of protectionism. In a period
After all, if this economic alchemy of political reaction, the covert approach
really worked, we could shut our borders is tempting. But hypocrisy is not a
to all imports, pay one another $1,000 an sensible long-term strategy for liberals,
hour, and we'd all be rich. It doesn't work nor is willfully ignoring the importance
that way. In fact, as a society, we're clearly of economic productivity.
better off taking advantage of the $1 In many basic industries, American
widgets. The "comparative advantage" wages are not all that far out of line, as
of cheap Asian labor is an advantage to Bob Kuttner seems to acknowledge in
us too. That's why trade is good. the case of autos. Modest wage adjust-
But what about the poor widget ments can save these jobs and these in-
makers? And what about the social dustries for America. It is uncomfortable
cost of unemployment? If former widget for a well-paid journalist to be urging pay
makers aren't working at all, they aren't cuts for blue-collar workers. On the other
 NO Michael Kinsley / 291

hand, steelworkers (when they are work- it's worth looking at Japan
Certainly,
ing) make more than the median Amer- for about how to succeed in
clues
ican income. Protectionism to preserve the world economy, and certainly one
wage levels is just a redistribution of na- key to Japan's success seems to be a
tional wealth; it creates no new wealth. government-coordinated industrial pol-
Nothing is wrong with redistribution, but icy. (The current vogue for "industrial

in any radical socialist redistribution of policy" is assessed by my colleague

wealth, the pay of steelworkers would go Robert Kaus in the February Harper's —
down, not up. So it's hard to see why forgive the plug.) But why must such a
the government should intervene to pro- policy include trade barriers? One rea-
tect steelworkers' wages at the expense of son Japan thwarts imports is a conscious
general national prosperity. This is espe- decision to reduce workers' living stan-
cially true when millions are unemployed dards in order to concentrate national re-
who would happily work for much less, sources on industrial investment. I pre-
and there is no jobs program for them. sume what Kuttner and other
this isn't
liberal trade revisionists have in mind.
But Bob Kuttner believes that protec-
Kuttner and others include protection-
tion can be good for general national
ism in their "industrial policy" for two
prosperity even apart from the wage
other reasons. First, as a sort of bribe to
question, in an age when other nations'
get unions to go along with sterner mea-
"comparative advantage" comes from
government policies that include protec-
sures —possibly necessary, but not a case
for protection on its own merits. Second,
tionism. It is important to separate differ-
to give promising industries a captive
ent strands in the common protectionist
market in which to incubate and gather
argument that we have to do it because
strength before taking on the world.
Japan does it. Many politicians of vari-
The trouble with this "nurture" argu-
ous stripes, and William Safire in a re-
ment is that there's no end to it. Kuttner
cent column, argue (on an implicit anal-
himself says that it's "not unreasonable"
ogy between trade war and real war) that
to "treat every emerging technology" this
only by threatening or building trade bar-
way, and also says that "most of Amer-
riers ofour own can we persuade the
ica's major industries can be winners"
Japanese to dismantle theirs and restore
with the right treatment. After you add
free trade. Kuttner, by contrast, thinks
the few hopeless loser industries where
that the idea of free trade is outmoded;
we must allegedly create barriers to save
that the Japanese are smart to restrict im-
American wages, you've got the whole
ports and we would be smart to do the
economy locked up, and whether this
same as part of an "industrial policy."
will actually encourage efficiency or the
Both Safire and Kuttner assume incor- ite is, at the very least, an open
needs to be mutual.
rectly that free trade question. And if every major country pro-
In fact, the theory of free trade is that na- tects every major industry, there will be
tions benefit from their own open bor- no world market for any oi them to con-
ders as well as the other guy's. This may quer.
be right or wrong, but the mere fad that Kuttner's model for "managed trade"
Japan is protectionist does not settle the is the Multi-1 lber Arrangement, An inter-
question of what our policy should be national agreement that restricts imports
 — —
292 / 15. SHOULD THE U.S. PROTECT DOMESTIC INDUSTRIES?

of textiles. This, according to Kuttner, per- to bring down a feverish temperature. As

mitted the American textile industry to for the suggestion that the next generation
modernize and become productive, to the of technology will bring the real payoff
point where exports exceeded imports well, they were probably promising the
a less impressive accomplishment if you same thing two decades ago when the
recall that the M.F.A. restricts imports. Multi-Fiber Arrangement began.
Kuttner concedes that, despite the Kuttner also worries that "without
productivity gains, textile prices are some limitation on imports," Keynesian
higher than they would be without fiscal policies don't work. This is like
protection from cheap foreign labor. the monetarists who worry that financial
(Indeed, the current situation in the advances such as money market funds
textile industry, as Bob Kuttner describes will weaken the connection between
it, seems to vindicate Luddites, who inflation and the money supply. Unable
got their start in textiles; human beings to make their theory accord with life,
could do the work more efficiently, they want the government to make
but machines are doing it anyway.) So life accord with their theory. There is

what's the point? According to Kuttner, —

a world economy which Bob Kuttner
"The benefits include not only jobs, but seems to recognize as a good thing
contributions to G.N.P., to the balance and this means Keynesian techniques
of payments, and the fact that investing will increasingly have to be applied
in this generation's technology is the internationally
ticket of admission to the next." Yet There can be no pretense that domestic
Kuttner does not challenge the "algebraic content legislation has anything to do
manipulations" he cites that show how with "industrial policy" —improving the
each job saved costs the nation "several competitive ability of American industry.
hundred thousand dollars" in higher It is protectionism, pure and unadorned,

textile prices. The only "contribution to and each job "saved" will cost other
G.N.R" from willful inefficiency like this American workers far more than it
can be the false contribution of inflation. will bring the lucky beneficiary. Like
The balance of payments is a measure most protectionist measures, far from
of economic health, not a cause of it; aiding America's adjustment to world
restricting imports to reduce that deficit is competition, it just helps put off the day
like sticking the thermometer in ice water of reckoning.
POSTSCRIPT
Should the United States Protect
Domestic Industries from Foreign
Competition?
The desirability of free trade is one of few issues on which a large majority of
professional economists agree. Survey after survey confirms this: Economists
are ardent supporters of free trade. In spite of this general consensus, protec-
tionism is hotly debated. This certainly is the case in these two essays.
Kuttner argues two basic points in his essay. First, he contends that the
world that English economist David Ricardo modeled in 1817 is starkly dif-
ferent than the world we know today. He describes our world as "a world of
learning curves, economies of scale, and floating exchange rates." It is a world
where comparative advantage "is created not by markets but by government
action." Second, he maintains that although free markets will lead to factor
price equalization —
that is, wage rates in developing countries will rise and
U.S. wage rates will fall as long as there is a differential —
we should not, and
cannot, allow this to happen. He asks: Do we want wage levels in the United
States to fall to a dollar an hour?
Kinsley does not believe that free trade is a relic from the past. After
looking at the simple mathematics of Kuttner 's proposal, Kinsley contends,
—
"Protectionism is, in effect, a 'make work' jobs program but a ridiculously
expensive one, both directly and indirectly." He believes we can achieve the
same end without sacrificing the benefits of "international specialization."
Kinsley goes on to argue that when "every major country protects every
—
major industry" the natural consequence of Kuttner's national industrial
—
policy "there will be no world market for any of them to conquer." He
contends that we will return to the isolationists' world, a world that is poorer
than it need be.
Since the majority of economists support the notion of free trade, readings
supporting this position are very easy to identify. However, if you would
like to read an extreme position paper, you might try Paula Stern's "Ronald
Reagan: The International Bad Boy on Trade," The International Economy
(July/August 1991). In this essay she argues that "the essence of Reagan's
trade policy became clear: Espouse free trade, but find an excuse on every
occasion to embrace the opposite." For a more scholarly discourse, you might
read Douglas Irwin's "Retrospectives: Challenges to Free Trade," journal of
Economic Perspectives (Spring 1991). Irwin concludes that when all is said and
done, the charges leveled at free trade "will not fundamentally challenge the
belief of economists in free trade."

293
ISSUE 16
Does Free Trade Make the Poor, Poorer?

YES: William Greider, from "Global Warning: Curbing the Free Trade Free-
fall/' The Nation (January 13, 1997)

NO: Gary Burtless, from "Worsening American Income Inequality: Is World

Trade to Blame?" The Brookings Review (Spring 1996)

ISSUE SUMMARY
YES: Columnist and social critic William Greider warns that blind acceptance
and promotion of "free-market doctrine" must inevitably lead to deepening
inequality and deterioration at home.
NO: Gary Burtless, a senior fellow at the Brookings Institution, concedes that
the demand for and relative wages of less skilled workers have plunged,
but he maintains that this dramatic shift is not confined to the traded-goods
sector.

Many claim that the United States is in the midst of a radical redistribution of
income. The rich are getting richer and the poor, poorer. This is indicated in the
data, which measures the share of "real income" received by families ranked
from lowest income to highest income and then separates the population into
five equal groups or "quintiles."
Income distributional patterns are markedly different before and after 1979.
Prior to 1979, economic growth benefited all income groups. That is, whether
you were poor (part of the first quintile), middle class (part of the second,
third, or fourth quintile), or affluent (part of the fifth quintile), the average
realincome in your income group increased. True, some groups gained more
than others over time, but nevertheless, in the words of John F. Kennedy, "a
rising tide raises all boats."
After 1979 this pattern changed. The tide of economic growth raised the
yachts of the rich, just as it did in the pre-1979 period; but apparently the row-
boats of those with meager or moderate means were washed into the "stag-
nant backwaters" of the economy. The real income, or purchasing power
income, of the bottom 40 percent of all American households fell (the bottom
20 percent falling by 8.8 percent), while the real incomes of the top 40 percent
rose (the real income of the top 5 percent rising by 45.5 percent). This rep-
resents a redistribution of income, but it is a redistribution from the poor to
the rich. This is not an expected pattern in this land of "equal opportunity,"
where public policy has attempted to level the playing field for all, rather

294
than provide a few in society an unsurmountable lead in the race to the top
of the mountain.
Much has been written about the underlying cause or causes of this radical
shift in the distribution of income in the United States. (Note that the 1995
quintile shares reported in 1997 indicated a possible reversal of this pattern.
For the first time since 1979, the most affluent households in the United States
— the top 20 percent and the top 5 percent—experienced a very modest decline
in their share of income. The share income received by the top 5 percent
of all
fell from compared to the 1994
21.1 percent to 21.0 percent in the 1995 data
data, while the top 20 percent share fell from 46.9 percent to 46.5 percent.) The
disturbing pattern that characterizes the post-1979 period has been variously
—
attributed to (1) the influx of unskilled immigrants both documented and
undocumented; (2) changes in age composition of the population where —
15-to-24-year-olds are a larger proportion of the potential workforce; (3) the
marked rise in the percentage of the workforce with a college education,
resulting in a wage gap when compared to those without advanced education;
(4) the decline in the economic influence of the labor union movement; (5)
the shift from an industrial-based economy to a service-based economy; (6)
the rapidly rising skill levels required for employment in all sectors of the
—
economy; (7) changing public policy reducing the progressivity of federal
taxes and curtailing the magnitude and extent of the "safety net"; (8) the
growing presence of female-headed households; and (9) the globalization of
the world economy.
It is the latter issue that is debated by William Greider and Gary Burtless.

Greider takes the position that the "freefall" in the incomes of middle-class
Americans can be traced to the blind acceptance of free markets and free
trade without the mediating influence of government. Burtless, on the other
side, argues that there are many reasons for the "widening income gap" and
none of them are linked to liberalizing international trade.

295
 William Greider
YES

GLOBAL WARNING: CURBING THE

FREE-TRADE FREEFALL

The global system of finance and commerce is in a reckless footrace with

history, plunging toward a dreadful reckoning with its own contradictions,
pulling everyone along with it. Responsible experts and opinion leaders,
of course, do not generally share my sense of alarm. Nor do most politi-
cal authorities, who, in any case, seem thoroughly intimidated by economic
events. Some important voices in business and finance do occasionally ex-
press similar anxieties, but multinational enterprise is preoccupied with its
own imperatives, finance capital consumed by its own search for returns.
Public opinion may be uneasy, even angry, but people generally are confused
and rudderless.
The destructive pressures building up within the global system are leading
toward an unbearable chaos that, even without a dramatic collapse, will
likely provoke a harsh, reactionary politics that can shut down the system.
This outcome is avoidable if nations will put aside theory and confront what
is actually occurring, if they have the courage to impose remedial changes
before it is too late.
If the positive energies of this revolutionary process are to be preserved,

ithas to be slowed down, not stopped, and redirected on a new course of

development that is more moderate and progressive, that promises broader
benefits to almost everyone. The economic problem requires governments to
discard the hollow abstractions of financial accounting and begin rebuilding
the tangible foundations for balanced prosperity, for work and wages, and
—
for greater social equity not only for older, wealthier nations but for the
aspiring poor in the emerging "one world/' It is far easier to describe some
ways this might be achieved than to imagine that governing elites will act
upon them.
first priority is to reregulate finance capital. Governments will have
The
to reimpose some of the control discarded during the last generation, both
to stabilize financial markets and to make capital more responsive to the
needs of producing economies. Measures like transaction taxes on foreign
exchange would be a beginning. Such controls would take some of the

From William Greider, "Global Warming: Curbing the Free Trade Freefall," The Nation (January
13, 1997). Copyright © 1997 by The Nation. Reprinted by permission.

296
 YES William Greider/ 297

profit out of currency trading and other market forces or the social convulsions
speculative but would not
activities they sow if societies will act to counter
inhibit long-term flows of capital for them. A shared prosperity emerges, as
foreign investment and trade. Keynes taught, only when people throw
The popular belief that governments off passivity and leam to take control of
lack the power to control international their fate.
fiance simply wrong: to disarm the
is Governments can counter the disor-
exaggerated power and random follies of ders and ameliorate losses mainly by
the global bond market, they can tighten stimulating consumption, creating more
terms for easy credit; in some arenas —
buyers for unsold goods the rising mar-
of credit, ceilings on interest rates can ket demand that activates idle factories
be reimposed; prohibitions on accepting and workers. The present regime is fun-
transfers of offshore funds could shut damentally pathological because it de-
down the banking centers where capital stroys consumer incomes while creating a
hides from securities laws and income growing surfeit of goods. Many different
taxes. Governments, in essence, must measures can push the global system in
reclaim the ruling obligations of the the opposite direction, but the underlying
nation-state from private markets. problem, bluntly stated, requires shift-
The central economic problem of our ing returns from capital to labor, revers-
present Industrial Revolution, not so dif- ing the maldistribution of incomes gener-
ferent in nature from our previous one, is ated by the marketplace under the rentier
an excess of supply — the growing, per- system.
manent surpluses and
of goods, labor Greater social equity is not only con-

productive capacity. The supply problem sistent with but required by a sound
is the core of what drives destruction and expanding economy: When rising
and instability: accumulation of redun- incomes are broadly distributed, it cre-
dant factories as new ones are simulta- ates mass purchasing power fueling a—
neously built in emerging markets, mass virtuous cycle of growth, savings and
unemployment and declining wages, ir- new investment. When incomes are nar-
regular mercantilist struggles for market rowly distributed, as they are now, the
entry and shares in the industrial base, economic system feeds upon itself, erod-
market gluts that depress prices and prof- ing its own energies for expansion, bury-
its, fierce contests that lead to coopera- ing consumers and business, even gov-
tive cartels among competitors, and other ernments, in impossible accumulations of
consequences. debt. A relative few become fabulously
wealthy, but a healthyeconomy is not
sustained by manic investing. Nothing
The shocking lesson of economic history about modem technologies or the "in-
—experience that now seems largely formation age" has altered these ancient
forgotten — is that vast human suffering fundamentals.
and random destruction of productive
capacities are unnecessary. From the
crisis and turmoil of the early twentieth The genuine meaning of "one world"
century, nations painfully discovered that will be tested by how nations answer
there is nothing inevitable about these this question: Can the global system be
298 / 16. DOES FREE TRADE MAKE THE POOR, POORER?

turned toward a less destructive path programs that try to help people after
without throwing poor people over the they are already poor or unemployed.
side? Older economies may be tempted The same principle could target the com-
to revert to insular, self-protective reme- mon practice, at least among U.S. com-
dies, but this will destroy the promise of panies, of escaping the social overhead of
the globalizing revolution and could even doing business by marginalizing workers
produce its own implosion of commerce in piecemeal jobs —
the "temporary" or
— balkanized struggles for markets that "contract" work that lacks decent wages
substitute political conflict for the eco- or benefits. The supposed efficiency of
nomic disorders. The challenge of "one these measures actually involves pushing
world" is to create the standards for a pro- the social costs —health care or income
gressive system that everyone can trust, —
support for indigent retirees onto oth-
that does not leave anyone out. ers, mainly the general public.
The imperatives for a new world order Direct taxation of financial capital
can be boiled down to a series of mutually could also create a mechanism for re-
reinforcing propositions, each of which warding the firms and investors who
would help to redress the economic take responsibility for broader economic
imbalances of supply and demand. They and social consequences while punishing
include the following ideas: the free riders. Globalizing corporations,
which move jobs offshore and arbitrage
1. Tax capital instead of labor. Even a modest tax concessions from different govern-
shift in tax structures can stimulate the ments, ought to be treated less favorably
creation of new and wage incomes
jobs than the enterprises that are conscien-
while it creates the mechanism for tiously increasing their domestic employ-
making investors and corporations more ment. Capital investors, likewise, have a
accountable for their behavior. The tax financial obligation to the commonweal
codes of most of the advanced industrial that protects them.
nations are tilted against work, focusing A direct tax on wealth is not as radi-
regressive payroll taxes on wage earners cal as it may sound to Americans, since
and their employers, thus raising the real eleven other nations in the Organization
cost for a company that expands its work for Economic Cooperation and Develop-
force. By comparison, wealth is
financial ment, including Germany, already have
lightly taxed and, at least in the United modest versions. The principle is not dif-
States, is not subject to the property taxes ferent from ordinary property taxes or
that people pay on real-property assets business-license taxes on merchants or
likehomes and businesses. professionals, since capital owners ben-
Reducing the tax barrier to employ- efit from the public domain. For in-

ment can be done in a progressive man- stance, Edward Wolff has proposed that
ner that favors work for the less skilled the United States follow the model of
—lower payroll tax rates on jobs at the Switzerland and adopt a system of mod-
lower end of the wage scale, higher taxes est, graduated rates that would start by
at the high end. That would provide a exempting the first $100,000 of financial
discreet incentive to multiply jobs for assets, tax the next $100,000 at a rate of
those who need them most—a cheaper only .05 percent and rise to a rate of 0.3
and more effective approach than social percent about $1 million. He calculates
 YES William Greider/ 299

that such a system would have raised doing the opposite. The global dis-
it is

—
only $40 billion in 1994 a lot of money would not be stopped,
persal of industry
but hardly an onerous burden on the but firms and shareholders would have
wealthy, nor a solution to the fiscal dis- to help pay for what they left behind.
orders. This approach inevitably favors do-
A central purpose of taxing capi- mestic companies over multinationals,
tal, however, is to establish the means but it also discards the fraudulent propo-
for defining the responsibility of capi- sition that any tax break or subsidy to
tal owners each nation and its peo-
to business automatically translates into a
ple. If capital wants to enjoy record re- benefit for society at large. If mat assump-
turns from the global system, it must help tion was ever sound, it is clearly suspect
pay for the economic and social wreck- in the era of globalizing corporations.
age it leaves behind. Once that princi- Governments promoting the trading for-
ple is established, the tax code can begin tunes of multinationals have not yet an-
to make distinctions among both corpo- swered the gut question: Who in the na-
rations and investors, based upon their tion benefits from this process, owners or
civic behavior. workers, capital or citizens?
"The emerging modern system gives a
larger share of income and power to cap- 2. Reform the terms of trade to insure
ital, yet the burdens of government and more balanced flows of commerce, compelling
community have steadfastly been shifted exporting nations to become larger con-
to labor/' as one financial economist ex- sumers of global production. The present
plained to me. "At some point, we have to system is propped up by the persistent
ask whether utterly free capital is a bene- trade deficits of wealthier nations, mainly
fit to everyone. Free capital is certainly a the United States, a condition that can-
benefit to the people who own the capital. not endure for much longer. Rhetorical
But they couldn't exist if these govern- promises notwithstanding, global agree-
ments did not exist to protect them. No ments like the General Agreement on Tar-
one wants to locate the Chicago Board of iffs and Trade (GATT) and the endless

Trade in Bangkok or Jakarta. They want rounds of trade disputes have failed ut-
to be in the United States or maybe five terly to redress trade imbalances. Indeed,
or six other countries, where their trans- prospects are worsening as China and
actions and their wealth will be safe." other major new industrial powers pre-
Similar logic could change the strate- pare to enter the world market. A fun-
gic calculations of multinational corpo- damental principle, therefore, must be
rations as they disperse production, per- established: An industrial economy can-
haps by making preferential distinctions not expect to construct a vast oversupply
in the tax code. If the national objective is of production for export while refusing
to stimulate domestic employment, then to accept equivalent volumes of imports
capital or corporate stocks might gel a from others.
reduction or even exemption from cap- The system, in effect, has to provoke a
ital gains taxation if the corporate bal- meaningful showdown with the Japanese
ance sheet confirms that the enterprise model ot wealth accumulation the mer- —
is increasing jobs by investing at home. cantilist practices that exact BerO-SUm

Capital should be taxed at the full rate it advantage at the expense of trading
300 / 16. DOES FREE TRADE MAKE THE POOR, POORER?

partners. Those economies that persist their wages is sanctioned and protected.
in accumulating huge trading surpluses Morality aside, the economic objective
should lose their cost-free access to for- is straightforward: Raising wages at the

eign markets through emergency tariffs bottom enlarges the base of consumption
or other measures. On the other hand, for everyone's goods. Even in the best of
nations that practice genuine reciprocity circumstances, the downward pressures
of buying and selling, including the as- on high-wage labor markets will not
piring poor nations, should be rewarded abate soon, given the vast sea of available
with preferences. In short, Japan and low-wage workers. But every gain in
other Asian nations like China that fol- wage levels at the bottom, even a modest
low Japan's strategic path would face an gain, translates into immediate economic
unsentimental choice: Either expand im- benefit for the system: more
global
ports or expect to be stuck with excess purchasing power.
productive capacity. At present, the system functions in re-
The objective of temporary trading bar- verse, eroding consumption by replac-
riers would not be to protect domestic ing high-wage labor with cheap labor. To
industrial sectors but to force everyone be sure, the new industrial workers in
to confront the underlying crisis of sur- Asia and Latin America have new wage
pluses. Every trading nation, including incomes to spend, but overall the sys-
poor nations hoping to become less poor, tem experiences a net loss in the poten-
has a tangible stake in solving the supply tial for mass consumption. The challenge,

problem because it poses a principal ob- roughly speaking, is to create a global

stacle to adopting a pro-growth regime system that functions most energetically
for the world. Under the current system, by pulling the bottom up instead of the
older economies may actually suffer from top down. Many poorer nations are nat-
faster growth if their rising consumption urally hostile to the suggestion, fearing
simply generates a deluge of imports and that they will lose the comparative ad-
larger trade deficits, while the foreign vantage of cheap labor or political control
markets remain closed to their produc- over their work forces. But companies or
tion. Until this zero-sum condition is cor- nations that rely on repression and ex-
rected, the potential for greater growth ploitation of the weak for trading advan-
will remain stymied. Emergency tariffs to tage are not truly ready for membership
correct a nation's financial disorders are in a "one world" economy. They should
an extreme measure, but not prohibited be penalized, even excluded.
by GATT. If the United States threatened The easiest way to accomplish this
such measures, other nations might at last reform is to insert an enforceable "social
face up to the larger global problem of clause" in the global trade agreements
oversupply. requiring all trading nations to honor
long-established international rules for
3. Bring the bottom up — raising wages on labor rights. As a practical matter, that
the low end as rapidly as possible —by is happen at the level of
unlikely to
requiring trading nations to honor labor GATT and the World Trade Organization,
rights. By defending human freedom, the since both developing countries and
trading system can establish that the multinational corporations are opposed
collective right of workers to bid up to any labor reform.
 —
YES William Greider/ 301

The political opening lies in negoti- sumption, and it is socially enlightened

ating regional or nation-to-nation com- because it eases global poverty.
pacts that establish networks of social Writing off these debts is probably
standards and extend trading preferences inevitable, in any case, since most of
to those who honor them (the oppor- the loans can never be repaid. Right
tunity Bill Clinton failed to act upon now, the interest costs simply bleed the
when pushing NAFTA). Reciprocal trade poor nations further each year and often
agreements that link several rich nations require new loans so they can keep
with several poor nations could estab- up payments on old loans. Liquidation
lish a working model that demonstrates would free their meager cash flows
the positive economic energies that flow for genuine development and at least
from labor reform. As participants bene- the possibility that they may someday
fit on both ends, other nations, rich and become significant consumers in the
poor, may see the wisdom of emulating global system.
the reform. To accompany the debt forgiveness,
however, the operating purposes of
Nations are, of course, entitled to their
international lending
sovereignty —the power to set domestic
the
must also be reformed. The I.M.F. and
institutions

social standards free of foreigners' inter-

World Bank must develop greater respect
ference^ —but that does not require for-
for indigenous strategies for growth,
eigners to buy their goods. Advanced
promoting a more patient development
economies need not meddle in other na-
of domestic economies instead of simply
tion's domestic politics, since they can
enforcing the financial imperatives of the
regulate the behavior of their own multi-
global system. To cite the most obvious
nationals, both at home and abroad. If the
contradiction, these institutions routinely
national interest lies in bringing up wages
use their power to suppress wages and
worldwide, then governments may with-
consumption in the developing countries
draw subsidies and tax preferences from
when the advanced nations that finance
companies that, like the U.S. electron-
their lending have an interest in achiev-
ics industry in Malaysia, actively seek
ing the opposite. If the lending institu-
to block labor rights of their foreign
change direction, then
tions are unable to
workers.
sponsoring governments should with-
draw funding and abolish them, writing
4. Forgive the debtors — that is, initiate a gen- off their loan portfolios in the process.
eral write-off of bad debts accumulated by
poorer nations. Extinguishing failed loans 5. Reform the objectives of central banks so
issued by international agencies such as they will support a pro-growth regime in-
the International Monetary Fund and the stead of thwarting it. The purposes of mon-
World Bank would free desperately poor etary policy have to be returned to a more
economies, especially in Africa, to pur- balanced and democratic perspective
sue more viable strategies for domes- an understanding that growth, employ-
tic development. The liquidation of debt ment and wages are crucial to a sound
obligations is fundamentally a stimula- economy no important than the pre-
less

tive economic measure since it free- rogative oi Stored wealth. So long as the
for other pursuits, including active con- Federal Reserve and the central banks of
 —

302 / 16. DOES FREE TRADE MAKE THE POOR, POORER?

other nations stand in the way of more influences of supply and demand. If a
vigorous growth that might allow a rein- new era of growth is to occur, new the-
flation of wages, the problem of weaken- oretical understandings must replace the
ing consumption and oversupply is sure traditional rules of central banking.
to increase, accompanied by compound-
ing debt burdens. 6. Refocus national economic agendas on
The policy choices embedded in the the priority of work and wages, rather than
regulation of money and credit always trade or multinational competitiveness, as the
involve difficult trade-offs between dif- defining issue for domestic prosperity. Ob-
ferent risks —recession or inflation, idle viously, these objectives are intertwined
capacity or overheated activity, failed and interacting, but it makes a great dif-
debtors or financial speculation. But the ference as to which to put first. If ad-
consequences of these choices are not dis- vanced nations, especially the United
tributed evenly throughout society, es- States, concentrate on promoting em-
pecially when policy is always skewed ployment and more equitable incomes,
toward the interests of wealth holders. they can make a great contribution to the
Most of the leading central banks are os- global system, in addition to domestic
tensibly independent of politics, yet this well-being, by boosting mass consump-
does not prevent them from adhering tion. If governments continue to be pre-
faithfully to the narrow constituency of occupied with globalization and promo-
finance capital. Their prejudices are un- tion of the free-market doctrine, then they
likely to change until the competing in- must inevitably accept the consequences
terests— labor, manufacturing and other of deepening inequality and deteriora-
sectors —organize counter-pressures de- tion at home.
manding a more generous policy of eco- The actions that governments could
nomic growth. To make central banks take will require new spending, but
yield, theyshould be reconstituted as should focus less on government social
open and accountable governing institu- aid programs and more on wage reali-
tions. ties in private-sector labor markets. Many
Unfortunately, central banks are stuck such measures are traditional forms of
in the past, still fighting the last war intervention: raisingminimum wages,
against inflation when the global system strengthening labor laws to encourage
now danger a mas-
faces the opposite — companies to share productivity gains
sive deflation of prices,economic activ- with workers, restoring progressive taxa-
ity and debt. The trade-offs surrounding tion to redistribute income, curbing the
monetary policy have been profoundly luxurious corporate subsidies embed-
altered by globalized finance and pro- ded in the tax code and government
duction. Yet central bankers continue to programs, underwriting major works
operate in the traditional manner, as if projects like high-speed rail systems or
they were still regulating self-contained urban housing rehabilitation.
domestic economies. This anomaly leads If it is true that global pressures will
them to err repeatedly on the downside drag down wages and employment for
discouraging domestic economic activity another generation, then the eco-
at least
and new investment in the name of sta- nomic imperative for large-scale subsi-
bility —even as markets respond to global dized employment is inescapable. If peo-
 YES William Greider/ 303

pie cannot find jobs that promise a liv- ness enterprises or a national child-care
ing wage for families, then all the vari- system —new business activity that be-
ous social interventions that government comes a significant employer while fill-

undertakes will be futile. Instead, soci- ing real needs. Every such step, of course,
eties will accumulate another generation tends to distribute the economic returns
of dispossessed and alienated citizens. more broadly through society and thus
The same essential question has to be creates more buyers for the world's sur-
asked of every public measure: Does it plus production.
genuinely promise to enhance work and If people can get beyond passivity and
wages? In debating that question, peo- insecurity, an era of economic experimen-
ple will discover that much of what gov- tation lies —
ahead ventures that explore
ernment currently does is useless or even new and economic arrangements,
social
harmful to broadly shared prosperity. But projects that can be encouraged by gov-
the answers may also begin to bring the ernment, not managed by it. Among rich
economic future into clearer focus, defin- and poor, people are already exploring
ing potential new pillars for domestic ideas that may change their destiny, so-
economic activity. Financial reform, for cial invention that needs not wait upon
instance, might direct credit subsidies to market forces.
sectors like housing or small-scale busi-
NO Gary Burtless

WORSENING AMERICAN INCOME

INEQUALITY: IS WORLD
TRADE TO BLAME?
Since 1970 American incomes have become strikingly less equal. Living stan-
dards of poor and lower middle-class Americans have fallen while those of
affluent Americans have continued to improve. And the trend toward in-
equality has not been confined to the United States. Nations throughout the
industrialized world have seen income disparities rise since the late 1970s.
Many people blame rising income inequality on the growing importance of
trade, especially trade with nations in the developing world, in the past quar-
ter century. In The Trap, a bestseller in Western Europe, Sir James Goldsmith
argues that free trade with low-wage countries has harmed and threatens to
impoverish low-skilled and middle-class workers in the advanced industrial
countries. A similar argument was used by Ross Perot and other U.S. oppo-
nents of the North American Free Trade Agreement, who warned that freer
trade with Mexico would eliminate industrial jobs and reduce the wages of
semi-skilled U.S. workers. More recently, Republican presidential aspirant
Patrick Buchanan has called for an "equalization tax" on imports from third
world countries to protect American workers against competition from Asian
and Latin American workers who may be paid one-tenth the U.S. industrial
wage. How well does the case against free trade stand up to the facts?

TRENDS IN U.S. INCOME INEQUALITY

There is no disputing the worsening trend in U.S. income inequality. Figure

1 documents the rate of change in income for Americans divided into five
quintiles of the income distribution. Income changes are calculated after tak-
ing account of changes over time in the price level and changes in the size
of families in different parts of the income distribution. (Average family size
shrank after 1969, so it took less income to support families at the same stan-
dard of living.) The black bars represent income changes during 1969-79, the
gray bars, changes between 1979 and 1993. During 1969-79, Americans in all

From Gary Burtless, "Worsening American Income Inequality: Is World Trade to Blame?" The
Brookings Review (Spring 1996). Copyright © 1996 by The Brookings Institution Reprinted by
permission

304
 NO Gary Burtless / 305

quintiles made income gains, though families with a highly paid male earner
people in the lowest income quintile were more than average to have
likely
made the smallest percentage gains. After a highly paid female earner. These non-
1979, incomes fell in each of the three trade- related economic and demographic
bottom quintiles while continuing to trends account for more than half the
grow in the top two. Compounded over growth in overall U.S. income inequality
the 24-year period, the differences in the since 1969.
rate of change in income imply dramatic
movements in relative well-being. At the
EARNINGS INEQUALITY
5th percentile, income fell 34 percent; at
the 95th percentile, it rose 43 percent. Even if trade is not to blame for trends
In 1969, income at the 95th percentile of in unearned income or changes in the
adjusted personal income was a little less composition of American households,
than 12 times income at the 5th percentile. it could still be an important source

By 1993, income at the 95th percentile of growing wage inequality. Figure 2,

was more than 25 times income at the 5th based on annual earnings reports in
percentile. the Census Bureau's Current Population
Several developments lie behind the Survey, shows that between 1969 and
widening income gap, and most of them 1993, earnings fell for men in the bottom
have little direct or indirect link to lib- 40 percent of the earnings distribution,
eralized international trade. Significant remained unchanged for men in the
gains in capital income during the decade middle quintile, and rose for men at
of the 1980s, for example, caused un- the top. The disparate trends in wage
earned income to grow strongly in the earnings became more pronounced after
top part of the income distribution. And 1979. Earnings fell sharply in low-wage
at thesame time, changes in the pattern groups, and wage disparities between
of government transfers —with growing well-paid and poorly paid men widened
cash transfers going to the elderly, many at an accelerated pace. Although overall
of whom tend to be well up the income wage trends have been much healthier for
distribution, and shrinking cash transfers women (gray bars in Figure 2), women
to the poor —
reduced the effectiveness have also experienced widening earnings
combating poverty.
of those transfers in disparities, especially in recent years.
Changes house-
in the structure of U.S. After 1979 women in the top quintile
holds also added to income inequality. saw their earnings climb more than 25
Single-parent families are more likely percent. For women at the bottom, annual
to be poor than families that have two earnings fell after 1979.
parents, and a much higher percentage
of Americans now lives in single-parent
DOES TRADE HARM UNSKILLED
families. Finally, the dramatic increase
U.S. WORKERS?
in paid employment among American
women has tended to boost inequality The argument that trade blame
is to
since the late 1970s. In the 1950s and for U.S. earnings inequality rests on the
1960s, families with a well-paid male assumption that trade hurts U.S. workers
earner were less likely than average to with skills similar to those of workers
have a well-paid female earner. By m developing countries. The intuition
306 / 16. DOES FREE TRADE MAKE THE POOR, POORER?

Figure 1

Change in Adjusted Real Personal Income, by Quintile, 1969-93

25%

Bottom Middle

Note: Personal incomes are "adjusted" to reflect differences in family size. The top quintile extends only
through the 97th percentile.

Source: Author's tabulations of the March 1970, 1980, and 1994 Current Population Survey files.

behind this view is straightforward: very- ers, and still others will specialize in new
poorly paid unskilled workers overseas products where relative wages and fac-
take away job opportunities and drive tor prices favor production in the United
down the wage of unskilled American States. No matter which alternative they
workers. choose, the demand for less-skilled work-
ers in the traded-goods industries will
It is easy to see in theory how surg- fall. Shrinking demand will reduce the
ing exports from developing countries relative wage of less-skilled workers in
could harm less-skilled U.S. workers in comparison with highly skilled workers.
the trade-affected industries. To counter
the competition from cheap unskilled la- But if trade is the main factor behind
bor abroad, American employers must the growing woes of unskilled workers
reduce the wages, or make less intensive in traded-goods industries, then
the
use, of unskilled labor if they wish to re- firms that do not produce internationally
main in business. Presumably, some em- traded goods and services should take
ployers who continue to rely heavily on advantage of the shrinking wage of
unskilled workers will go bankrupt, oth- less-skilled workers by hiring more of
ers will move production overseas, others them. If, instead, they also begin to pare
will adopt new technologies that permit back use of unskilled labor, it must be
them to dismiss some unskilled work- something other than (or in addition to)
 — —
NO Gary Burtless/ 307

Figure 2
Changes in Real Earnings, by Gender and Earnings Quintile, 1969-93
40%

30%

20%

10%

I
0%

-10%

-20%
pM Men
Women

Bottom 2nd Middle 4th Top

Note: Annual earnings of full-time, year-round wage and salary workers. Top quintile extends only through
the 96th percentile for men and the 99th percentile for women.

Source: Author's tabulations of the March 1970, 1980, and 1993 Current Population Surveys.

trade that is lowering the demand for ings at the 10th percentile. Male in-
less-skilled workers. equality is growing in both the most
Figure 3 helpsshow whether trade is and the least trade-affected industries,
behind the drop in relative demand for and it is growing at the same rate
less-skilled labor. It compares wage in- 47 percent between 1969 and 1993. Al-
equality trends among male workers in though wages are more equal among
two broad classes of U.S. industries women in trade-affected industries than
one (including manufacturing, mining, among women in the least-affected in-
and agriculture) that is highly trade- dustries, wage inequality among women
affected and another (including construc- has grown faster in the nontrade in-
tion, retail trade, personal services, and —
dustries since 1979 the very period in
public administration) that is not trade- which problems and manufac-
U.S. trade
affected. (An excluded group of indus- tured imports were concentrated. When
tries, including transportation, whole- the data for men mu\ women are com-
sale trade, finance, and insurance, falls bined, the earnings ratio in the most
in an intermediate category.) Earnings trade-affected industries rose 2^ per-
inequality is calculated as the ratio of cent between L969and L993 —exactly the
annual earnings at the 90th percentile same as the n^e in inequality
of the earnings distribution to earn- industi
308 / 16. DOES FREE TRADE MAKE THE POOR, POORER?

Figure 3
Ratio of Earnings of Male Workers at 90th Percentile to Earnings at 10th
Percentile, 1969-93
5.5

5.0

Least trade-affected industries

4.5

4.0

Most trade-affected industries

3.5

3.0
1969 1973 1977 1981 1985 1989 1993

Note: Annual earnings of full-time, year-round wage and salary workers.

Source: Author's tabulations of selected Current Population Surveys.

The same pattern of relative earn- pay premium than women in other in-
ings change is apparent in trends among dustries, but the difference is compara-
workers with different levels of school- tively small.
ing. Educational pay premiums have Even though wage inequality and ed-
risen since 1969 for every industry and ucationalpay premiums moved in the
for both sexes. But the premiums have same pattern across different industries,
not risen any faster in the industries most liberalized trade may still explain the pro-
affected by trade than they have in other nounced toward greater inequality.
shift
industries. For working men as a group, In a competitive and efficient labor mar-
the premium for post-college education ket, pay premiums for skill and education
rose 36 percent between 1969 and 1993; should eventually rise and fall together
for men in trade-affected industries, the across industries, whatever the reason for
premium rose 33 percent. Andthe gap in the change in pay premiums.
pay between high school dropouts and But if the trade from newly industrial-
men with some college rose exactly as fast izing countries in Asia and Latin Amer-
among men in trade-affected industries ica is placing special pressure on produc-
as it did among men as a whole. Women ers in trade-affected industries, we would
in the trade-affected industries had a expect these industries to shed low-wage
somewhat larger rise in the post-college workers/aster than industries where com-
 NO Gary Burtless / 309

Figure 4
Percentage of Full-time Equivalent Male Workers without a High School
Diploma, 1969-93
45%

40%

35%
Most trade-affected industries
30%

25%

20%

Least trade-affected industries

15%

10%
1969 1973 1977 1981 1985 1989 1993

Source: Author's tabulations of selected Current Population Surveys.

petitive pressure comes exclusively from from 36 percent in 1969 to 13 percent in

other domestic firms. To what extent was 1993. If anything, industries unaffected
this the experience in the United States? by trade cut their use of low-skill work-
ers even faster than trade-affected indus-
Between 1969 and 1993, trade-affected tries —
a pattern that is extremely hard to
industries did indeed reduce the percent- square with the claim that foreign trade
age of less educated workers on their pay- is the main factor behind soaring wage
rolls (Figure 4). In 1969, 42 percent of inequality.
male and 45 percent of female workers
in trade-affected industries had no high
school degree. By had
1993, those figures
BESET ON ALL SIDES
fallen to 18 percent for men, 17 percent
for women. These trends certainly seem Over the past quarter century, the nation
consistent with the view that liberal trade has seen a dramatic shift in the pattern of
has deprived less-skilled workers of job demand for workers with different levels
opportunities in the traded-goods sector. of skill. Job opportunities for the less-
But employment patterns in industries skilledhave shrunk, and relative wages
unaffected by trade moved in exactly the for unskilled and semi-skilled workers
same direction. The percentageof male have plunged. But these trends are not
workers without a high school degree in confined to the traded-goods sector. They
the industries least affected by trade fell are also apparent in industries, such
310 / 16. DOES FREE TRADE MAKE THE POOR, POORER?

as construction and retail trade, where terns of immigration into the United
international trade is a minor concern. States, declining minimum wages, and
International trade, seems, has not
it the dwindling influence of labor unions
been the decisive factor in the trend have also contributed to the job woes
toward greater earnings inequality. Other of unskilled and semi-skilled workers.
developments have been at least as Liberal trade with the newly industri-
influential, not more so.
if alizing countries of the world has cer-
Among economists, the leading expla- tainly played a part in worsening the job
nation for increased wage inequality is prospects of America's unskilled work-
changes in the technology of production. ers. But if we follow the advice of Ross
Such innovations as the personal com- Perot and Patrick Buchanan and erect a
puter or new forms of business organiza- new wall of trade protection, we would
tion have favored workers with greater do to ease the plight of less-skilled
little

skill and reduced the value of unskilled workers. Too many other forces are con-
labor. spiring to push their wages down.
But other developments are also at
work. Economic deregulation, new pat-
POSTSCRIPT
Does Free Trade Make the Poor, Poorer?

Perhaps no single issue in this book will affect you more directly than this
issue on income not that you will end up in the bottom 60
distribution. It is

percent of the U.S. households that are trapped in the "stagnant backwaters
of our economy." Quite the contrary. You are far more likely to be college
graduates or soon-to-be college graduates and you will be the winners in any
future economic "competitions."
In spite of this, you should be concerned. Unless this pattern is moderated,
we will become a country of the "haves" and the "have nots."
see the Many
process well underway. The "haves" are increasingly becoming isolated in
their exclusive communities and the "have nots" are increasingly concen-
trated in their deteriorating inner-city neighborhoods. The less movement
that occurs between these two extremes, as the middle class disappears and
the extremes are stretched farther and farther apart, the more distrust will
grow and the seeds of social unrest sown.
The cause of this perverse distribution of income is unclear. Greider would
have us return to the pre-Reagan days when the federal government was ac-
tive in the American economy. For more on Greider 's views, read his column
that regularly appears in Rolling Stone or check out one of his recent books:
One World, Ready or Not: Vie Manic Logic of Global Competition (Simon and
Schuster, 1997); Who Will Tell the People: Vie Betrayed of American Democracy
(Simon and Schuster, 1992); or How the Federal Reserve Runs the Country (Si-
mon and Schuster, 1992). Greider is not alone in his views. Hines and Lang
in their essay "The New Protectionism," The Nation (July 15 and 22, 1996)
assert that "globalization unquestionably leads to lower wage econom
Jerry Mandur in "The Dark Side of Globalization," in the same issue of Vie
Nation, tell us that "the only boats that will be lifted are those of the owners
and managers of the process; the rest of us will be on the beach, facing a rising
tide."
There is much written on the other side of this issue. Conservatives such as
John O. McGinnis are horrified at the prospect of limited markets. See "Re-
straining Leviathan," National Review (March 11, 1996). For a more sophisti-
cated reflection of Greider's thesis, refer to Norman S. Fieleke's "Is Global
Competition Making the Poor Even Poorer?" New England Economic Re\
(November/December 1994). Finally, there is another strongly worded e!

opposing government intervention, by James A. Dom, entitled "Trade and

Human Rights: The Case of China," Cato Journal (Spring/Summer 1996).

311
 —

ISSUE 17
Does Global Warming Require
Immediate Government Action?
YES: Cynthia Pollock Shea, from "Protecting Life on Earth: Steps to Save the
Ozone Layer/' Worldwatch Paper 87 (1988)
NO: Lester B. Lave, from "The Greenhouse Effect: What Government Actions
Are Needed?" Journal of Policy Analysis and Management (vol. 7, no. 3, 1988)

ISSUE SUMMARY
YES: Cynthia Pollock Shea, a senior researcher with the Worldwatch Insti-
tute, pleads with governments and industries to initiate a "crash program"
designed to halt emissions of chemicals such as chlorofluorocarbons, which
deplete the ozone, before irreparable damage is done to world agriculture,
marine life, and human health.
NO: Professor of economics Lester B. Lave warns against drastic solutions
that could themselves be harmful or, at a minimum, "costly if the greenhouse
consequences are more benign than predicted."

Few of us can forget the heat wave of the summer of 1988. Electric bills sky-
rocketed as air conditioners ran day and night. Bright green lawns turned
yellow-brown. Lakes, streams, and reservoirs fell to critically low levels; car
washing was discouraged, lawn sprinkling was banned, and toilets were
bricked. Citizensand policymakers alike were concerned that the world was
entering the long-predicted and much-feared period of global warming as-
sociated with the greenhouse effect.
As summer turned to fall, then-presidential candidate Bush promised vot.
ers that if he were elected, he would become the "environmental president."

He would protect the environment from the advancing global warming

at least he would attempt to slow its progress. Once elected he joined other
heads of state in a Parisenvironmental summit. This, in turn, led to the pol-
icy prescriptions that he introduced in a speech delivered at Georgetown
University in early February 1990. Four broad policies were detailed in this
speech:

1. Increase the information [Link] proposed a sharp increase in U.S. expen

ditures on studies focused on "global climate change."
2. Redirect and increase expenditures on basic energy research and development
from $16.4 billion to $17.5 billion. This represented a modest 6.4 percent

312
 Increase in theDepartment of Energy's budget and some redistribution of
funds from civilian applied research and development programs to grants
for basic research.
3. A phaseout of most chlorofluorocarbons. In line with a 1987 international
agreement, the Montreal Protocol, President Bush proposed a 50 percent
cut in the production of these powerful greenhouse gases that attack the
ozone layer.
4. A "plant-a-tree" program. The Bush administration proposed planting a
billion trees each year at a cost of $170 million annually.

The question we must ask is whether or not these presidential initiatives are
appropriate in light of the costs and benefits of public action to slow or reverse
the progress of global warming. Once again we must turn to our marginal
analysis to determine how aggressive public policy should be in slowing
the progress of global warming. We can anticipate that alternative policies
will have increasing marginal costs and decreasing marginal benefits as more
ambitious programs are employed. Two views of these costs and benefits
are provided in the following essays. Cynthia Pollock Shea warns that if
decisive action is not taken immediately to protect the ozone layer, we will
face serious health hazards, reduced crop yields, decreased fish populations,
and industrial damage. Lester B. Lave, on the other hand, argues that there
is too much uncertainty to rush forward with sweeping policy action. He

preaches moderation.
Since the consequences of these policy decisions may be irreversible and
not fully felt for many decades in the future, extreme care must be taken.
Older generations may be totally immune from the consequences. It is the
younger generations that will pay for the mistakes made in the early 1990s.

313
 Cynthia Pollock Shea
YES

PROTECTING LIFE ON EARTH:

STEPS TO SAVE THE OZONE LAYER
When British scientists reported in 1985 that a hole in the ozone layer had
been occurring over Antarctica each spring since 1979, the news came as a
complete surprise. Although the theory that a group of widely used chemicals
called chlorofluorocarbons (CFCs) would someday erode upper atmospheric
ozone had been advanced in the mid-1970s, none of the models had predicted
that the thinning would first be evident over the South Pole —
or that it would
be so severe.
Ozone, the three-atom form of oxygen, is the only gas in the atmosphere that
limits the amount of harmful solar ultraviolet radiation reaching the earth.
Most of it is found at altitudes of between 12 and 25 kilometers. Chemical
reactions triggered by sunlight constantly replenish ozone above the tropics,
and global air circulation transports some of it to the poles.
By the Antarctic spring of 1987, the average ozone concentration over the
South Pole was down 50 percent. Although the depletion was alarming,
many thought that the thinning was seasonal and unique to Antarctica. But
an international group of more than 100 experts reported in March 1988 that
the ozone layer around the globe was eroding much faster than models had
predicted. Between 1969 and 1986, the average concentration of ozone in the
stratosphere had fallen by approximately 2 percent.
As ozone diminishes, the earth receives more ultraviolet radiation, which
promotes skin cancers and cataracts and depresses the human immune sys-
tem. As more ultraviolet radiation penetrates the atmosphere, it will worsen
these health effects, reduce crop yields and fish populations, damage some
materials such as plastics, and increase smog. Compounds containing chlo-
rine and bromine, which are released from industrial processes and products,
are now widely accepted as the primary culprits in ozone depletion. Most of
the chlorine comes from CFCs; the bromine originates from halons used in
fire extinguishers.
Spurred to action by the ozone hole, 35 countries have signed an interna-
tional agreement — —
the Montreal Protocol aimed at halving most CFC emis-
sions by 1998 and freezing halon emissions by 1992. But the agreement is so

From Cynthia Pollock Shea, "Protecting Life on Earth: Steps to Save the Ozone Layer," Worldwatch
Paper 87 (1988). Copyright © 1988 by The Worldwatch Institute. Reprinted by permission. This
paper is available from Worldwatch Institute, 1776 Massachusetts Avenue, Washington, DC
20036.

314
 YES Cynthia Pollock Shea/ 315

riddled with loopholes that its objectives formed into frozen, and therefore nonre-
will not be met. Furthermore, scientific active, nitric acid.
findings subsequent to the negotiations Spring sunlight releases the chlo-
reveal that even if the treaty's goals were rine, starting a virulent ozone-destroying
met, significant further deterioration of chain reaction that proceeds unimpeded
the ozone layer would still occur. for five or six weeks. Molecules of ozone
New evidence that a global warming are transformed into molecules of or-
may be under way strengthens the need dinary, two-atom oxygen. The chlorine
to further control and phase out CFC and emerges unscathed, ready to attack more
halon emissions. With their strong heat- ozone. Diminished ozone in the vortex
absorbing properties, CFCs and halons means the atmosphere there absorbs less
are an important contributor to the green- incoming solar radiation, thereby perpet-
house effect. Currently available control uating lower temperatures and the vortex
technologies and stricter standards gov- itself.
erning equipment operation and mainte-
Paradoxically, the phenomenon of
nance could reduce CFC and halon emis-
global warming encourages the process.
sions by some 90 percent. But effective
Higher concentrations of greenhouse
government policies and industry prac-
gases are thought to be responsible for
tices to limit and ultimately phase out
an increase in the earth's surface temper-
chlorine and bromine emissions have yet
ature and a decrease in the temperature
to be formulated. Just as the effects of
of the stratosphere. In addition, methane,
ozone depletion and climate change will
one of the primary greenhouse gases, is
be felt worldwide, a lasting remedy to
a significant source of stratospheric wa-
these problems must also be global.
ter vapor. Colder temperatures and in-
creased moisture both facilitate the for-
THE OZONE DEPLETION PUZZLE mation of stratospheric clouds.

As a result of the efforts of many scien- While many of the meteorological

tists, the pieces of the ozone depletion and chemical conditions conducive to
puzzle have gradually been falling into ozone depletion are unique to Antarctica,
place. During the long, sunless Antarc- ground-based research in Greenland in
tic winter —from about March to August the winter of 1988 found elevated chlo-

— air over the continent becomes isolated rine concentrations and depressed ozone

in a swirling polar vortex that causes tem- levels over the Arctic as well. Although

peratures to drop below -90 degrees Cel- a strong vortex does not develop there

sius. This is cold enough for the scarce and temperatures are not as low, polar
water vapor in the dry upper atmosphere stratospheric clouds do form.
to freeze and form polar stratospheric The theories on how chlorine inter-
clouds. Chemical reactions on the sur- n the surface of particles in po-
face of the ice crystals convert chlorine lar stratospheric clouds .ir? leading to
from nonreactive forms such as hydro- worries that similar ozone-depleting re-

gen chloride and chlorine nitrate into actions may

OCCUl around the globe. It
molecules that are very sensitive to sun- chemicals such as sulfate aerosols from
light. Gaseous nitrogen oxides, ordinar- volcanoes and human-made sulturs are
ily able to inactivate chlorine, are trans- capable ot hosting the same catalytic reac-
 "

316 / 17. DOES GLOBAL WARMING REQUIRE IMMEDIATE GOVERNMENT ACTION?

tions, global ozone depletion may accel- Table 1

erate even more rapidly than anticipated. Global Decline in Atmospheric

Ozone, 1969-1986*
Consensus about the extent of ozone
Year-round Winter
depletion and its causes strengthened
decrease decrease
with the release of the NASA Ozone Latitude (percent) (percent)
Trends Panel report on March 15, 1988.
Ozone were documented around
losses 53-64° N -2.3 -6.2

The blame
the globe, not just at the poles. 40-53° N -3.0 -4.7

was firmly placed on chlorofluorocar- 30-^0° N -1.7 -2.3

19-30° N -3.1 n.a.
bons. The panel reported that between
0-19° N -1.6 n.a.
30 and 64 degrees north latitude, where
most of the world's people live, the to- 0-19° S -2.1 n.a.
tal amount of ozone above any particu- 19-29° S -2.6 n.a.
lar point had decreased by between 1.7 29-39° S -2.7 n.a.

and 3 percent in the period from 1969 to 39-53° S -4.9 n.a.

1986 (Table 1). The report further stated 53-60° S -10.6 n.a.

that while the problem was worst over 60-90° S -5.0 or more n.a.

Antarctica during the spring, " ozone ap- *Data for the area 30 to 64 degrees north of the
pears to have decreased since 1979 by 5 equator are based on information gathered from
satellites and ground stations from 1969 to 1986.
percent or more at all latitudes south of Data for the area from 60 degrees south to the
60 degrees south throughout the year." South Pole are based on information gathered from
The hole alone covers approximately 10 satellites and ground stations since 1979. All other
information was compiled after November 1978
percent of the Southern Hemisphere.
from satellite data alone.

Sources: U.S. National Aeronautics and Space Ad-

Within a matter of weeks the report's ministration, Ozone Trends Panel; Cass Peterson,
"Evidence of Ozone Depletion Found Over Big Ur-
conclusions were widely accepted, and ban Areas," The Washington Post, March 16, 1988.
public debate on the issue began to
build. Ozone depletion is occurring far
more rapidly and in a different pat-
EFFECTS OF ULTRAVIOLET
tern than had been forecast. Projections
RADIATION
of the amount and location of future
ozone depletion are still highly uncertain. At present, ozone absorbs much of the ul-
Although the fundamental mechanisms traviolet light that the sun emits in wave-
of ozone depletion are generally under- lengths harmful to humans, animals, and
stood, the effect of cloud surface chem- plants. The most biologically damaging
istry, the rate of various chemical reac- wavelengths are within the 290- to 320-
tions, and the specific chemical pathways nanometer band, referred to as UV-B. But
are still in doubt. According to Sherwood according to uncertain projections from
Rowland, one of the first to sound a warn- computer models, erosion of the ozone
ing, policy decisions now and for at least shield could result in 5 to 20 percent more
another decade must be made without ultraviolet radiation reaching populated
good quantitative guidelines of what the areas within the next 40 years —most of it

future holds. in the UV-B band.

 YES Cynthia Pollock Shea / 317

In light of the findings of the NASA may even decrease the effectiveness of
Ozone Trends Panel, the U.S. Environ- some inoculation programs, such as those
mental Protection Agency (EPA) damage for diphtheria and tuberculosis.
projections cited in this section are con- and aquatic ecosystems are
Terrestrial
servative. Although the EPA ranges are also affected. Screenings of more than
based on current control strategies, they 200 plant species, most of them crops,
assume ozone depletion levels of 1.2 to found that 70 percent were sensitive to
6.2 percent. Yet all areas of the globe have UV-B. Increased exposure to radiation
already suffered depletion beyond this may decrease photosynthesis, water-use
lower bound. efficiency, yield, and leaf area. Soybeans,
Globally, skin cancer incidence among a versatile and protein-rich crop, are
Caucasians is already on the rise, and particularly susceptible. One researcher
it is expected to increase alarmingly Maryland discovered
at the University of
in the presence of more UV-B. Some that a simulated ozone loss of 25 percent
600,000 new cases of squamous and basal reduced the yield of one important
cell carcinoma —
the two most common soybean species by as much as 25 percent.
but rarely fatal skin cancer types are — He also found that plant sensitivity to
reported each year in the United States UV-B increased as the phosphorus level
alone. Worldwide, the number of cases is in the soil increased, indicating that
at least three times as high. Each 1 percent heavily fertilized agricultural areas may
drop in ozone is projected to result in 4 be the most vulnerable.
to 6 percent more cases of these types of Aquatic ecosystems may be the most
skin cancer. The EPA estimates that ozone threatened of all. Phytoplankton, the one-
depletion will lead to an additional 31,000 celled microscopic organisms that engage
to 126,000 cases of melanoma —a more in photosynthesis while drifting on the
—
deadly form of skin cancer among U.S. ocean's surface, are the backbone of the
whites born before 2075, resulting in an marine food web. Because they require
additional 7,000 to 30,000 fatalities. sunlight, they cannot escape incoming ul-
Under the same EPA scenarios, from traviolet radiation and continue to thrive.
555,000 to 2.8 million Americans born Yet if they remain at the water's surface,
before 2075 will suffer from cataracts of studies show that a 25 percent reduc-
the eyes who would not have otherwise. tion in ozone would decrease their pro-
Victims will also be stricken earlier in life, ductivity by about 35 percent. A signif-
making treatment more difficult. icant destruction of phytoplankton and
Medical researchers also fear that its subsequent decomposition could even

UV-B depresses the human immune raise carbon dioxide levels, speeding the
system, lowering the body's resistance warming of the atmosphere.
to attacking micro-organisms,making it Zooplankton and the larvae of sev-
less able to fight the development of eral important fish species will be doubly
tumors, and rendering it more prone strained: Their sole food supply, phyto-
to infectious [Link]
In plankton, will be scarcer. For some shell-
countries, particularly those near the fishspecies B 10 percent decrease in
equator that are exposed to higher ozone could result in up to an 18 per-
UV-B levels, parasitic infections could cent increase in the number of abnormal
become more common. The response larvae. Commercial fish populations al-
318 / 17. DOES GLOBAL WARMING REQUIRE IMMEDIATE GOVERNMENT ACTION?

ready threatened by overharvesting may strated by their discoverer, Thomas

have more difficulty rebuilding due to Midgley, Jr., in 1930, when he inhaled
effects of increased UV-B. Some species vapors from a beaker of clear liquid
will undoubtedly be more vulnerable to and then exhaled to extinguish a can-
increased ultraviolet radiation than oth- dle. A safe coolant that was inexpen-
ers, and the changes are likely to be dra- sive to produce was exactly what the re-
matic. Ultimately, entire ecosystems may frigeration industry needed. E.I. du Pont
become more unstable and less flexible. de Nemours & Company marketed the
Increased UV-B levels also affect compound under the trademark Freon.
synthetic materials, especially plastics, (In chemical shorthand, it is referred
which become brittle. Studies conducted to as CFC-12). International production
for the EPA estimated that without added soared, rising from 545 tons in 1931 to
chemical stabilizers, the cumulative dam- 20,000 tons in 1945. Another use for the
age to just one polymer, polyvinyl chlo- chemical, as a blowing agent in rigid in-
ride, could reach $4,700 million by 2075 sulation foams, was discovered in the late
in the United States alone. 1940s.
Ironically, as more ultraviolet radiation Over time, the versatility of the various
reaches the ground, the photochemical CFCs seemed almost endless. CFC-11
process that creates smog will acceler- and CFC-12 were first used as aerosol
ate, increasing ground-level ozone. Stud- propellants during World War II in the
ies show that ground-level ozone retards fight against malaria. In the postwar
crop and tree growth, limits visibility, and economy, they were employed in aerosol
impairs lung functions. Urban air qual- products ranging from hairspray and
ity, already poor in most areas of the deodorant to furniture polish. By the late
world, will worsen. In addition, strato- 1950s, a combination of blowing agents
spheric ozone decline is predicted to in- CFC-11 and carbon dioxide was used
crease tropospheric amounts of hydrogen to make softer furniture cushions, carpet
peroxide, an acid rain precursor. padding, and automobile seats.
Despite the many uncertainties regard- Many social and technological devel-
ing the amount of future ozone depletion, opments in recent decades were assisted
rising UV-B levels, and their biological ef- by the availability of CFCs. Air condition-
fects, it is clear that the risks to aquatic ers made it possible to build and cool
and terrestrial ecosystems and to human shopping malls, sports arenas, high-rise
health are enormous. The central conclu- office buildings, and even automobiles.
sion of the EPA studies is that "the bene- Artificial cooling brought comfort, busi-
fits of limiting future CFC/halon use far ness, and new residents to regions with
outweigh the increased costs these regu- warm climates. And healthier, more in-
lations would impose on the economy/' teresting diets are now available because
food can be refrigerated in the production
and distribution chain.
CHEMICAL WONDERS,
Even the computer revolution was
ATMOSPHERIC VILLAINS aided by CFCs. As microchips and other
Chlorofluorocarbons are remarkable components of electronic equipment be-
[Link] are neither toxic nor came smaller and more sophisticated, the
flammable at ground levels, as demon- need to remove the smallest contami-
 YES Cynthia Pollock Shea/ 319

Table 2 Table 3
Global CFC Use, by Category, 1985 Per Capita Use of CFC-1 1 CFC-1 2, and
,

CFC-113, 1986 (Kilograms Per Capita)

Share of total

Use (percent) CFC- CFC- CFC-

11 12 113 Total*
Aerosols 25
Rigid-foam insulation 19 United .34 .58 .31 1.22
Solvents 19 States
Air conditioning 12 Europe .47 .34 .12 .93
Refrigerants 8 Japan .23 .29 .43 .91
Flexible foam 7
•Rows not completely additive due to trade
Other 10
Source: U.S. Environmental Protection Agency,
Source: Daniel F. Kohler and others, Projections Regulatory Impact Analysis: Protection of Strato-
of Consumption of Products Using Chlorofluorocar- spheric Ozone, 1 987.
bons in Developing Countries, Rand N-2458-EPA,
1987.

States — at 1.22 —
kilograms but Europe
nants became critical. CFC-113 is used as and Japan are not far behind (Table 3).

a solvent to remove glue, grease, and sol- From 1931 through 1986, virtually all

dering residues, leaving a clean, dry sur- the CFC-11 and CFC-12 produced was
face. CFC-113 is now the fastest growing sold to customers in the Northern Hem-
member of the CFC family; worldwide isphere. Since raw chemicals and prod-
production exceeds 160,000 tons per year. ucts made with and containing CFCs
An industry-sponsored group, the were then exported, in part to develop-
Alliance for Responsible CFC Policy, pegs ing countries, final usage was not quite
the market value of CFCs produced as lopsided. Indeed, the Third World ac-
in the United States at $750 million counted for 16 percent of global CFC con-
annually, the value of goods and services sumption in 1986 (Table 4). As popula-
directly dependent on the chemicals at tions, incomes, and the manufacturing

$28,000 million, and the end-use value base grow in developing countries, CFC
of installed equipment and products use there is projected to rise.
at $135,000 million. Around the world, Halons, which are used in fighting
aerosols are still the largest user of fires in both hand extinguishers and
CFCs, accounting for 25 percent of the total-flooding systems for large enclosed
total (Table 2). Rigid-foam and solvent areas, contain bromine, a more effective
applications, the fastest growing uses for ozone destroyer than chlorine. Demand
CFCs, are tied for second place. for halons, which were developed in
In 1987, global CFC production (ex- the 1940s, quadrupled between 1973 and
1 >S4 and is still growing at a rate of 15
L
cluding the People's Republic of China,
the Soviet Union, and Eastern Europe) percent annually.
came close to 1 million tons. Combined Alarming though the latest ozone mea-
production of CFC-11 and CFC-12 ac- surements are. they reflect only the a - i

counts for at least three-fourths of this to- sponses to gases released through the
tal. Total per capita use of the three most early 1980s, Liases now rising through
common CFCs is highest in the United the lower atmosphere will take up to
320 / 17. DOES GLOBAL WARMING REQUIRE IMMEDIATE GOVERNMENT ACTION?

Table 4 in production by 1993, and another 30

CFC Consumption by Region, 1986 percent cut by 1998. Halon production is

subject to a freeze based on 1986 levels
Share of starting in 1992....
total The means to achieve these reduc-
Region (percent) tions are left to the discretion of indi-

29'
vidual nations. Most signatory countries
United States
Other industrial countries* 41
are responding with production limits on
Soviet Union, Eastern Europe 14 chemical manufacturers. Although this
Other developing countries 14 approach complies with treaty guide-
People's Republic of China, India 2 lines, it effectively ensures that only those

*The European Community accounts for more than

willing to pay high prices will be able to
half, followed by Japan, Canada, Australia, and continue using CFCs. It also places the
others. onus of curbing emissions on the myriad
Source: "The Ozone Treaty: A Triumph for All," industrial users of the chemicals and on
Update from State, May/June 1988.
the consumers of products that incorpo-
rate them. Moving quickly to protect the
ozone layer calls for a different approach
eight years to reach the stratosphere.
And an additional 2 million tons of sub-
—one that targets the largest sources of
the most ozone-depleting chemicals.
stances containing chlorine and bromine
When concern about the ozone layer
are stillon the ground, trapped in insula-
first emerged in the 1970s, some indus-
tion foams, appliances, and fire-fighting
trial country governments responded.
equipment.
Since 56 percent of combined CFC-11
Chlorine concentrations in the upper
and CFC-12 production in 1974 was used
atmosphere have grown from 0.6 to 2.7 in aerosols, spray cans were an obvi-
parts per thousand million in the past
ous target. Under strong public pres-
25 years. Under even the most optimistic
sure, Canada, Norway, Sweden, and the
regulatory scenarios, they are expected
United States banned CFC propellants in
to triple by 2075. Bromine concentrations at least 90 percent of their aerosol prod-
grow considerably faster.
are projected to
ucts. The change brought economic as
Without a complete and rapid phaseout well as environmental benefits. Hydro-
of CFC and halon production, the real
carbons, the replacement propellant, are
losers will be future generations who less expensive than CFCs and saved the
inherit an impoverished environment. U.S. economy $165 million in 1983 alone.
The European Community adopted a dif-
ferent approach. In 1980, the member
REDUCING EMISSIONS
countries agreed not to increase their ca-
On September 16, 1987, after years of pacity to produce these two CFCs and
arduous and heated negotiation, the called for a 30 percent reduction in their
Montreal Protocol on Substances That use in aerosol propellants by 1982 (based
Deplete the Ozone Layer was signed by on 1976 consumption figures).
24 countries. Provisions of the agreement Despite rapid growth, CFC-113 emis-
include a freeze on CFC production (at sions may be some of the easiest and most
1986 levels) by 1989, a 20 percent decrease economical to control. The chemical is
 YES Cynthia Pollock Shea/ 321

only used to clean the final product and is rectly to the atmosphere, requires the use
not incorporated in it. Thus emissions are of recovery and recycling technologies.
virtually immediate; three-fourths result Careful study of the automobile air
from vapor losses, the remainder from conditioning market in the United States,
waste disposal. A U.S. ban on land dis- the largest user of CFC-12 in the country,
posal of chlorinated solvents that took ef- has found that 34 percent of emissions
fect in November 1986, consideration of can be traced to leakage, 48 percent occur
similar regulations elsewhere, the high during recharge and repair servicing, and
cost of incinerating CFC-113 (because it the remainder happen through accidents,
contains toxic fluorine), and accelerating disposal, and manufacturing, in that
concern about ozone depletion have all order. Equipment with better seals and
created strong incentives for solvent re- hoses would reduce emissions and result
covery and recycling. in less need for system maintenance.
Since CFC-113 costs about twice as Over the longer term, phasing out
much as other CFCs, investments in the use and emissions of CFCs will
recovery and recycling pay off more require the development of chemical
quickly. Recycling of CFC-113 is now substitutes that do not harm the ozone
practiced on-site at many large computer layer. The challenge is to find alternatives
companies. Smaller electronics firms, for that perform the same function for a
which in-house recycling is not eco- reasonable cost, that do not require
nomical, can sell their used solvents to major equipment modifications, that are
commercial recyclers or the distributors nontoxic to workers and consumers, and
of some chemical manufacturers. that are environmentally benign
Capturing CFC emissions from flex- The time has come to ask if the
ible-foam manufacturing can also be ac- functions performed by CFCs are really
complished fairly quickly but requires necessary and, if they are, whether they
investment in new ventilation systems. can be performed in new ways. If all

New suction systems coupled with car- known technical control measures were
bon adsorption technologies are able to used, total CFC and
halon emissions
recover from 40 to 90 percent of the CFCs could be reduced by approximately 90
released. percent. Many of these control strategies
Another area that offers significant are already cost-effective,and more will
savings, at a low cost, is improved de- become so push up the
as regulations
sign, operating, and maintenance stan- price of ozone-depleting chemicals. The
dards for refrigeration and air condi- speed with which controls are introduced
tioning equipment. Codes of practice to will determine the extent of ozone de-
govern equipment handling are being pletion in the years ahead and when
drawn up by many major trade asso- healing of the ozone layer will begin.
ciations. Key among the recommenda-
tions are to require worker training, to
limit maintenance and repair work to au-
BEYOND MONTREAL
thorized personnel, to install leak detec- An international treaty to halve the pro-
tion systems, and to use smaller refrig- duction oi a chemical feared responsible
erant charges. Another recommendation, tor destroying an invisible shield is un-
to prohibit venting of the refrigerant di- precedented But unfortunately, foi
322 / 17. DOES GLOBAL WARMING REQUIRE IMMEDIATE GOVERNMENT ACTION?

eral reasons, the Montreal Protocol will of these findings, logic suggests a virtual
not save the ozone layer. phaseout of CFC and halon emissions by
many inducements were offered
First, all countries as soon as possible. Releases

to enhance the treaty's appeal to prospec- of other chlorine and bromine-containing

tive signatories —
extended deadlines for compounds not currently covered under
developing and centrally planned econo- the treaty also need to be controlled and
mies, allowances to accommodate indus- in some cases halted.
try restructuring, and loose definitions The timing of the phaseout is cru-
of the products that can legitimately be cial. Analysts at EPA examined the ef-

traded internationally. The cumulative fects of a 100 percent CFC phaseout by

effect of these loopholes means that, even 1990 and a 95 percent phaseout by 1998.
with widespread participation, the proto- Peak chlorine concentrations would dif-
col's goal of halving worldwide CFC use fer by 0.8 parts per thousand million,
by 1998 will not be met. some one-third of current levels. And un-
Second, recent scientific findings show der the slower phasedown, atmospheric
that more ozone depletion has already cleansing would be prolonged consid-
occurred than treaty negotiators assumed erably: Chlorine levels would remain
would happen in 100 years. A recent EPA higher than the peak associated with the
report concluded that by 2075, even with accelerated schedule for at least 50 years.
100 percent global participation in the As noted, it is technically feasible to
protocol, chlorine concentrations in the reduce CFC and halon emissions by at
atmosphere would triple. The agreement least 90 percent. Sweden is the first coun-
will not arrest depletion, merely slow its try to move beyond endorsing a theo-
acceleration. retical phaseout. In June 1988 the par-
Third, several chemicals not regulated liament, after extensive discussions with
under the treaty are major threats to the industry, passed legislation that includes
ozone layer. Methyl chloroform and car- specific deadlines for banning the use of
bon tetrachloride together contributed 13 CFCs in new products. Consumption is

percent of total ozone-depleting chemical to be halved by 1991 and virtually elim-

emissions in 1985. As the use of controlled inated by 1995. Environmental agencies
chemicals diminishes, the contribution of in Britain, the United States, and the Fed-
these two uncontrolled compounds will eral Republic of Germany have endorsed
grow. emissions reductions of at least 85 per-
The recognition that global warming cent. Chemical producers in these three
may have already begun strengthens countries account for over half the global
the case for further and more rapid output of controlled substances.
reductions in CFC emissions. CFCs Levying a tax on newly manufactured
currently account for 15 to 20 percent CFCs and other ozone-depleting sub-
of thegreenhouse effect and absorb stances one way governments can cut
is

wavelengths of infrared radiation that emissions and accelerate the adoption of

other greenhouse gases allow to escape. alternative chemicals and technologies. If
Indeed, one molecule of the most widely the tax increased in step with mandatory
used CFCs is as effective in trapping heat production cutbacks, it would eliminate
as 15,000 molecules of carbon dioxide, the windfall profits for producers, encourage
most abundant greenhouse gas. In light recovery and recycling processes, stimu-
 .

YES Cynthia Pollock Shea/ 323

late use of new chemicals, and provide developments ensures that environmen-
a source of funding for new technologies tally damaging and outdated equipment
and for needed research. Encouraging in- will continue to be used for years to come,
vestments in recycling networks, incin- further eroding the Third World technol-
erators for rigid foams, and collection ogy base. . .

systems for chemicals that would oth-

erwise be discarded could substantially The scientific fundamentals of ozone
trim emissions from existing products, depletion and climate change are known,
from servicing operations, and from new and there widespread agreement that
is

production runs. Research on new refrig- both have already begun. Although
eration, air conditioning, and insulation current models of future change vary
processes is worthy of government sup- in their predictions, the evidence is
port. Unfortunately, international fund- clear enough to warrant an immediate
ing for developing such technologies to- response. Because valuable time was
tals less than $5 million. lost when governments and industries
As mentioned in the text of the Mon- relaxed their regulatory and research
treal Protocol, results of this research, as efforts during the early 1980s, a crash
well as new
technologies and processes, program is now essential. Human health,
need tobe shared with developing coun- food supplies, and the global climate
tries. Ozone depletion and climate warm- all hinge on the support that can be

ing are undeniably global in scope. Not garnered for putting an end to chlorine
sharing information on the most recent and bromine emissions.
NO Lester B. Lave

THE GREENHOUSE EFFECT: WHAT

GOVERNMENT ACTIONS ARE NEEDED?
Human beings are causing global-scale changes for the first time [A]rticles
by Gordon MacDonald and Irving Mintzer document the " greenhouse'' effect
and give some indications of the environmental changes that will result.
The possibility of such global changes rouses deep emotions in people: awe
that humans have become so powerful, rage that we are tampering with
the natural environment on a large scale, and fear that we might create an
environment hostile to our progeny. Technologists tend to focus on the first
emotion with the optimism that we can also find ways to head off or solve
the problems. Environmentalists fix on the second, fearing that humans can
only ruin nature. This article focuses on the third, asking what governmental
or other social actions are possible and warranted. What should be done now
and in the foreseeable future as a result of what is currently known about the
atmospheric concentration of greenhouse gases, the resulting climate change,
and the consequences for people?

WHY DOES THE GREENHOUSE EFFECT

RECEIVE SO MUCH ATTENTION?
Scientists have been giving great attention to the greenhouse effect for more
than a decade, despite the vast qualitative and quantitative uncertainties.
The public joins scientists in the concern that current activities could create
a much less hospitable planet in the future. Congress has also directed its
concern to these issues. Congress generally regards programs whose impact
is more than three to ten years in the future as hopelessly long term; it seems

bizarre that greenhouse effects, which are a century or so into the future, have
received major Congressional attention
Greenhouse effects have the attributes of being (1) global (in the sense that
all regions are affected), (2) long term (in the sense that near-term effects

are undetectable and important effects or people and their well being are
perhaps a century in the future), (3) ethical (in the sense that they involve
the preferences and well being of people who have not been born yet, as

From Lester B. Lave, "The Greenhouse Effect: What Government Actions Are Needed?" Journal
of Policy Analysis and Management, vol. 7, no. 3 (1988). Copyright © 1988 by John Wiley & Sons,
Inc. Reprinted by permission. Notes omitted.

324
 .

NO Lester B. Lave/ 325

well as plants, animals, and the en- mosphere, the amount being absorbed by
vironment more generally), (4) poten- the oceans, and the amount being taken
tially catastrophic (in the sense that large up in plants.
changes in the environment might re-
The dynamics can be even more dif-
sult, as well as massive loss of human
understand, because the oceans
ficult to
lifeand property), and (5) contentious (in
hold less carbon as they warm. Thus,
the sense that coming to decisions, trans-
there could be a destabilizing feed-
lating these into agreements, and enforc-
back of a warmer atmosphere leading
ing agreements would be difficult due to
to ocean warming, which induces re-
important ''spillover'' or external effects,
lease of carbon to the atmosphere. With
uncertainty, the incentives for individual
the oceans becoming a net source rather
nations to cheat, the difficulty of detect-
than a sink, atmospheric concentrations
ing cheating, and the difficulty of enforc-
would increase more rapidly, leading to
ing agreements even after cheating is de-
rapidly increasing atmospheric tempera-
tected). In addition, many of the likely
tures, which induce ocean warming and
public investments such as attempts to
carbon release. Is this scenario one that
substitute for carbon dioxide producing
activities would be expensive and disrup-
—
leads to disaster or one where the ocean
warming takes so long that fossil fuels
tive. In other words, this set of issues exer-
are fully used and the increased carbon
cises almost all of the tools of policy anal-
taken up by plants before the oceans
ysis and poses deep problems to decision
warm enough to release appreciable car-
analysts. Below, I point out some partic-
bon dioxide to the atmosphere? To what
ularly attractive research areas, such as
extent, and how quickly, would increased
behavioral reactions, crucial to formulat-
plant growth, due to a warmer climate,
ing policy regarding greenhouse gases.
more rain, and higher atmospheric con-
Uncertainty. A
dominant question in
centrations of carbon dioxide, absorb
formulating greenhouse policy is: What
much more of the atmospheric carbon
is the uncertainty concerning current
and slow or stop atmospheric warming?
statements about emissions, atmospheric
accumulation, resulting climate changes, The speed with which natural ecosys-
and resulting effects on the managed and tems can adapt to climate change is also
unmanaged biospheres? . . a matter of concern. A large-scale cli-

The Department of Energy has put ma- mate change, comparable carbon
to a
jor resources over the past decade into dioxide doubling, has occurred over the
understanding the carbon cycle, the cur- last 18,000 years since the end of the
and sinks of carbon in the
rent sources last great ice age. While the tempera-
environment and the mechanisms that ture changes are comparable, the previ-
handle increasing carbon emissions into ous change occurred over 18,000 years
the environment. It is safe to say that while the change due to the greenhouse
the carbon cycle is not understood well, effect would occur over a century or so,
with uncertainty regarding perhaps 20% perhaps one-hundred times faster. This
of total sources and sinks of carbon enter- rate of change could exceed the abilities of
ing the environment. Controversies sur- natural ecosystems to adapt. The amount
round the importance of deforestation, Oi change is small, however, compared
the amount of carbon retained in the at- to what is currently experienced for the
 —
326 / 17. DOES GLOBAL WARMING REQUIRE IMMEDIATE GOVERNMENT ACTION?

changes from day to night or season to Clearly, these models are "wrong" in the
season. sense of being bad examples of reality.
The issues related to carbon dioxide are But the central question is whether fail-
much different from the issues related ing to include these elements results in
to other greenhouse gases. Neither of an error of 10% or whether the models
the two feedback mechanisms sketched could be wrong to the extent of predict-
above apply to CFC (chlorofluoruCar- ing warming when these gases actually
bons) or methane. The Environmental result in atmospheric cooling
Protection Agency estimates that about As shown below, exploring the con-
half of the atmospheric warming, after sequences of this warming requires de-
a century, would be attributed to gases tailed predictions or assumptions for
—
other than carbon dioxide an estimate each area about climate, storm patterns,
that is markedly different from those of and the length of the growing season.
ten years ago. Much needs to be done These predictions are little more than ed-
to understand feedback mechanisms for ucated guesses. For the modelers, this un-
the other greenhouse gases and to in- certainty is a stimulus to do better. For
vestigate possible interactions among the the policy analyst, the uncertainty must
gases. For example, atmospheric warm- be treated explicitly in deciding what
ing is likely to increase the demand for actions are warranted now and in the
air conditioning, which would lead to future.
greater electricity use (resulting in in- Even vast uncertainty need not pre-
creased carbon dioxide emissions) and to clude taking preventive action. Uncer-
greater emissions of CFC from compres- tainty should induce caution and prevent
sor leaks. The warming would also in- decision makers from rushing into ac-
crease thedemand for insulation, some tions and commitments, however. For ex-
of whichwould be foam insulation made ample, precipitous action would have led
with CFC, releasing much more of this to forbidding military and 747 flights in
gas to the atmosphere. the stratosphere in the early 1970s. Then,
The current global circulation models in the late 1970s, precipitous action might
are magnificent examples of technical vir- have led to building aircraft to fly in the
tuosity The physical movements and en- stratosphere as much as possible. Finally,
ergy fluxes of the atmosphere are de- today aircraft flights in the stratosphere
scribed by partial differential equations are regarded as irrelevant to stratospheric
that are too complicated to be solved ex- ozone levels.
plicitly Thus the modelsdepend upon ex- It is prudent to be concerned about po-

pert judgment to decide what aspects of tentially disastrous effects and to be will-
the problem should be treated explicitly ing to take some actions now, even given
within the model and how much atten- the uncertainty. For example, American
tion each aspect should get. The current regulators insisted on building strong
predictions of the consequences of dou- containment vessels around civilian nu-
bling atmospheric carbon dioxide come clear reactors, even though they regarded
mainly from models that treat the oceans the chance of a mishap that would re-
as if little mixing occurred and there were quire the containment vessel as remote.
no currents. The models also ignore many The USSR regulators did not insist on
chemical reactions in the atmosphere. such safeguards, with quite different re-
 NO Lester B. Lave/ 327

suits between the problems at Three Mile out all coal-burning plants within several
Island and the tragedy at Chernobyl. decades. The decision to do that would
While there major uncertainty, the
is be enormously expensive and disruptive.
policy conclusions about CFC emissions Such a decision would have to be agreed
are different today from those about to in every country and enormous re-
carbon dioxide emissions, as I discuss sources would be required to implement
below. it. I would not support such a decision for

Accountingfor the Uncertainty. The long- many reasons.

term an increase in greenhouse
effects of Short of such heroic measures, are there
gases are unknown and almost certainly any actions that might be taken now,
unknowable. The physical changes, such even though uncertainty dominates the
as the gross increase in temperature predictions of effects? Prudence would
for each latitude might be predicted, dictate that we
should take actions that
but it is unlikely that the dates of might prove highly beneficial, even if
last frost and first freeze and detailed they are unlikely to be needed, if their
patterns of precipitation will be known cost is small. Proscribing coal use is
for each growing area. Still more difficult not an attractive insurance policy, but
to forecast is the adaptive behavior we should give serious consideration to
of individuals and governments. The limiting the growth rate of coal use.
accumulation of greenhouse gases could The world discovered after 1974 that
be enormously beneficial or catastrophic there was not a one-to-one coupling
for humans. Or more likely, it would be of energy use and economic activity.
beneficial at some times and places and Since then, the developed countries have
catastrophic at others. experienced a considerable increase in
Preventive actions are akin to pur- economic activity while most countries
chasing an insurance policy against po- use little or no more energy than in
tentially catastrophic greenhouse effects. 1974. Reducing the emissions of other
Most people voluntarily purchase life in- greenhouse gases would be less difficult
surance, even though the likelihood of and disruptive than large reductions in
dying in a particular year is very small. I coal use. In particular, it is not difficult
suspect that people would be willing to or expensive to switch to CFC substitutes
pay a premium for a policy that would that are less damaging and to stop using
protect against an inhospitable Earth a these chemicals as foaming agents for
century or so hence. But, the question is plastics and in consumer products.
what type of insurance policy is most at- Thus, one of the best ways to deal
tractive and how much of a premium are with uncertainty is to look for robust
people willing to pay. actions, actions that would be benefi-
Preventing all greenhouse effects is vir- cial in the worst case, not harmful in
tually impossible. If the climate changes other cases, and not very costly to take.
and resultant human consequences are Emphasizing energy conservation is per-
to be headed off, then heroic actions haps the host example of I prudent pol-
would be required immediately to re- onservation makes sense without
duce emissions of all the greenhouse any appeal to greenhouse effects! given
gases throughout the world. For exam- the deaths and disea iated with
ple, nuclear plants could be built to phase mining, transport, and air pollution trom
328 / 17. DOES GLOBAL WARMING REQUIRE IMMEDIATE GOVERNMENT ACTION?

coal. The greenhouse effects simply un- In contrast, an environmental change

derline what is already an obvious con- such as the greenhouse effect is viewed
clusion, but not one that is being pur- with horror. Such changes are gener-
sued vigorously. So much energy could ally not desired by anyone, but rather
be saved by adjusting fully to current emerge as the unintended consequences
market prices that sufficient conservation of society's actions. Those who are hor-
might be attained merely by encourag- rified might admit that there are some
ing this adjustment. In particular, large changes that are likely to be beneficial,
subsidies to energy use distort resource- but they would still regard the overall
allocation decisions significantly. effect as catastrophic. People tend to be
A
second example of an inexpensive more alarmed by large-scale, rapid en-
insurance policyis switching to less vironmental changes because the conse-
damaging CFCs and using less of them. quences would be important and uncon-
Another approach is to develop a trollable.
strategy of reevaluation at fixed intervals
or as new information becomes available.
Why are Americans such determined
optimists about new technology and such
Instead of viewing the current decision
determined pessimists about environ-
as the only opportunity to worry about
mental changes? I suspect that much of
greenhouse issues, one can attempt to
the difference is explained by the good
which particular outcomes would
clarify
intent of the inventor versus the un-
cause greatest concern. Then one could
intended nature of the environmental
revisit the issues periodically to see if
change. If so, this suggests that people
uncertainty has been resolved or at least
have unwarranted faith in the good inten-
substantially diminished.
tions of inventors, compared to the unin-
tended changes from taking resources or
SOCIAL AND ECONOMIC using the environment as a garbage pail.
CONSEQUENCES OF Deriving the social and economic
CLIMATE CHANGE
consequences of climate change is more
Announcement of an invention, such as difficult than might appear. To be sure,
a new drug, is generally greeted with if an area becomes so hot or dry that

public approval. Certainly there is recog- habitation is impossible, or if an area

nition that innovations may bring un- is under water, the consequences are
desired consequences, such as occurred evident. Thus, if sea level rose, the
with Thalidomide, and so premarket test- low-lying parts of Louisiana, Florida,
ing and technology assessment have been Bangladesh, and the Netherlands would
established and emphasized in many reg- be drastically affected. The vast number
ulatory areas. An innovation seems to be of short-term effects are difficult to
defined in terms of the intent of the in- predict and evaluate. Furthermore, the
ventor to produce something that will long-term changes are likely to be less
make society better or at least to make drastic (adjustment occurs to mitigate the
him richer. On net, it is fair to say that although this might take a
difficulties,
such innovations are viewed positively, long term for an ecosystem), and so the
with the untoward consequences to be consequences will be even more difficult
dealt with if they arise. to infer.
 NO Lester B. Lave/ 329

In particular, a change in climate might mean there was sufficient winter

presents a challenge to farmers. If sum- precipitation to provide water for sum-
mers are hotter and drier in the corn belt, mer irrigation; it would certainly mean
then a farmer growing corn in Illinois that there was sufficient water elsewhere
isgoing to experience crop failure more in the country to be transported to the
frequently, due both to droughts and to midwest for irrigation. Large dams and
heat damage. As the climate changes, rare canals might be required, but the tech-
crop damage will give rise to occasional nology for this is available. Certainly this
and then frequent damage. Will the Illi- water would be more expensive than that
nois farmer keep planting com, surviving currently available, but there is no rea-
with the aid of ever-larger government son to be concerned about starvation or
subsidies? Or will he plant new crops that even large increases in food prices for the
flourish under the hotter, drier climate? U.S. On net, food and fibers might be
Climate change also presents an oppor- slightly more expensive or less expensive
tunity. Sylvan Wittwer, a noted agron- in the U.S. under the new climate, but the
omist, observed that "... the present change is almost certain to be small com-
level of atmospheric carbon dioxide is pared to other economic changes.
suboptimal, and the oxygen level is For the U.S., there is no difficulty with
supraoptimal, for photosynthesis and finding the appropriate technology for
primary productivity in the great ma- breeding new crops that fit the climate,
The increased atmo-
jority of plants/' developing a less water-intensive agri-
spheric carbon dioxide concentrations culture, or for moving water for irriga-
would enhance growth and water-use tion. The difficulty would be whether
efficiency, more and faster
leading to agronomists are given the right tasks,
growth. Charles Cooper remarks that whether farmers give up their old crops
a doubled atmospheric concentration of and farming methods, and whether so-
carbon dioxide "... is about as likely to ciety can solve the myriad social prob-
increase global food, at least in the long lems associated with damming newly en-
run, as to decrease it. It is certain though, larged rivers and moving the water to
that some nations, regions, and people where it is needed.
will gain and others will lose." A new cli- The "less managed" areas, including
mate regime with more precipitation and forests, grasslands, and marsh, might
a longer growing season bodes well for experience large changes and a system
—
agriculture if we figure out what crops far from long-term equilibrium. These
to plant and figure out generally how effects would be scarcely discemable in
to tailor agriculture to the new climate measured gross national product, but
regime, and how to deal with new pests. would be viewed as extremely important
The midcontinental drying, if it occurs, by many environmental.
could mean the end of current agricul- Water projects and resources men
tural practices in the midwest. This cli- erally might pose a greater problem.
mate change might induce more irriga- Large-scale water projects, such as dams
tion, dry farming practices such as have and canals, are built to last t^r long
been demonstrated in Israel, new culti- periods. Once built, they an
vars, different crops, or even ceasing to ily changed. Thus, major climate change

cultivate this land. The increased rains could lead to massive dams fed by tiny
330 / 17. DOES GLOBAL WARMING REQUIRE IMMEDIATE GOVERNMENT ACTION?

streams or dams completely inadequate that the changes might be beneficial or

for the rivers they are designed to con- made beneficial by individual actions and
trol. Similarly, treaty obligations for the government policies.
Colorado are inflexible and could pose The difficulty is public concern that
major problems if there is less water flow- global scale effects are now possible;
ing down the river. Similarly, the cli- we have had a "loss of innocence/'
mate change would induce migration, In the past, if an individual ruined
both across areas in the U.S. and from a plot of land, he could move on. If

other countries. The legal and illegal mi- human actions caused major problems
gration could pose major problems. Fi- such as the erosion of the Dalmatian coast
nally, Americans treasure certain natu- of Yugoslavia, there was always other
ral resources, such as waterfalls. Climate inviting land. But, if the Earth is made
change that stopped the flow at popular inhospitable, there is no other inviting
falls would be regarded seriously. planet readily at hand.
Commenting on energy modeling, I share this concern, but find it naive.
Hans Landsberg wrote: "... all of us Having acquired the power to influence
who have engaged in projecting into the the global environment, there is no
more distant future take ourselves too way to relinquish No
one intends
it.

seriously What is least considered is to change the global environment by

how many profound turns in the road emitting greenhouse gases. Rather, the
one would have missed making 1980 change is an inadvertent consequence
projections in 1930! I am not contending of business as usual. The culprit is not
that the emperor is naked, but we surely a malevolent individual or rapacious
overdress him/' company. Instead, it is the scope of
human activities stemming from a large
population, modern technology, and
REPRISE: WHY SO MUCH CONCERN an unbelievable volume of economic
FOR THE GREENHOUSE EFFECT?
activity. These culprits are not going
It is the symbolic nature of the issues that to disappear, however much we might
has drawn attention to the greenhouse all wish that people did not have the

effect. Anyone who thinks he can see ability to affect our basic environment.
100 years into the future is mad. If In this sense, the human race has lost its
humans have now acquired the power environmental innocence.
to influence the global environment, The symbolism is important because of
then it is likely that we will cause the need to educate the public and gov-
changes even larger than those discussed ernment and gauge their reactions to this
here within the next century or so. first global environmental issue. If people

Both the greenhouse effect and other and governments show themselves to be
global changes could be predominantly concerned and willing to make sacrifices,
beneficial or harmful to humans and the prospect for the future looks brighter.
various aspects of the environment, If instead, each individual and nation re-
although they are likely to be beneficial in gards the effects as primarily due to oth-
some times and places and detrimental in ers, and as someone else's problem, the
others. But a large element of the public increases in economic activity and ad-
debate is almost scandalized at the notion vances in technology promise a future
 NO Lester B. Lave/ 331

with major unintended changes in the ides. It is hard to imagine that a debate
Earth's environment. among 140 nations on the greenhouse ef-
Such changes could be dealt with by fect would lead to an agreement to adopt
concerned global action to stop the stim- binding programs to abate emissions.
ulus and thus the response. Or they could A multinational agreement on control-
be dealt with by individual and national ling CFC has been negotiated in 1987.
actions to adapt to the consequences. This is an extremely encouraging, and
However much I might wish for con- surprising development. There are many
among countries,
certed action I do not obstacles to effective implementation,
believe this is likely to occur. There are however, from ratification by each coun-
too many disparate interests, too much try to best faith efforts to abide by the
to be gained by cheating, too much sus- sense of the agreement.
picion of the motives of others, and too
little control over all the relevant ac-

tors. Thus, reluctantly, I conclude that

CONCLUSION
mitigation through adaptation must be The greenhouse effect is the first of what
our focus. are likely to be many long-term, global
For example, within the United States, problems. Analysis is difficult because of
federal environmental laws have been the vast uncertainty about causes and ef-
only a modest success in preventing en- fects, as well as of the consequences of the
vironmental pollution. Ozone problems resulting climate change. The current un-
have worsened, ground water has be- certainties together with the costs of pre-
come more polluted, and we seem no cipitous action imply that heroic actions
closer to dealing with radioactive and to curtail the emissions of all greenhouse
toxic wastes. When the scope of the prob- gases are not justified. Nonetheless, the
lem becomes international, as with acid current facts support a program of en-
rain, there is little or no progress. Curtail- ergy conservation, abatement, research,
ing sulfur oxides emissions into the air and periodic reconsideration that is far
necessarily involves promoting some in- more activist than the current policy of
terests while hurting others. Those who the U.S. government.
would be hurt are, not surprisingly, more
skeptical about whether low levels of acid I would like to thank Stephen Schneider
sulfate aerosols cause disease than those and Jesse Ausubel comments. This
for
who believe that they would benefit. Get- work was supported part by the
in
ting agreement on action has proven es- National Science Foundation (Grant No.
sentially impossible for abating sulfur ox- SES-8715564).
POSTSCRIPT
Does Global Warming Require
Immediate Government Action?
The harsh reality is that the environment is deteriorating. Very few, if any,
physical scientists dispute this fact. What is disputed is the rate of decline
in the global environment and whether or not citizens acting at the end of
the twentieth century should try to alter this process. Do we have enough
knowledge of the future to take dramatic steps today that will reshape the
world of tomorrow? These are hard questions. If we answer incorrectly, our
children and our children's children may curse us for our lack of resolve to
solve environmental problems that were clear for all to see.
Shea and Lave both agree that there is a clear and present danger associated
with ozone-depleting chemicals, such as chlorofluorocarbons, which are also
the gases that contribute to the greenhouse effect. What they disagree upon
is whether or not we know enough today to take immediate, decisive action.

Do you know enough? If you do not, we suggest that you read further in this
area. It is your future that is being discussed here.
A brief history of scientific concerns about the greenhouse effect, which
stretches back to the late nineteenth century, is found in Jesse H. Ausubel,
"Historical Note/' in the National Research Council's Changing Climate: Report
of the Carbon Dioxide Assessment Committee (National Academy Press, 1983).
We should note that there are a number of other essays in Changing Climate
that may be of interest to you. The Environmental Protection Agency (EPA)
has published many studies you might want to examine. See, for example,
the EPA's study entitled The Potential Effects of Global Climate Change on the
United States (December 1989) or Policy Options for Stabilizing Global Climate
(February 1989). An extensive analysis of the scientific, economic, and policy
implications are also found in the 1990 Economic Report of the President.

332
ISSUE 18
Should Pollution Be Put to
the Market Test?

YES: Alan S. Blinder, from Hard Heads, Soft Hearts (Addison- Wesley, 1987)
NO: David Moberg, from "Environment and Markets: A Critique of Tree
Market' Claims/' Dissent (Fall 1991)

ISSUE SUMMARY
YES: Alan S. Blinder, a member of the Board of Governors of the Federal

Reserve System, urges policymakers to use the energy of the market to solve
America's environmental problems.
NO: Social criticDavid Moberg warns against giving businesses more flex-
ibility and economic incentives, and he argues that clear public policy and
direct government intervention will have the most positive effects on the
environment.

Markets sometimes fail. That is, markets sometimes do not automatically

yield optimum, economically efficient answers. This is because prices some-
times do not reflect the true social costs and benefits of consumption and
production. The culprit here is the presence of externalities. Externalities are
spillover effects that impact third parties who had no voice in the determina-
tion of an economic decision.
If, for example, my friend and coeditor Frank J. Bonello decided to "cut a

few corners" to hold down the costs of his commercially produced banana
cream pies, he might well create a negative externality for his neighbors. That
is, if in the dark of night, Bonello slipped to the back of his property and

dumped his banana skins, egg shells, and other waste products into the
St. Joe River that borders his property, part of the cost of producing banana

cream pies would be borne by those who live downstream from the Bonello
residence. Since the full costs of production are not borne by Bonello, he
can set a competitively attractive price and sell many more pies than his
competitors, whom we assume must pay to have their waste products carted
away.
If Bonello is not forced to internalize the negative externality associated

with his production process, the price attached to his pies gives an improper
market signal in regard to the true scarcity of resources. In brief, because
Bonello's pies are cheaper than his competitors, demanders will flock to his

334
doorstep to demand more and more of his pies, unknowingly causing him to
dump more and more negative externalities on his neighbors downstream.
In this case, as in other cases of firms casting off negative externalities, the
public sector may have to intervene and mandate that these externalities be
internalized. This is not always an easy task, however. Two difficult questions
must be answered: (1) Who caused the external effect? Was it only Bonello's
banana cream pie production? and (2) Who bore the costs of the negative ex-
ternal, and what are their losses? These questions require detective work. We
must not only identify the source of the pollution, but we must also identify
the people who have been negatively affected by its presence and determine
their "rights" in this situation. Once this has been achieved, the difficult task
of evaluating and measuring the negative effects must be undertaken.
Even if this can be successfully negotiated, one last set of questions remains:
What are the alternative methods that can be used to force firms to internalize
their externalities, and which of these methods are socially acceptable and
economically efficient? This is the subject of the debate that follows.
Alan S. Blinder warns against the limitations inherent in a market solution
to this problem; however, he still supports harnessing the power of the market
in order to rid the world of the harmful effects of pollution. David Moberg,
on the other hand, takes care to note that private market solutions can be
effective. But he maintains that, many times, old-fashioned regulation can be
even more effective.

335
 Alan S. Blinder
YES

CLEANING UP THE ENVIRONMENT:

SOMETIMES CHEAPER IS BETTER
We cannot give anyone the option of polluting for a fee.

—Senator Edmund Muskie

(in Congress, 1971)

In the 1960s, satirist Tom Lehrer wrote a hilarious song warning visitors
to American cities not to drink the water or breathe the air. Now, after the
passage of more than two decades and the expenditure of hundreds of bil-
lions of dollars, such warnings are less appropriate —
at least on most days!
Although the data base on which their estimates rest is shaky, the Environ-
mental Protection Agency (EPA) estimates that the volume of particulate
matter suspended in the air (things like smoke and dust particles) fell by half
between 1973 and 1983. During the same decade, the volume of sulfur diox-
ide emissions declined 27 percent and lead emissions declined a stunning
77 percent. Estimated concentrations of other air pollutants also declined.
Though we have some way to go, there is good reason to believe that
still

our air is cleaner and more healthful than it was in the early 1970s. While the
evidence for improved average water quality is less clear (pardon the pun),
there have at least been spectacular successes in certain rivers and lakes.
All this progress would seem to be cause for celebration. But economists are
—
frowning and not because they do not prize cleaner air and water, but rather
because our current policies make environmental protection far too costly.
America can achieve its present levels of air and water quality at far lower
cost, economists insist. Trie nation is, in effect, shopping for cleaner air and
water in a high-priced store when a discount house is just around the corner.
Being natural cheapskates, economists find this extravagance disconcerting.
Besides, if we shopped in the discount store, we would probably buy a
higher-quality environment than we do now

IS POLLUTION AN ECONOMIC PROBLEM?

. Nothing in this discussion
. implies that the appropriate level of environ-
. . .

mental quality is a matter for the free market to determine. On the contrary,

From Alan S. Blinder, Hard Heads, Soft Hearts (Addison-Wesley, 1987), pp. 136-137, 139-145,
147-149, 154-156, 158-159. Copyright © 1987 by Alan S. Blinder. Reprinted by permission of
Addison-Wesley Longman Inc. Notes omitted.

336
 .

YES Alan S. Blinder/ 337

the market mechanism is ill suited to the The Efficiency Argument

task; if left to its own devices, it will It is now why economists
time to explain
certainly produce excessive environmen- emissions fees can clean up
insist that
tal degradation. Why? Because users of the environment at lower cost than
clean air and water, unlike users of oil mandatory quantitative controls. The
and steel, are not normally made to pay secret is the market's unique ability to
for the product. accommodate individual differences — in
Consider a power plant that uses this case, differences among polluters.
coal, labor, and other inputs to produce Suppose society decides that emissions
electricity. buys all these items on
It of sulfur dioxide must decline by 20
markets, paying market prices. But the percent. One obvious approach is to
plant also spews soot, sulfur dioxide, and mandate that every source of sulfur diox-
a variety of other undesirables into the ide reduce its emissions by 20 percent.
air. In a real sense, it "uses up" clean Another option is to levy a fee on dis-
—one of those economic goods which
air charges that is large enough to reduce
people enjoy— without paying a penny. emissions by 20 percent. The former
Naturally, such a plant will be sparing is the way our current environmental

in its use of coal and labor, for which it regulations are often written. The latter is
pays, but extravagant in its use of clean the economist's preferred approach. Both
air, which is offered for free. reduce pollution to the same level, but the
That, in a nutshell, is why the market fee system gets there more cheaply. Why?
safeguard the environment. When
fails to Because a system of fees assigns most of
items of great value, like clean air and the job to firms that can reduce emissions
water, are offered free of charge it is easily and cheaply and little to firms that
unsurprising that they are overused, find it onerous and expensive to reduce
leaving society with a dirtier and less their emissions.
healthful environment than it should Let me illustrate how this approach
have. works with a real example. A study
The analysis of why the market fails in St. Louis found that it cost only $4
suggests the remedy that economists for one paper-products factory to cut
have advocated for decades: charge particulate emissions from its boiler by
polluters for the value of the clean air or a ton, but it cost $600 to do the same
water they now take for free. That will job at a brewery. If the city fathers
succeed where the market fails because instructed both the paper plant and
an appropriate fee or tax per unit of the brewery to cut emissions by the
emissions will, in effect, put the right same amount, pollution abatement costs
price tag on clean air and water just as — would be low at the paper factory but
the market now puts the right price tag astronomical at the brewery. Imposing
on oil and steel. Once our precious air a uniform emissions tax is a more cost-
and water resources are priced correctly conscious strategy. Suppose a $100/ton
polluters will husband them as carefully tax is announced. The paper company
as they now husband coal, labor, cement, will see an opportunity to save $100 in
and steel. Pollution will decline. The taxes by spending $4 on cleanup, tor a
environment will become cleaner and $96 net profit. Similarly, any other firm
more healthful. . . whose pollution-abatement costs ui
338 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

than $100 per ton will find it profitable to The Enforcement Argument
cut emissions. But firms like the brewery, Some critics of emissions fees argue
where pollution-abatement costs exceed that a system of fees would be hard to
$100 per ton, will prefer to continue enforce. In some cases, they are correct.
polluting and paying the tax. Thus the We obviously cannot use effluent charges
profit motive will automatically assign to reduce concentrations of the unsightly
the task of pollution abatement to the pollutant glop if engineers have yet

—
low-cost firms something no regulators to devise an effective and dependable
can do. devise for measuring how much glop
Mandatory proportional reductions firms are spewing out. If we think glop
have the seductive appearance of "fair- is harmful, but are unable to monitor it,

ness" and so are frequently adopted. our only alternative may be to require
But they provide no incentive to min- firms to switch to "cleaner" technologies.
imize the social costs of environmental Similarly, emissions charges cannot be
clean-up. In fact, when the heavy polit- levied on pollutants that seep unseen
ical hand requires equal percentage re- — and unmeasured —into groundwater
ductions by every firm (or perhaps from rather than spill out of a pipe.
every smokestack), it pretty much guar- In many cases, however, those who ar-
antees that the social clean-up will be far gue that emissions fees are harder to en-
more costly than it need be. In the pre- force than direct controls are deceiving
vious example, a one-ton reduction in themselves. If you cannot measure emis-

annual emissions by both the paper fac- sions, you cannot charge a fee, to be sure.
tory and the brewery would cost $604 per But neither can you enforce mandatory
year. But the same two-ton annual pollu- standards; you can only delude yourself
tion abatement would cost only $8 if the into thinking you are enforcing them. To
paper factory did the whole job. Only by a significant extent, that is precisely what
lucky accident will equiproportionate re- the EPA does now. Federal antipollution
ductions in discharges be efficient. regulations are poorly policed; the EPA
Studies that I will cite later... sug- often declares firms in compliance based
gest that market-oriented approaches to on nothing more than the firms' self-
pollution control can reduce abatement reporting of their own behavior. When
costs by 90 percent in some cases. Why, checks are made, noncompliance is fre-
economists ask, is it more virtuous to quently uncovered. If emissions can be
make pollution reduction hurt more? measured accurately enough to enforce a
They have yet to hear a satisfactory an- system of quantitative controls, we need
swer and suspect there is none. On the only take more frequent measurements to
contrary, virtue and efficiency are proba- run a system of pollution fees.
bly in harmony here. If cleaning up our Besides, either permits or taxes are
air and water is made cheaper, it is rea- much easier to administer than detailed
sonable to suppose that society will buy regulations. Under a system of mar-
more clean-up. We can have a purer en- ketable permits, the government need
vironment and pay less, too. The hard- only conduct periodic auctions. Under a
headed economist's crass means may be system of emissions taxes, the enforce-
the surest route to the soft-hearted envi- ment mechanism is the relentless and
ronmentalist's lofty ends. anonymous tax collector who basically
 — —
YES Alan S. Blinder/ 339

reads your meter like a gas or electric be held responsible for the results; and
company. No fuss, no muss, no bother (6) he needs more time

and no need for a big bureaucracy. Just a

bill. The only way to escape the pollution Other Reasons to Favor Emissions Fees
tax is to exploit the glaring loophole that Yet other factors argue for market-based
the government deliberately provides: re- approaches to pollution reduction.
duce your emissions. One obvious point is that a system of
Contrast this situation with the dif-
mandatory standards, or one in which
a particular technology is prescribed by
ficultiesof enforcing the cumbersome
law, gives a firm that is in compliance
command-and-control system we now
with the law no incentive to curtail its
operate. First, complicated statutes must
emissions any further. If the law says that
be passed; and polluting industries will
the firm can emit up to 500 tons of glop
use their considerable political muscle in
per year, it has no reason to spend a penny
state legislatures and in Congress to fight
to reduce its discharges to 499 tons. By
for weaker laws. Next, the regulatory
contrast, a firm that must pay $100 per
agencies must write detailed regulations
ton per year to emit glop can save money
defining precise standards and often pre-
by reducing its annual discharges as long
scribing the "best available technology"
as its pollution-abatement costs are less
to use in reducing emissions. Here again
than $100 per ton. The financial incentive
industry will do battle, arguing for looser
to reduce pollution remains.
interpretations of the statutes and often
turning the regulations to their own ad-
A second, and possibly very important,
virtue of pollution fees is that they create
vantage. They are helped in this effort by
incentives for firms to devise or purchase
the sheer magnitude of the information-
innovative ways to reduce emissions. Un-
processing task that the law foists upon
der a system of effluent fees, businesses
the EPA and state agencies, a task that
gain if they can find cheaper ways to con-
quickly outstrips the capacities of their
trol emissions because their savings de-
small staffs.
pend on their pollution abatement, not on
Once detailed regulations are promul- how they achieve it. Current regulations,
gated, the real problems begin. State and by contrast, often dictate the technology.
federal agencies with limited budgets Firms are expected to obey the regulators,
must enforce these regulations on thou- not to search for creative ways to reduce
sands, if not millions, of sources of pol- pollution at lower cost.
lution. The task is overwhelming. As one For this and other reasons, our cur-
critic of the system put it, each polluter rent system of regulations is unnecessar-
argues: ily adversarial. Businesses feel the

he is compliance with the regula-

in
eminent is out to harass them
and they —
(1)
act accordingly. Environmental protec-
tion; (2) if not, it is because the regulation
tion agencies lock horns with industry
is unreasonable as a general rule; (3) if
in the courts. The whole enterprise takes
not, then the regulation is unreasonable
in this specific case; (4) if not, then it is up On the atmosphere Of a bullfight rather
to the regulatory agency to tell him how- than that ot a joint venture. A market-
to comply; (5) if forced to take the steps based approach, which made dear that
recommended by the agency, he cannot •\ eminent wanted to minimize the
 —
340 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

costs imposed on business, would nat-

it pollute" based on coherent arguments
urally create a more cooperative spirit. that should sway policy, or are they knee-
That cannot be bad. jerk reactions best suited to T-shirts?* My
Finally, appearance of fairness
the own view is that there is little of the
when regulations take the form of uni- former and much of the latter. Let me
form percentage reductions in emissions, explain.
as they frequently do, is illusory. Sup- Some of the invective heaped upon the
pose Clean Jeans, Inc. has already spent idea of selling the privilege to pollute
a considerable sum to reduce the amount stems from an ideologically based dis-
of muck it spews into the Stench River. trust of markets. Someone who does not
Dirty Jeans, Inc., just downriver, has not think the market a particularly desirable
spent a cent and emits twice as much. way to organize the production of auto-
Now a law is passed requiring every firm mobiles, shirts, and soybeans is unlikely
along the Stench to reduce its emissions to trust the market to protect the environ-
by 50 percent. That has the appearance ment. As one congressional staff aide put
of equity but not the substance. For Dirty it: "The philosophical assumption that

Jeans, the regulation may be a minor nui- proponents of [emissions] charges make
sance. To comply, it need only do what is that there is a free-market system that
Clean Jeans is already doing voluntarily.
But the edict may prove onerous to Clean
responds. to ... relative costs — I reject
that assumption." This remarkably fatu-
Jeans, which has already exploited all the ous statement ignores mountains of ev-
cheap ways to cut emissions. In this in- idence accumulated over centuries. For-
stance, not only is virtue not its own re- tunately, it is a minority view in America.
—
ward it actually brings a penalty! Such Were it the majority view, our economic
anomalies cannot arise under a system problems would be too severe to leave
of marketable pollution permits. Clean much time for worry about pollution.
Jeans would always have to buy fewer
Some of the criticisms of pollution fees
permits than Dirty Jeans
are based on ignorance of the arguments
or elementary errors in logic. As men-
OBJECTIONS TO "LICENSES tioned earlier, few opponents of market-
TO POLLUTE" based approaches can even explain why
economists insist that emissions fees will
Despite the many powerful arguments
get the job done more cheaply.
in favor of effluent taxes or marketable
emissions permits, many people have One commonly heard objection is that

an instinctively negative reaction to the a rich corporation confronted with a

whole idea. Some environmentalists, in pollution tax will pay the tax rather
particular, rebel at economists' advocacy than reduce its pollution. That belief

of market-based approaches to pollution shows an astonishing lack of respect for

control —which they label "licenses to avarice. Sure, an obstinate but profitable
pollute/' a term not meant to sound company could pay the fees rather

complimentary. Former Senator Muskie's

dictum, quoted at the beginning of this '[Earlier in his book, Blinder warns his readers
about simplistic answers to complex questions. He
chapter, is an example. The question concludes that "if it fits on a T-shirt, it is almost
is: Are the objections to "licenses to certainly wrong." —
Eds.]
 —
YES Alan S. Blinder/ 341

than reduce emissions. But it would Angeles or New York to hazardous lev-
do that only if the marginal costs els, it makes mayors
perfect sense for the
of pollution abatement exceed the fee. of those cities to place legal limits on driv-
Otherwise, its obduracy reduces its ing, on industrial discharges, or on both.
profits. Most corporate executives faced There is simply no time to install a system
with a pollution tax will improve their of pollution permits.
bottom lines by cutting their emissions, A final obvious case is when no
not by flouting the government's intent. adequate monitoring device exists, as in
To be sure, it is self-interest, not the public the case of runoff from soil pollution.
interest, that motivates the companies to
Then a system of emissions fees is out
clean up their acts. But that's exactly the of the question. But so also is a system of
idea behind pollution fees direct quantitative controls on emissions.
One final point should lay the moral The only viable way to control such
issue to rest. Mandatory quantitative pollution may be to mandate that cleaner
standards for emissions are also licenses technologies be used.
—
to pollute just licenses of a strange sort.
But each of these is a minor, and well
They give away, with neither financial
recognized, exception to an overwhelm-
charge nor moral condemnation, the right
ing presumption in the opposite direc-
to spew amount of pollution
a specified
tion. No sane person has ever proposed
into the air or water. Then they absolutely
selling permits to spill arsenic into wa-
prohibit any further emissions. Why is
ter supplies. None has suggested that the
such a license morally superior to a
mayor of New York set the effluent tax
uniform tax penalty on all pollution?
on carbon monoxide anew after hearing
Why is a business virtuous if it emits
the weather forecast each morning. And
500 tons of glop per year but sinful if it
no one has insisted that we must me-
emits 501? Economists make no claim to
ter what cannot be measured. Each of
be arbiters of public morality. But I doubt
these objections is a debater's point, not
that these questions have satisfactory
a serious challenge to the basic case for
answers.
market-oriented approaches to environ-
The choice between direct controls and
mental protection
effluent fees, then, is not a moral issue.
It is an efficiency issue. About that,
economists know a thing or two.
RAYS OF HOPE: EMISSIONS
Having made my pitch, I must confess
TRADING AND BUBBLES
that there are circumstances under which
market-based solutions are inappropriate There are signs, however, that environ-
and quantitative standards are better. mental policy may be changing for the
One obvious instance is the case of a better. The EPA seems to be drifting
deadly poison. If the socially desirable slowly, and not always surely, awa\
is no point
level of a toxin is zero, there technology-d riven direct controls toward
inimposing an emission fee. An outright more market-oriented approaches. But
ban makes more sense. not because the agency has been con-
Another case is a sudden health emer- by the logic Of economists' argu-
!

gency. When, for example, a summertime ments. Rather, it was driven into a comer
air inversion raises air pollution in Los by the inexorable illogic of its own pro-
 .

342 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

cedures. Necessity proved to be the mid- and EhiPont saved $12 million in capital
wife of common sense. costsand $3 million per year in operating
The story begins in the 1970s, when costs.
itbecame apparent that many regions Partly because it was hampered by
of the country could not meet the air the courts, the bubble concept was little
quality standards prescribed by the Clean used at first. But bubbles have been
Air Act. Under the law, the prospective growing rapidly since a crucial 1984
penalty for violating of the standards judicial decision. By October 1984, about
was Draconian: no new sources of seventy-five bubbles had been approved
pollution would be permitted in these by the EPA and state authorities and
regions and existing sources would not hundreds more were under review or in
be allowed to increase their emissions, various stages of development. The EPA
implying a virtual halt to local economic estimated the cost savings from all these
growth. The EPA avoided the impending bubbles to be about $800 million per year.
clash between the economy and the That may seem a small sum compared
environment by creating its "emissions- to the more than $70 billion we now
offsets"program in 1976. Under the spend on environmental protection. But
new rules, companies were allowed to remember that the whole program was
create new sources of pollution in areas still in the experimental stage, and these

with substandard air quality as long as bubbles covered only a tiny fraction of
they reduced their pollution elsewhere the thousands of industrial plants in the
by greater amounts. Thus was emissions United States.
trading born. The bubble program was made per-
The next important step was invention manent only when EPA pronounced the
of the "bubble" concept in 1979. Under experiment a success and issued final
this concept, all sources of pollution from guidelines in November 1986. Econo-
a single plant or firm are imagined to be mists greeted this announcement with
encased in a mythical bubble. The EPA joy. Environmentalist David Doniger . .

then tells the company that it cares only complained that, "The bubble concept is
about total emissions into the bubble. one of the most destructive impediments
How these emissions are parceled out to the cleanup of unhealthy air." By now,
among the many sources of pollution many more bubbles have been approved
under the bubble is no concern of the or are in the works. Time will tell who
EPA. But it is vital to the firm, which was right.
can save money by cutting emissions in The final step in the logical progression
the least costly way. A striking example toward the economist's approach would
occurred in 1981 when a DuPont plant be to make these "licenses to pollute"
in New Jersey was ordered to reduce fullymarketable so that firms best able to
its emissions from 119 sources by 85 reduce emissions could sell their excess
percent. Operating under a state bubble abatement to firms for which pollution
program, company engineers proposed abatement is too expensive. Little trading
instead that emissions from seven large has taken place to date, though the
stacks be reduced by 99 percent. The EPA's November 1986 guidelines may
result? Pollution reduction exceeded the encourage it. But at least one innovative
state's requirement by 2,300 tons per year state program is worth mentioning.
 YES Alan S. Blinder/ 343

The state of Wisconsin found itself tion control with seemingly everyone else
unable to achieve EPA-mandated levels lined up on the other side. Are economists
of water quality along the polluted crazy or is everyone else wrong?

Fox and Wisconsin Rivers, even when ... I have argued the seemingly im-
it employed the prescribed technology. plausible proposition that environmen-
A team of engineers and economists tal economists are right and everyone
then devised a sophisticated system of else really is wrong. I have tried to con-

transferable discharge permits. Firms vey a sense of the frustration economists

were issued an initial allocation of feel when they see obviously superior
pollution permits (at no charge), based policies routinely spurned. By replac-
on historical levels of discharges. In total, ing our current command-and-control
these permits allow no more pollution system with either marketable pollution
than is consistent with EPA standards permits or taxes on emissions, our envi-
for water quality. But firms are allowed ronment can be made cleaner while the
to trade pollution permits freely in the burden on industry is reduced. That is
open market. Thus, in stark contrast to about as close to a free lunch as we are
the standard regulatory approach, the likely to encounter. And yet economists'
Wisconsin system lets the firms along the recommendations are overwhelmed by
—
river not the regulators —
decide how an unholy alliance of ignorance, ideology,
to reduce discharges. Little emissions and self-interest.
trading has taken place to date because This is a familiar story. The one novel
the entire scheme has been tied up in aspect in the sphere of environmental
litigation. But one study estimated that policy is that the usual heavy hitter of this
pollution-control costs might eventually triumvirate — self-interest — is less pow-
fall by as much as 80 percent compared to erful here than in many other contexts. To
the alternative of ordering all firms along be sure, self-interested business lobbies
the river to reduce their discharges by a oppose pollution fees. But, as I pointed
uniform percentage. out, they can be bought off by allowing
The state of Wisconsin thus came some pollution free of charge. Doing so
to the conclusion that economists have may outrage environmental purists, but
maintained all along: that applying a little it is precisely what we do now.
economic horse sense makes it possible to It is the possibility of finessing vested
clean up polluted rivers and reduce costs hope
financial interests that holds out the
at the same time —
a good bargain. That that good environmental policy might
same bargain is available to the nation one day drive out the bad. For we need
for the asking only overcome ignorance and ideology,
not avarice.
Ignorance is normally beaten by
A HARD-HEADED, SOFT-HEARTED knowledge, lew Americans now realize
ENVIRONMENTAL POLICY that practical reforms of our environmen-
Economists who specialize in environ- tal policies can reduce the national clean-
mental policy must occasionally har- up bill from more than $70 billion per
bor self-doubts. They find themselves year to less than $50 and proba-
billion,

lined up almost unanimously in favor bly to much less. Even fewer understand
of market-based approaches to pollu- the reasons why It the case tor market-
344 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

based policies were better known, more tening, progress toward their goals, their
and more people might ask the obvi- objections may melt away.
ous question: Why is it better to pay The economist's approach to envi-
more for something we can get for less? ronmental protection is no panacea. It
Environmental policy may be one area requires an investment in monitoring
where William Blake's optimistic dictum equipment that society has not yet made.
— "Truth can never be told so as to be un- It cannot work in cases where the sources

—
derstood and not believed" is germane. of pollution are not readily identifiable,
such as seepage into groundwater. And
Ideology is less rooted out,
easily itwill remain an imperfect antidote for
for it rarely succumbs to rational argu- environmental hazards until we know a
ment. Some environmentalists support great deal more than we do now about
the economist's case. Others understand the diffusion of pollutants and the harm
itwell and yet oppose it for what they they cause.
perceive as moral reasons. I have ar- But perfection is hardly the appropri-
gued at length that here, as elsewhere, As things stand now, our en-
ate standard.
thinking with the heart is less effective vironmental policy may be a bigger mess
than thinking with the head; that the than our environment. Market-based ap-
economist's case does not occupy the proaches that join the hard head of the
moral low ground; and that the environ- accountant to the soft heart of the envi-
ment is likely to be cleaner if we offer soci- ronmentalist offer the prospect of gen-
ety clean-up at more reasonable cost. As uine improvement: more clean-up for less
more environmentalists come to realize money. It is an offer society should not
that T-shirt slogans are retarding, not has- refuse.
NO David Moberg

ENVIRONMENT AND MARKETS: A

CRITIQUE OF "FREE MARKET" CLAIMS

The soot-darkened skies and fouled waters of Eastern Europe have given
apologists for laissez-faire capitalism a new rallying cry: the "free market/'
far from being nature's enemy, is the environment's savior.
Some environmentalists have argued is no fundamental conflict
that there
between environmental responsibility and market" economics. Ecology,
"free
they contend, is ultimately sound, profitable business and environmental reg-
ulation must employ market forces if it is to succeed. They advocate giving
business more flexibility and incentives, such as the right to buy and sell
pollution rights, to increase efficiency and innovation so as to meet environ-
mental goals.
Other environmentalists, however, continue to share a skepticism, with
roots in both conservative and leftist traditions, about the compatibility of the
market and the environment. This camp is also dissatisfied with the results of
the first two decades of environmental regulation. Its advocates want a more
aggressive democratic voice in what are usually private decisions. Ecological
principles have become the basis for alternative models to capitalist markets,
conflicting with or complementing the longstanding social class critiques.
Ecologists have also opened another front criticizing not just the adequacy of
market mechanisms but also market society in general and its exaltation of
individual acquisitiveness and unbridled growth of commodity production.
All human societies have been shaped by interaction with nature, from the
nomadism of hunters to the settled cultures of rich ecological niches, such
as our own Northwest Coast or the slash-and-burn agriculture of tropical
forests. Although earlier cultures undermined themselves by radically alter-
ing environments, stripping forests from the hills of Greece or raising the
salinity of irrigated Mesopotamian soil, the worst depredation oi the envi-
ronment has come since the rise of capitalism. Now there is the prospect that
human society has such an unsustainable relation with nature that both the
future of humanity and the fate of thousands oi other creatures is at stake.

From David Moberg, "Environment and [Link]: A Critique of Fnv [Link]' Cl.u:
(Fall 1991). Copyright © 1991 by David Motecg. Reprinted by permission.

345
346 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

But has capitalism itself been the cause is possible to level the playing field with
of environmental damage or is the root taxes, fees, or penalties for the polluter,
problem industrial technologies or a but it is difficult to assess the price of
growing population that consumes more damage to the environment, especially
and more goods? if it is not a localized toxic spill but a
Although the rapid growth of both global problem, like the greenhouse ef-
population and global consumption fect. Litigation over Exxon's Alaska oil
magnifies every environmental impact, spillor over compensation to the vic-
there are huge differences in environmen- tims of Union Carbide's Bhopal disaster
tal effects among nations, even the indus- suggests the ethically and economically
trialized ones. The worst environmental knotty problems.
insults are a result of modern industry,
but not all industries degrade the envi-
ronment equally. The nature of society,
WHO DETERMINES THE LOSSES?
not just its size or technology, is largely There are similar problems if more direct
responsible for the crisis in nature. environmental regulations are subjected
Obviously, the private market damages to cost-benefit analysis: how much is

the natural environment because pollu- a human life worth? Some economists
tion is external to the balance sheets of argue that it's the person's likely future
private business. A factory owner doesn't lifetime earnings. That makes an Indian
pay to flush waste down the river or into peasant pretty expendable compared to a
the air; the costs are borne by nature as Connecticut executive. Such cost-benefit
well as other people who share the envi- analyses illegitimately import values of
ronment. On the other hand, if a farmer the marketplace to answer questions that
preserves a marsh that cleans the stream's arise because of fundamental flaws in
water, nourishes fish and wildlife, and that same market system.
prevents floods, he paid nothing for
is How much is a sea otter worth?,
those services. But if he sells it to be filled Business Week asked. Surveying people
in for a shopping center, he will make about how much the animals are worth
money, and our accounting system eval- to them or measuring lost income if

uates this as economic growth*, with no sea disappeared may keep a

otters
deductions for this loss of the wetland's few economists employed, but it does
natural functions. Likewise, nobody pays not answer the question. If only one
for the Amazon forest serving as "the respondent said it was of infinite value,
lungs of the world" or preserving its di- that would throw off the survey. If you
verse life forms for the future. So, the mar- limit the response to how much a person
ket doesn't adequately account for either would be willing to spend, the result
negative or positive externalities. would obviously be affected by how
If an ingenious entrepreneur devises much money people have, a standard
a pollution-free production process that flaw of market preference analysis.
costs more than her competitor's, she will Nobody asks the sea otter how much
probably lose the market race: in most otters are worth. But the presumption
cases, nobody —except for a few gener- that human-kind's use of the world
ous souls —will pay the tab for her con- is sole measure of its value is
the
tribution to the common welfare. Now it arrogant. Nor can anyone survey future
 —
NO David Moberg/ 347

generations on their valuations of nature. have charged, with compelling evidence,

And trying to measure the environment that the short-term preoccupations of
in terms of clean-up costs makes the American business have weakened the
neat presumption, easy in economics but American economy. With regard to na-
questionable in nature, that all processes ture, myopic economic calculation is even
are reversible. more devastating. Given the scale and
So, correctly pricing the environmental toxicity of human activity today, waiting
effects of human activities is at best
rough for the market to signal a need for change
guesswork, an attempt to squeeze pro- may result in catastrophic, even irre-
found issues of value into a Procrustean versible damage, such as global warming
bed of price. Ultimately, despite imported or extinction of valuable species. There is

trappings of economic analysis, the deci- a fundamental conflict, Daly and Cobb
sion is social: what does society value? argue, between short-term profit maxi-
mization and the real needs and concrete
resources of the whole community far
The market also fails to value adequately into the future.
the depletion of nonrenewable resources.
Again, future generations are largely
DEFERRING GRATIFICATION
ignored. How does the market allocate
the right of a few generations in the Again, the calculations of the market are
twentieth and twenty-first centuries to inadequate. Economists often discount a
use up most of the world's nonrenewable future sum of money, figuring its present
hydrocarbon resources? For a Brazilian value as the amount that, if put in the
gold miner or peasant, suffering in an bank at current interest rates, would yield
economy burdened by huge external the future sum. For the same reasons
debts, short-term market rationality may that bedevil other efforts to price nature,
dictate destroying the forest (just as such discounting fails to assess the future
the short-term rationality of the banks value of the environment. From a free-
collecting their debts indirectly destroys market perspective, it may be rational for
the forest). But its resources of flora the private owner to kill the goose that
and fauna are lost, its land rendered lays the golden egg —
if it can be sold now

useless. In differentways, then, the for more than its discounted future value
extreme inequities of income generated and the proceeds invested. But thereby,
in the global market exhaust the planet Daly and Cobb argue, "society has lost a
— from the pressure of impoverished perpetual stream of golden cc
Third World masses on the land to When we consider how long certain
the disproportionate consumption of toxic substances and especially radioac-
nonrenewable resources and generation tive wastes are likely to remain threats,
of waste in the richest countries the problem is compounded: w
on the blind
Laissez-faire religion rests the inheritance oi Future generations and
faith thatmaximizing profits will over leave them with a poisonous debt. It
time yield the most rational results. iet future people could be consulted, they
even within a capitalist framework, tar- would never sign the one-sided contract
sighted investment at the expense of cur- now being written. We can conclude that
rent profits often makes sense. Critics tor several different reasons the market
 —

348 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

doesn't accurately price goods so as to on energy declines as income increases,

take account of their environmental con- although the use of energy increases
sequences. It ignores negative and posi- (at the lowest income levels a decline
tive externalities, accounts for deple-
ill in car ownership modifies this trend).
tion of natural resources, inappropriately Then there would be attempts to cope,
measures income and welfare, and fails by cutting back some use (much use
to take responsibility for future genera- is not very discretionary), and then,

tions' welfare. more important, by increasing efficiency.

Also, other energy alternatives would
become more competitive. And there
Since the defense of the market usually would obviously be public clamor to
rests in large part on its ability to allocate —
do something from unleashing nuclear
resources efficiently and provide accurate power to promoting solar energy.
information through prices, this failure U.S. experience after the OPEC price in-
to incorporate the environment is not a creases of the 1970s illustrates the mixed
trifling flaw. record on market response to higher en-
Can it be corrected? Increasingly ergy prices. Because the economy was ill-
some environmentalists argue for " green prepared to absorb the shocks, much of
taxes" that would adjust prices upward to the stagflation of the decade can be at-
include uncounted environmental costs. tributed to everybody's efforts to pass on
U.S. energy users don't pay directly for as the costs to someone else. But the U.S.
much as $300 billion a year in subsidies economy, with some governmental en-
and tax credits (at least $50 billion a year, couragement, also became more energy
mainly to fossil fuels and nuclear power), efficient. In little more than a decade
environmental degradation, damage to after the first OPEC price increase, the
health, military expenditures (the Gulf energy intensity of the U.S. economy
War alone would have added approxi- energy per unit of GNP dropped by—
mately $25 a barrel to imported oil), or about one-fourth. Energy production, in-
employment effects of energy policies, ac- cluding new sources of oil, increased in
cording to Harold M. Hubbard, a scien- —
response to higher prices but far less
tist atResources for the Future. By other than mainstream economists predicted.
calculations, we should now be paying Much of the efficiency gain was
more than $100 a barrel for oil if all costs driven by government regulation as well
were included. But Hubbard acknowl- as by market factors. But what's re-
edges that "calculating the actual cost markable is how limited the response
of energy is not a simple matter. The. . . was, considering the potential. After
answers that economists derive may de- all, even before the OPEC price hikes,

pend as much on social values as they Germany and Japan used roughly half
do on analytical solutions to well-defined as much energy per unit of GNP
problems/' as the United States and afterward
If consumers had to pay directly for the still made efficiency gains nearly as
full price of energy, several things would great or greater than the United States
happen. First, there would be economic did. Further, using technologies that
shock and an increase in inequality. In are commercially available now, the
general, the proportion of income spent United States could reduce its electric
 —
NO David Moberg/ 349

energy consumption by 70 percent at in real oil prices in the mid-eighties

less than the present cost of generating —spurred more response? Consumers
electricity, according to analyses by often are ill-informed about alternatives
guru Amory Lovins's Rocky
efficiency and find it difficult to make lifetime
Mountain Institute. Although the U.S. energy cost assessments (cheap initial
auto industry forced by federal standards cost of a regular incandescent bulb is
as much as by prices, made dramatic more persuasive than the argument that
efficiency gains, the auto industry is still lifetime costs of an expensive compact
far from realizing the potential of diesel fluorescent are lower, for example). Even
or gasoline engines, not to mention more many industries simply don't under-
advanced power sources. stand how energy efficiency can benefit
Still, raising the price to some esti- them. They insist that they recover the
mated real price would be a clumsy, entire cost of efficiency investments in
slow, inequitable way of bringing about a year or two, although they might
needed changes. First, there is noth- plan on recovering other investments in
—
ing intrinsically good and a lot bad five years. Sometimes consumers don't
about high energy prices. What society directly make decisions: developers or
needs is an inexpensive way to get nec- landlords may make choices based on
essary work done without the external- their costs, leaving tenants with higher
ized costs. The question is: how do we bills.

get there in the most socially desirable

way?
There are large-scale institutional obsta-
cles to change as well. Automobile man-
WILL GOVERNMENT
ufacturers are to some extent captives of
REGULATION WORK? have created, but like the rest
tastes they
Direct government intervention is, de- of the auto-oil-highway complex, they
spite market mania, often the best route. have a huge stake in keeping changes
Japanese industries have become lead- incremental —only anticipation of direct
ers in efficiency because "the government governmental edicts on alternatives to
spurred their enthusiasm through a care- gasoline engines is leading manufactur-
fully coordinated, long-range program ers to gear up for electric vehicles. And
that continues even today/' the Wall Street private companies are largely incapable
Journal recently reported. "One clear les- ofmaking the kinds of massive invest-
son to learn from Japan is that forcing ments needed for expanded rail or mass
core industries to become more energy- transit.
one thing that government can
efficient is There are countless other ways in
do well." Other industrialized countries which businesses and consumers would
are more energy efficient than the United not respond rationally or quickly even
States because of public investment in to prices that fully reflect environmen-
their public mass transit systems or be- tal costs. Especially in making a major

cause of explicit government strategies, transition, the market is Sticky, luetic, v

such as Danish support of wind power. and inefficient For example, many farm-
Why hasn't the price of energy ers would like to shift from a less chemi-
even taking into account the decline cally intensive regime, especially as they
350 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

become aware that it is not only eco- a company compares polluting and
nomically viable but much healthier. But nonpolluting alternatives and calculates
making the transition can be too costly that pollution does pay? Or take another
—for example, suffering severe losses for example, representing a more familiar
several years until alternative controls of route in the eighties. Phillips Petroleum,
pests and weeds begin to work well. under pressure of debt incurred in
Or take the case of photovoltaic cells, fighting off a hostile takeover, laid off
clearly amuch-needed technology of the experienced union workers and replaced
near future. Even though deep-pockets them with ill-trained contract workers,
energy corporations bought up solar cell took short-cuts on safety, and pushed
firms in the seventies, U.S. companies production to the limit. Trie result was a
have been abandoning the field, in some major explosion in Pasadena, Texas, that
cases selling off to European firms. This killed twenty-six people and spread toxic
highlights another limit to the market materials throughout the environment.
model of efficiency: there are significant Many businesses around the world
cultural differences, especially regarding have become more innovative and com-
long-term investment, and differences petitive as a result of strict environmen-
in levels of government support for tal regulations. Both Germany and Japan
alternative energy policies. Both affect have tougher standards than the United
market responses. States and are growing faster. Some of the
most strictly regulated U.S. industries,
such as chemical, synthetics, and fabrics,
REGULATION CAN HELP
have gained international competitive-
COMPETITION
ness. Yet many businesses have chosen
Free-market enthusiasts insist that pri- the path followed by a large segment of
vate businesses be allowed to innovate southern California's furniture industry:
in response to market signals. But it is so- faced with tougher emissions standards,
cially undesirable to treat the corporation they fled to Mexico, where pollution laws
as a black box, ignoring what goes on in- are not enforced.
side it and tinkering only with the price What makes one company prevent pol-
signals going in and then coping with lution while improving its ability to com-
what comes out. This is especially true in pete and another company endanger its
an era when large, multinational corpora- employees and the surrounding commu-
tions dominate the global economy: their nity or flee abroad? Why does one busi-
power, size, and internal governance dis- ness seize opportunities to become en-
tort idealized market responses to price ergy efficient and another respond to
signals. competitive pressures by shortchanging
Corporate policies vary significantly. workers? How these distinct strategies
At 3M Company, executives wisely emerge but the general point is
varies,
instituted its "Pollution Prevention Pays" that when free marketeers talk about giv-
program and have saved $482 million ing businesses flexibility and allowing
since 1975, eliminated five hundred the market to stimulate innovation, part
thousand tons of waste, and saved of the flexibilityand innovation will be
another $650 million through energy socially good and part terrible. Why let
conservation. But what happens when private business make that momentous
 .

NO David Moberg/ 351

decision? Why should society wait until of even considering the question: unend-
after the dirty deed is done to try to clean ing growth is both their assumption and
up the mess? . . goal.
The alternative does not have to be
for the richer nations to take vows of
NIGHTMARE OF CONSUMPTION
poverty. Some of our problems come
Despite our own problems of inequality from relying on the dynamics of com-
of consumption, which tear at the social modity production rather than consider-
fabric of the United States, an overem- ing what needs we have and how those
phasis on commodity consumption is can be best served. We want homes and
the industrialized world's environmen- offices that are comfortable and well-
tal nightmare. In mass-consumption so- lighted. But electric utilities want to sell
cieties self-fulfillment is defined in terms electricity. It would be better for everyone
of buying more things, which leads to a if they devoted their resources to promot-
disproportionate use of the world's re- ing energy efficiency, but they will only
sources and contributes to waste crises, do so, in most cases, if they are compen-
from localized conflicts over municipal sated for part of sales forgone through
dumps to global destruction of the ozone efficiency-reduced demand. Increasingly,
layer. Of course, if raw materials were public utility commissions are enforcing
more accurately pricedand if corpora- such policies,and municipally owned
tions were responsible for what hap- utilities have aggressively pursued this
pened to the waste they produced, there service-oriented alternative because they
could be more reusable or at least recy- are not profit oriented.
clable packaging and less waste, all with- Environmental concerns should be
out a loss of meaningful consumption. added to many other motivations po- —
Environmentalists have contended that litical, philosophical, religious to chal- —
we must recognize limits to growth, lenge the model of "economic man" that
a most unpopular prospect for both market society helps to create. The highly
liberals and conservatives. Technically, individualistic, cost-minimizing, profit-
the limit to a sustainable economy is the seeking mentality of market society is not
amount of solar energy falling on the a result of "human nature" but a cultural
earth that can reasonably be captured, construction that denies a place for many
even though there are much stricter limits values and feelings that have appeared
on supplies of nonrenewable resources. in most human societies. True, there are
The specter of global warming or holes flaky manifestations of new-age spiritu-
in the ozone layer suggests that we could alism associated with the environmental
reach the limit of our use of nonrenew- movement, but the desire for a sense of
able fuels faster than we actually exhaust human community and harmony with
the earth's resources. Certainly there is the world is widespread and authentic.
no way that the earth can support the The logic of tree-market economics
spread of wealthy, industrialized nations' creates untenable abstractions, a> Daly
current extravagant consumption to the and Cobb, following economic historian
world's poor. Environmentalists are di- Karl Polanyi, emphasize. In the Lai

vided over what are the limits to the taire market vision, nature becomes land.
earth's capacity, but markets have no way Then land itselt is left out of the cal-
352 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

culation, with the assumption that it oriented regulations, such as tradable

is interchangeable with humanly cre- permits for discharges, will achieve en-
ated capital. Life becomes labor, or ab- vironmental goals efficiently The 1990
stract labor-power, and patrimony be- Clean Air Act revisions introduce such
comes capital. All values are reduced to tradable permits, and the Chicago Board
prices. Time is not concrete history, in- of Trade now plans a futures market
corporating natural biological processes, in pollution permits. There are numer-
but rather an infinite series of equiva- ous objections: such trade legitimates pol-
lent seconds. Places with distinctive fea- lution, it is likely to disadvantage the
tures disappear into an interchangeable poor and powerless (especially if con-
abstract space. By contrast, ecology re- ducted on an international scale), regu-
minds us that we live in a concrete world, latory regimes are already fairly flexible,
and that we often end up committing and markets in such permits may be hard
real, not just intellectual, violence upon to establish and inefficient. The only ev-
nature, humanity, and history. idence for efficiency so far comes from
econometric studies already biased to-
wards market solutions. Depending on
HOW DO WE DEAL the prices of permits or the level of taxes
WITH MARKETS? imposed, polluters could decide it was
So what do we do with markets? First, still cheaper to pollute.

we must put them in their place, and Even more important, a focus on
that place is secondary to considerations finding these market solutions diverts us
of social values. The fundamental flaws from the main point. Nearly all these
in the market, from the environmental regulatory regimes represent attempts
perspective alone, are enough to undo to control emissions, but as ecologist
economists' claims for marketplace su- Barry Commoner argues in his book
periority. The market needs be sub-
to Making Peace with the Planet, regulatory
ordinated not only to nature but also to efforts have at best slowed only slightly
broader human values that form a limit- the rate of environmental deterioration.
ing framework. That requires greater in- The environmental successes have
real
ternational cooperation. (This is already only come with outright bans of certain
happening to a small extent with bans substances, such as lead in gasoline or
on whaling and the ivory trade and in- paint. Instead of quibbling over how
ternational agreements on reducing chlo- much toxic substance can be released,
rofluorocarbons.) But ironically it also re- regulation should increasingly establish
quires granting nations and communities a standard of zero discharge. '"The tax [on
power to enforce stronger standards to pollutants] can't work until you've done
respond to their own local needs without the wrong thing," Commoner says. "You
having those undermined in the name of can't have a market in pollutant rights
free trade. until you have pollutants." The solution
Some environmentalists (including the is prevention.
Environmental Defense Fund and a But prevention can't always be out-
group convened under senators Tim right banning: for the foreseeable fu-
Wirth and the late John Heinz called ture, at least some hydrocarbons will be
Project 88) have argued that market- burned. In many cases, transitions to zero
 NO David Moberg/ 353

discharge may take time. During that ifenergy taxes are going to work most ef-
period, using tradable permits or other fectively,it should not be simply through

market-oriented methods should be con- the indirect effect of higher prices but also
sidered along with flexible regulation. through the investment of the new rev-
But rather than a panacea, such devices enue in efficiency and alternatives.
represent an interesting gimmick of un-
proven value.

Green consumerism and protest already

WHAT FORCES WILL WORK BEST? have had some impact. McDonald's, re-
There is increased interest in energy or sponding to a campaign against its styro-
carbon taxes to discourage fossil-fuel use
foam clamshell, has switched packaging
and give and is considering composting of its food
better signals on the true costs
wastes. Other businesses sense a good
of burning hydrocarbons, especially non-
market, although many are as duplici-
renewable sources. Eliminating subsidies
tous as Mobil Chemical, whose repre-
to dangerous or polluting sources, such
sentative said its "biodegradable" plastic
as nuclear power, would also give more
appropriate prices.
trash bags "are not an answer to landfill
crowding or littering Degradability is
It's obvious that energy is

and consequently misused, but relying

mispriced
just a marketing tool —
We're talking out
of both sides of our mouths because we
on taxes to bring about a change through
the market is likely to create great hard-
want to sell bags." Green consumerism is
an important phenomenon but is likely to
ship for low-to-middle-income people
remain marginal without other reinforc-
and increase inequality. Ideally, a transi-
ing measures.
tion would not greatly increase energy
bills but would increase energy prices There must first be clear public pol-
steadily in tandem with changes to alter- icy. A mixture of direct government ac-
native, renewable energy sources, a dif- tions (purchases, subsidies, prohibitions,

ferentmix of technologies, and greater research, and technical assistance) can be

energy efficiency. If the government de- combined with changed market incen-
veloped a strategy for transition to an es- tives (for example, taxes and markets in

sentially solar economy, then regular in- efficiency) in ways that complement each

creases in energy taxes could be used for other. Public policy,however, should de-
a variety of projects, including research. termine the direction.
Federal, state, and local governments can The disastrous effects of centralized
have a tremendous impact: government government control in the communist
purchases of solar cells or hydrogen- or countries should remain a reminder that
electric-powered cars could speed the government is no guarantee of virtue.
learning curve and cut prices quickly. Clearly government in the United States
Public investment would be needed to and elsewhea has often been the captive
develop mass transit and railroads. A Of Corporate interests. Environmental val-
full-scale industrial extension service to ues, like other values, must he cultivated
promote energy efficiency and non pol- among the electorate it public poll
luting technologies could speed indus- going tochange. In the long run, altering
trial transitions with less disruption. But COnomk man" outlook of market
354 / 18. SHOULD POLLUTION BE PUT TO THE MARKET TEST?

society will make environmental goals health and safety committees in every
easier to attain. workplace, protects everyone else.
Much of the progress toward envi- Environmental values lead to a model
ronmental sanity in the United States of society that subordinates the market
has come as a result of grass-roots to nature, but environmentalists cannot
protest, environmental impact fights, claim nature as their model any more
and legal action over local issues. Of- than the free marketeers can call their
—
ten dismissed as NIMBYism not-in- model "natural." No model of society
my-backyard —these movements are of- is natural; all are historical, cultural
ten concerned about other backyards as creations. And nature itself has forever
well. Even now the grass-roots protesters been altered by human culture.
among environmentalists exert pressure A new model of society can aspire
on the bigger, established environmental to respect natureand to make culture
groups that are entrapped in the rulemak- and nature as compatible as possible.
ing squabbles of federal legislation and The implications of the environmental
tempted to form alliances with big corpo- critique go beyond traditional ecologi-
rations (at times havingan influence, yet cal issues. Many similar critiques of the
also subtly losing their independence). market can be made on behalf of other
Besides guaranteeing a free and full cultural values. The market, for exam-
role for citizen protest, which big corpo- ple, does not take into account the exter-
rations especially want to eliminate, it is nalities of human poverty and inequal-
important that workers have broad pow- ity, economic dislocation, stunted work

ers to influence the safety and health of lives, and destruction of community. It
their work environment. Like the prover- gives the wrong price signals, the wrong
bial canaries in coal mines of the past, information. In taming the market to pro-
they are the first victims of pollution tect nature, we should not forget the well-
and toxicity. Giving them powers to pro- being of those most curious natural crea-
tect themselves, with mandated worker tures —ourselves.
POSTSCRIPT
Should Pollution Be Put to
the Market Test?

For the past 25 years a massive effort has been put forth in the United States
to advance environmental protection by using laws and regulation. Efforts
can be traced back to the 1970 National Environmental Policy Act (NEPA),
the first modern environmental statute that required environmental impact
statements on federal projects. That same year, Congress also passed the
Clean Air Act, which replaced a weak environmental statute with enforceable,
federal clean-air standards and timetables for industry to meet. Seven years
later, the Clean Water Act (1977) was passed. This act established standards

and permits, and it attempted to limit discharges in navigable waters and

protect wetlands from exploration.
At first, federal action was directed toward air- and water-pollution control;
this was accomplished by issuing regulations and permits. The second set of
initiatives focused on cleaning up hazardous waste dumps. This action was
first authorized by the Resource Conservation and Recovery Act (RCRA)

of 1976, which established a permit system for disposal sites and regulated
underground storage tanks. Later initiatives in this area were authorized by
the Comprehensive Environmental Response, Compensation, and Liability
Act (CERCLA) of 1980. This act, known as the Superfund, created a fund to
finance the clean-up of hazardous waste sites.
What is significant is that, until recently, efforts to control, contain, and
eliminate pollution and its effects have been accomplished largely by gov-
ernment regulation. Economists such as Blinder have argued for policies that
captured and utilized the strength of the market. However; as Moberg so ef-
fectively argues, the opposition has been successful in warning public policy
away from a free-market perspective that would allow "the private owner to
kill the goose that lays the golden egg" and in the process deny society "a

perpetual stream of golden eggs."

For a review of the legislation in the air pollution area, see Richard H.
Schulze, "The 20- Year History of the Evolution of Air Pollution Control leg-
I

islation in the U.S.A.," Atmospheric Environment (March L993). For a dis<

sion of some of the ethical issues Surrounding the pollution permits* see Paul
Steichmeier, "The Morality of Pollution Permits," Environmental Ethics (Sum-
mer 1993). And for other economic interpretations see Dwight R. ee, "AnI

Economist's Perspective on Air Pollution," Environmental Science and Tech-

nology (October 1993) and Joe Alper; "Protecting the Environment with the
Power of the Market," Science (June 25, 1993).

355
ISSUE 19
Has the North American Free Trade
Agreement Been a Success?
YES: Paul Krugman, from "How Is NAFTA Doing?" The New Democrat
(May /June 1996)
NO: Sarah Anderson, John Cavanagh, and David Ranney, from "NAFTA:
Trinational Fiasco/' The Nation (July 15, 1996)

ISSUE SUMMARY
YES: Paul Krugman, professor of economics at Stanford University, believes
that assessment of the North American Free Trade Agreement (NAFTA)
should be based on what things would have been like without it, and on
this basis NAFTA has been a success.

NO: Sarah Anderson, fellow at the Institute for Policy Studies, John Ca-
vanagh, codirector of the Institute for Policy Studies, and David Ranney,
professor of urban planning at the University of Illinois, Chicago, argue that
evidence is accumulating that NAFTA is not in the best interests of most of
the people in Canada, Mexico, and the United States.

The North American Free Trade Agreement (NAFTA) was signed into law in
fall 1993. The passage of NAFTA was no simple matter. Although the basic

agreement was negotiated by the Republican Bush administration, the Demo-

cratic Clinton administration faced the challenge of convincing Congress and
the American people that NAFTA would work to the benefit of the United
States as well as Mexico. In meeting this challenge President Bill Clinton did
not hesitate to use a bit of drama to press the case for NAFTA. He gath-
ered together the former U.S. presidents (Bush, Reagan, Carter, Ford, and
Nixon) and had them speak out in support of NAFTA. The public debate
probably reached its zenith with a face-to-face confrontation between Ross
Perot, perhaps the most visible and most outspoken opponent of NAFTA,
and Vice President Al Gore on the Larry King Live television show. The vote
on NAFTA in the House of Representatives reflected the sharpness of the
debate; it passed by only a slim margin.
In pressing the case for NAFTA, proponents in the United States raised two
major points. The first point was economic: NAFTA would produce real eco-
nomic benefits, including increased employment in the United States and in-
creased productivity. The second point was political: NAFTA would support
the political and economic reforms being made in Mexico and promote further

356
 —

progress in these two domains. These reforms had made Mexico a "better"
neighbor; that is, Mexico had taken steps to become more like the United
States, and NAFTA would support further change. In fighting NAFTA, U.S.
opponents countered both of these points. They argued that freer trade be-
tween the United States and Mexico would mean a loss of American jobs
Ross Perot's "giant sucking sound" was the transfer of work and jobs from
the United States to Mexico. Opponents also argued that NAFTA did not
do enough to protect the environment or to improve working conditions in
Mexico. They felt that the notion of passing NAFTA as a reward to the Mex-
ican government was premature; the government had not done enough to
improve economic and political conditions in Mexico.
Implementation of NAFTA began in 1994. But events in Mexico during
1994 and 1995 took an interesting series of twists. By December 1994 the
Mexican economy faced a balance of payments crisis, and the peso began to
depreciate. In order to prevent a collapse of the Mexican economy, President
Clinton organized a $50-billion multilateral assistance effort that included $20
billion of U.S. credit. The Mexican government also took action, including cuts
in government spending and increases in interest rates. The net result of these
events was a deep recession in the Mexican economy with a contraction of 7
percent during the first three quarters of 1995.
In assessing the impact of NAFTA, there are any number of different per-
spectives that can be employed. Should the focus be economic, political, or
both? Should the evaluation concentrate on the benefits and costs to the
United States, to Mexico, or both countries? How much of the history that
follows NAFTA can be attributed to NAFTA and how much can be attributed
to other factors? When is the appropriate time for an evaluation? In short,
evaluation is no easy task.
Some of the difficulties of evaluation are captured in the following se-
lections. Both were published at approximately the same time: three years
after the passage of NAFTA and some two-and-one-half years after its im-
plementation. In arguing that NAFTA should be considered a success, Paul
Krugman is less concerned with the economic consequences of NAFTA. He
believes that any realistic assessment of the economic benefits of NAFTA for
the U.S. economy would have admitted that these benefits would be marginal
at best. He believes that an assessment of NAFTA must concentrate, there-
fore, on its foreign policy implications. On these grounds, Krugman believes
NAFTA is a success. Sarah Anderson, John Cavanagh, and David Ranney are
more concerned with the economic implications of NAFTA and its impact
on people. While not a total failure, they believe that NAFTA led to a series
of economic problems, including Mexico's economic collapse and economic
inequality in the United States, Mexico, and Canada.

357
 Paul Krugman
YES

HOW IS NAFTA DOING?

More than two years ago, the United States, Canada, and Mexico entered into
the North American Free Trade Agreement. Debate over the pact was marked
both by extravagant promises about its benefits and by blood-curdling warn-
ings about its costs. Now that some time has passed, it's fair to ask, "How is
NAFTA doing?"
To many, the answer is obvious: Haven't events in Mexico economic —
crisis, political unrest, the revelation of scandals —given the lie to NAFTA's
supporters? But that visceral reaction misses the point. Whether we like what
we see in Mexico or not, the place isn't going away. There are 100 million
people right next door, with whom we must live one way or another. The
right question to ask about NAFTA is not whether conditions in Mexico and
our relations with it are all that we wish they were, but rather whether they
are better under NAFTA than they would have been without it. And despite
recent troubles, the clear answer is yes. Indeed, the real value of the new U.S.-
Mexican relationship is best seen in adversity: Mexico is coping with its latest
crises better than almost anyone would have imagined in the pre-NAFTA era.
NAFTA's defenders are saddled with a big public relations problem: The
agreement was sold under false pretenses. Over the protests of most econo-
mists, the Clinton Administration chose to promote NAFTA as a job-creation
program. Based on little more than guesswork, a few economists argued that
NAFTA would boost our trade surplus with Mexico, and thus produce a net
gain in jobs. With utterly spurious precision, the Administration settled on the
figure of 200,000 jobs created —and this became the core of the pro-NAFTA
sales pitch.
The overall number of U.S. jobs, however, was never going to be noticeably
affected by swings in our trade balance with Mexico. Our economy employs
more than 120 million workers; it has added more than 8 million jobs since
1992. Job growth has slowed since 1994, but not because those 200,000 export-
related jobs failed to materialize (the real culprit is the Federal Reserve's
interest rate policies).

From Paul Krugman, "How Is NAFTA Doing?" The New Democrat (May/June 1996), pp. 18-21.
Copyright © 1996 by the Democratic Leadership Council. Reprinted by permission.

358
 —
YES Paul Krugman / 359

If job creation isn't the point of NAFTA, tried to build political stability on the
what is?Another possible justification basis of one-party rule and economic
is the classic economic argument that development on the basis of a protected
free trade will raise U.S productivity and market and a powerful state sector.
hence living standards. Few economists, Eventually, it became clear that other
however, thought the pact would yield developing countries' market-oriented,
large gains of this type. Mexico's econ- export-driven economies were leaving
omy is simply too small to provide Amer- Mexico in the dust. It also became
ica with the opportunity for major gains clear that serious economic reform could
from trade. Typical estimates of the long- take place only along with a serious
term benefits to the U.S. economy from democratization.
NAFTA are for an increase in real income The international debt crisis of the
on the order of 0.1 percent to 0.2 percent. 1980s, which wreaked havoc with the
So, where's the payoff from NAFTA Mexican economy, had the paradoxical
for America? In foreign not eco-
policy, effect of opening up the possibility for
nomics: NAFTA reinforces the process of real change. During the crisis, the Mexi-
economic and political reform in Mexico. can ruling party turned to technocrats
most of them U.S.-educated, and many
of them possessing a strong sense of the
MEXICAN REFORM: MYTHS AND
REALITIES
virtues of U.S. institutions — to solve the
country's predicament. Salinas turned
As vast sums of money flowed into Mex- out to have been less than a whole-
ico in the early 1990s, it became chic to hearted reformer. Still, he brought into
talk about the "Mexican miracle." The power a group that was astonishingly
country was lauded for its economic re- honest, pro-market, and pro-democracy
forms; President Carlos Salinas became by any previous Mexican standards.
a business celebrity. But when enduring And the technocrats produced real
weaknesses in Mexico's political and eco- reform. Mexico's markets are far more
nomic systems manifested themselves in open to U.S. exports than they have boon
—
1994 the peasant uprising in Chiapas, since the early years of this century;
the assassination of presidential candi- many of the most wasteful and inefficient
date Luis Donaldo Colosio — the same in- public enterprises have been privatized;
vestors who had been
euphoric about a new economic base has emerged
Mexico a few months earlier panicked. in the north, far from the inefficiency
They were shocked —shocked! — to dis- and corruption of Mexico City. Much
cover that Mexico, after all, isn't a com- has changed on the political front, too:
bination of Switzerland and Singapore. Mexico's elections are freer and taircr
And they began pulling their money out than ever before.
as fast as they had poured it in. Mexico may not be Canada, but it is I
All of this could have been avoided far better neighbor now than it has been
if people had taken a realistic view of in living memory. Even more important,
events in Mexico. By the early 1 a reformist Mexico led by pro-American
the political and economic models that technocrats is tar preferable to the radical,

had ruled the nation for 50 years anti-American nation we will surely face
had reached a dead end. Mexico had if the reformers tail. Clearly, it is m our
360 / 19. HAS THE NORTH AMERICAN FREE TRADE AGREEMENT BEEN A SUCCESS?

interest to help the Mexican reformers or subsidized tend to be more visible

succeed. than the growth of new industries for
This is the context forjudging the deci- at least several years. Chile did not
sion to go ahead with NAFTA. The agree- begin to show a dramatic payoff to its
ment was a Mexican idea —proposed by market reforms until the mid-1980s, a
Salinas to lock in the reforms he had be- decade after those reforms began; Eastern
gun and to build confidence about Mex- European nations like Poland and the
ico's future as a liberalized economy. Czech Republic, which escaped Soviet
How could we have refused? Rejecting rule in 1989, are only now beginning to
Salinas's proposal would have been a achieve solid growth. And the massive
devastating slap in the face for the re- inflow of capital to Mexico between
formers, who would have been taunted 1990 and 1994 in some ways actually
with the way that America rewards its delayed the economy's transformation.
friends. By leading to a severely overvalued
Sensible NAFTA supporters had no peso, it slowed the emergence of new

illusions about Mexico. It is still a country —

manufacturing exports the engine of
with corrupt political bosses, tycoons long-term economic growth.
whose fortunes are built on bribery, Investors were too caught up in the
backward rural areas whose populations investment boom to realize it was pre-
are virtually disenfranchised, and urban mature. Finally, their confidence began
pockets of luxury ringed by slums. But to falter in 1994 as Mexican politics and
it is less like that than before. Mexico's policies began to waver. The uprising in
hope to become a better place and our Chiapas posed no real threat to the gov-
hope to have a better neighbor depend ernment, but it was a reminder both of
on continued reform. the vast, persistent inequities in Mexican
society and of the limited progress made
toward democracy. The assassination of
CRISIS AND RESCUE Colosio, which remains something of a
By early 1993, economists had begun mystery, deprived the country of a much-
to warn about the risks of a Mexican needed leader and raised further doubts
financialcrisis. They were concerned about stability. Also, during the run-up
about the dissonance between the wild to the 1994 election, the Mexican govern-
optimism of investors, who were pouring ment backslid on its record of responsi-
money into Mexico at the rate of ble monetary and fiscal policies, printing
about $30 billion a year, and the still and spending more money than it should
disappointing performance of the real have in an effort to buy votes.
Mexican economy, which was not yet The result was the crisis of Decem-
delivering substantial improvements in ber, in which a loss of confidence by in-
living standards for ordinary families. vestors forced a devaluation of the peso.
The failure of Mexican reforms to By itself, the speculation against the peso
generate immediate rapid growth should need not have been a catastrophe. Af-
not have been a big surprise. Economic ter all, currency crises are a common oc-
reform is usually a painful process; currence in the world of international fi-
the dislocations that are caused when nance. In fact, since 1990 major currency
old industries are no longer protected crises have forced devaluations not only
 YES Paul Krugman/ 361

in Mexico but in Britain, Finland, Ireland, that investing there will be highly prof-
Italy,Spain, and Sweden. The difficulties itable unless there is huge fall in
a further
were increased when Mexico's devalua- the peso. And no good economic
there is

tion was bungled, owing to missteps by a reason to expect such a fall: Mexican ex-
few officials (who were soon dismissed). ports are booming, the trade deficit has
They delayed the inevitable too long, car- been eliminated, by any normal calcula-
ried out the devaluation half-heartedly, tion the peso is undervalued. Investors,
and managed in general to convey a sense however, fear that the rule of the eco-
of both arrogance and incompetence that nomic reformers in Mexico is in danger;
further decreased confidence. Nonethe- that to put money into Mexico is to risk
less, this too is fairly standard when there losing it when there is a nationalist back-
is a currency and Mexico's han-
crisis, lash against the whole pro-market, pro-
dling of the situation was no worse than U.S. policy direction of the last decade. To
that in many other countries. induce them to keep their funds in Mex-
The reason that Mexico's crisis soon ico despite such fears, the government
ballooned to really dangerous propor- has been forced to keep interest rates very
tions was that financial markets, which high.
had been excessively euphoric about Why might there be a backlash? The
Mexico in the previous few years, over- biggest reason is the severe slump in the
reacted in the opposite direction when Mexican economy —a slump due mainly
the country hit a rough patch. This finan- to high interest rates.
cial panic threatened to become a self- In short, investors are in effect saying,
fulfilling crisis of confidence in the whole "I won't invest in Mexico unless I am
process of reform. offered a very high rate of return. need I

In simplified outline, this is what that high rate of return to compensate

happened: As investors grew worried me for the risks of a nationalist reaction,
about Mexico during the second half of which may be sparked by the need to
1994, the country began running out of provide investors like me with such a
foreign exchange reserves. To maintain high rate of return." It is a classic
the peso's value, the government would of self-fulfilling pessimism.
have had to raise interest rates sharply, What can be done? The best answer is
which would have pushed the faltering to ride out the storm. In time, the vicious
economy into a recession. Instead, the circle should become a virtuous circle.
government let the peso fall. Investors, After all, at current interest rates, invest-
in turn, became so disillusioned that ing in Mexico is an extremely profitable

they withdrew all their money from proposition unless you tear either hyper-
Mexico, sending the peso into a freefall. inflation or expropriation. It time passes
To keep the currency from collapsing, and these risks don't materialize, peo-
which would have triggered explosive ple will become more willing to invest
inflation, the Mexican government raised in Mexico. This will allow interest rates
interest rates after all — indeed, to very to fall, which will produce .\n economic
high levels. recovery, which will further reduce the
At this point, a vicious circle devel- perceived risks, and 90 on
oped. For more than a year, interest rates rhe great risk m 1995 w as that the Mex-
in Mexico have been very high so high — ican reformers would not he able to ride
362 / 19. HAS THE NORTH AMERICAN FREE TRADE AGREEMENT BEEN A SUCCESS?

out the storm —that the financial markets' but if it does, the likely victors will not be
self-fulfillingpessimism would destroy anti-market populists but pro-marketeers
their credibility before there was any who will continue the process of reform.
chance to turn things around. It is in this Mexico's political center is holding.
light that one must understand the $50 Meanwhile, it is beginning to look as
billion rescue package put together by the if the virtuous circle Mexico's rescuers

United States and other advanced coun- hoped for is materializing. Mexico's
tries. We extended Mexico a large line of interest rates have dropped and its
credit to buy the reformers some time. stocks have risen in recent months,
The rescue attempt must be evaluated and local economists are starting to
in terms of the alternatives. Should we talk about a fairly brisk short-term
have simply stood aside? This almost cer- economic recovery. Furthermore, with
tainly would have doomed the Mexican private capital returning, Mexico has
reformers. If this had happened, it's a started to pay back its emergency loans. It
safe bet that Republican Sen. Al D' Amato, now looks very likely that whatever else
who held hearings to grill Administra- may happen, the American taxpayer will
tion officials over the decision to grant get his or her money back.
President Ernesto Zedillo's government The recovery is still more a prospect
would have instead held
a line of credit, than a reality, and things could still go
hearings demanding to know, "Who lost very wrong. In particular, if U.S. politics
Mexico?" turn protectionist and isolationist, it is

Like the U.S. decision to go ahead hard to see how either Mexican recovery
with NAFTA in the first place, the rescue or Mexican reform can survive. But for
package was less an economic measure now, at least, things are looking up.
than a foreign policy move. Anyone who Will this short-term stabilization prove
thinks it put too much taxpayer money to be the beginning of a new period
at risk should try to make a realistic of sustained growth? Has Mexico really
estimate of the cost of policing a 2,000- turned a corner, or is this just the latest
mile border with a hostile and angry in a series of crises? Nobody knows. But
neighbor. Even though the rescue plan this is the wrong question to ask. One
was not guaranteed to succeed, it is cannot repeat it too often: Mexico cannot be
hard to see how the United States could wished away. We cannot wall it off behind
responsibly have done anything else. an electrified fence and then forget about
it. The important question for the United

States is not whether we like everything

THE CURRENT PROSPECTS
we see south of the border. It is whether
The most important development in our interests would have been better
Mexico this past year is what has not served by the radicalized Mexico we
happened. The ruling party has not aban- would have faced if we had rejected
doned its course of economic and polit- NAFTA or denied it a financial lifeline
icalreform. Nor is there a serious chal- last year —or by the struggling, troubled,
lenge to the legitimacy of the govern- but still reforming nation we actually
ment, either from armed peasants or pop- have to deal with. By that test, NAFTA
ulist politicians. The ruling party may and the rescue that followed have been
well lose the next presidential election, wise, successful policies.
WO Sarah Anderson, John Cavanagh,
and David Ranney

NAFTA: TRINATIONAL FIASCO

One issue you can be sure that [1996 presidential candidates] Bob Dole and Bill
Clinton will not disagree on is free trade. Both men were strong advocates of
the North American Free Trade Agreement, which went into effect in January
1994. The peoples North America have now lived with the agreement for
of
[more than] 900 days and, contrary to the promises of Dole, Clinton and their
advisers, NAFTA has turned out to be a losing proposition for all but the
Fortune 500.
Rather than increasing by the hundreds of thousands, as promised, jobs
have been disappearing in all three countries; those jobs that remain pay less
with fewer benefits. The U.S.-Mexico border, already a development debacle
when NAFTA was signed, is mired even deeper in health and environmental
nightmares. Mexico's highly touted middle class has been slammed back into
poverty. In Canada, one of the world's finest social welfare systems is under
siege. Many more promises on funding, immigration, agriculture and other
issues did not materialize. The leaders of the three NAFTA countries rarely
mention the trade pact, fearing, perhaps, that they will remind voters of their
exaggerated claims for it and how much needless misery it has produced.
Several dozen researchers and activists from all three countries have re-
cently completed a series of comprehensive studies on NAFTA that debunk
the prevailing myths. We focus here on five of the most prevalent ones. But
first a caveat: We do not argue that NAFTA caused Mexico's latest economic

collapse, nor did it create the growing inequality in all three nations, nor
most of the other problems outlined below. NAFTA did, however, make them
worse. In economic terms, NAFTA eased the movement of goods and invest-
ment among the three countries; it sped up the free-trade model that !

corporations have been pushing tor decades. NAFTA codifies an economic

ideology that glorifies the market, that demoni/es and defunds government
and that regards human beings as little more than customers in a ontmental ,

shopping mall.

From Sarah Anderson, John Cavanagh, tnd Pa\ td Ranney "NAFTA: [Link] Rasav" The
Nation Quly 15, 1996). Copyrig Reprinted by permission.

363
364 / 19. HAS THE NORTH AMERICAN FREE TRADE AGREEMENT BEEN A SUCCESS?

In previous crises, Mexico saved scarce

MYTH #1: NAFTA HAD NOTHING foreign exchange by using controls to
TO DO WITH THE RECENT exclude non-essential imports. But un-
MEXICAN CRISIS
der NAFTA, this is no longer allowed,
The evidence of Mexico's economic fail- even during emergencies. The agreement
ure, which burst into public view on the also prohibits restrictions on foreign-
eve of Christmas in 1994, is so over- exchange transactions without special
whelming that even the Clinton Adminis- permission. Finally, under NAFTA's
tration doesn't deny it. What it says is that "rules of origin" provisions, Mexico can-
the fault with poor economic man-
lies not impose requirements that could chan-
agement by the Mexican government. Al- nel foreign investment into productive
though NAFTA proponents claim that endeavors and away from speculation.
the crisis has postponed many of the ben-
efits they predicted would emerge from
the agreement, they argue that Mexico is MYTH #2: INCREASED EXPORTS
continuing on the right free-trade track WILL LEAD TO MORE JOBS
and that things would be much worse in
the absence of NAFTA. In fact, NAFTA President Clinton boasted that NAFTA
merely formalized and extended policies had created some 340,000 U.S. jobs. But
the President's claim is based on an
that were first imposed upon the coun-
try by the International Monetary Fund
erroneous formula that asserts that every
in 1982 in response to Mexico's massive
$1 billion in new exports creates another
15,000 to 20,000 jobs. The formula is
foreign debt. These policies, popularly
flawed, in part because it considers only
known as structural adjustment, repre-
exports and doesn't subtract jobs lost
sent an approach to economic develop-
ment that requires slashing government when the United States imports goods
that used to be produced here. Although
expenditures and opening the country
U.S. exports to Mexico have grown
to foreign goods, services and capital
without government regulation; in four some since NAFTA went into effect,

words: Trade more, spend less. the Administration's own numbers show
In Mexico's case and for many other
that imports from Mexico have gone
countries suffering structural adjust-
through the roof; a U.S. trade surplus of

ment, the effect of everyone exporting $1.7 billion in 1993 spiraled downward
more drives prices down and makes ser- into a deficit of $15.4 billion by 1995.
Hence, by the Administration's formula,
vicing the debt even harder. Meanwhile,
during the NAFTA negotiations, the In-
many more U.S. jobs have been destroyed
ternational Monetary Fund and World by NAFTA than have been created.
Bank pressured the Mexican government The Administration admits that 75,000
to ease trade and investment barriers U.S. workers have been thrown out
even further. As a result, foreign capi- on the street as a result of the free-
tal is increasingly coming in the form trade agreement. These figures are from
of speculative portfolio investment, or the NAFTA Transitional Adjustment
"hot money," which requires high inter- Assistance program, which provides
est rates that discourage productive in- retraining and other aid to U.S. workers
vestment. who lose their jobs as a result of a shift
 NO Anderson, Cavanagh, and Ranney / 365

in production toMexico or Canada, or of signed in 1988. Between 1988 and 1994,

increased imports from those nations. Canada lost 17 percent of its manufactur-
The surge in Mexican exports to the ing jobs, and unemployment rose from
United States should, in theory, have 7.5 percent in1989 to just under 10 per-
created many new jobs in Mexico. cent in 1995. A study by the Canadian
Indeed, Mexico's plummeting peso has Centre for Policy Alternatives shows that
drastically lowered labor costs for global companies that lobbied hard for the free-
companies operating there, and several trade pacts have been the biggest job
hundred thousand new maquiladora slashers. Thirty-seven firms belonging to
jobs have been spawned on the border. a pro-NAFTA business association have
However, this increase has been dwarfed cut more than 215,000 jobs since 1988.
by the 1.4 million to 2 million jobs
that vanished during NAFTA's first
two years, as record numbers of small
MYTH #3: INCREASES IN
and medium-sized businesses lost the
PRODUCTIVITY WILL BE SPREAD
battle with high interest rates and filed
TO WORKERS
for bankruptcy. NAFTA proponents had In lobbying for the free-trade agree-
claimed that the agreement would so ment, the corporate group USA*NAFTA
improve the Mexican economy that claimed that "NAFTA itself will improve
pressures to migrate to the United working conditions by generating eco-
States would greatly subside. In fact, nomic growth, which will enable all
displaced workers and peasants swelled three countries to provide more jobs with
the number of Mexicans apprehended in higher pay in a better working environ-
attempted border crossings by a dramatic ment." To the contrary, NAFTA has given
43 percent from 1994 to 1995. corporations increased power to drive
And there is an even deeper flaw in the down wages and working conditions.
NAFTA jobs argument. Even if a country The most direct method is through
does have a trade surplus, it is faulty "whipsaw bargaining," or threatening to
to assume that corporations always use shift production to Mexico unless work-
profits generated by exports to create ers agree to concessions. Xerox used this
new jobs. Many successful exporting technique effectively in Webster, New
companies have instead chosen to use York, where workers agreed to reduce the
these profits to finance mergers or invest base pay rate by 50 percent for new em-
in labor-saving machinery, which can ployees and cut workers' compensation
lead to job cuts. Firms like Zenith, Xerox, in exchange for job guarantees through
Caterpillar and Allied Signal are major the year 2001. The Webster workers had
exporters from the United States, yet all reason to take the company's relocation
of them have eliminated thousands of threats seriously, since Xerox had recently
U.S. jobs. A study of Illinois's top export moved jobs south of the border from
industries showed they were laying off and Massachusetts.
plants in Illinois
workers at a higher rate than other Another common corporate tact ;>

industries. use the argument that increased inter-

In Canada, an equally alarming job national competition under NAFTA re-
hemorrhage dates back to the Canada- quires greater "flexibility" through hiring
U.S. Free Trade Agreement, which was more workers on a part-time or tempo-
366 / 19. HAS THE NORTH AMERICAN FREE TRADE AGREEMENT BEEN A SUCCESS?

rary basis. Corporate-backed lawmakers heads of state throughout the world, in-
are using the same argument to push an- cluding Clinton, Ernesto Zedillo in Mex-
tiworker legislation, such as the efforts ico and Jean Chretien in Canada. The
to strip away the government's power benefits of such enhanced competitive-
and safety regulations;
to enforce health ness, however, have turned out more of-
outlaw union shops and unions' use of ten than not to be a mirage, as the evi-
corporate campaigns; legalize company dence presented above indicates. But the
unions; and abolish overtime pay. tragedy of NAFTA and free trade runs
Thus, while corporations experience deeper than lost jobs and falling wages. A
productivity growth, workers are not key element of the drive for international
sharing in the benefits. In all three competitiveness has been an assault on
NAFTA countries, increases in real wages government.
are lagging far behind increases in Nation readers are familiar with the at-
wages
productivity. In Mexico, real as of tack on social programs and federal reg-
May 1996 were 35 percent below their ulations in the United States. In Canada,
pre-1994-crisis levels. In Canada, as in the cuts in unemployment insurance reduced
United States,real wages are stagnating the number of unemployed Canadians
and the proportion of full-time workers who qualify for benefits from 87 percent
living in poverty continues to grow. in 1989 to 49 percent in 1994; this will fall
In response to NAFTA's critics, the to 33 percent when the latest round of
Clinton Administration negotiated a la- cuts is implemented.
fully
bor side agreement, but it contains a In Mexico, NAFTA has worsened con-
narrow definition of worker rights and ditions engendered by twelve previ-
is weighted down with an enormously ous years of austerity. These measures
complex, time-consuming and bureau- have been particularly devastating for
cratic dispute resolution mechanism. Not rural Mexicans. A requirement for en-
surprisingly, to date, complaints about try into the agreement was the removal
violations of worker rights have been of subsidies for family farmers, who
filed at only four plants (three in Mex- also face drastic cuts in available credit
ico and one in the United States). Not and public services in areas such as
a single worker involved in these com- veterinary medicine, agricultural exten-
plaints has benefited so far from the pro- sion and public health. In December
cess. However, through tremendous per- 1995, Mexico's Institute of Social Security,
sistence, unions and other groups have which oversees health care and social se-
been able to use the agreement to draw curity for salaried workers, was shifted
more attention to the general problem of from public to private administration and
worker rights violations. funding.

MYTH #4: INCREASED MYTH #5: GROWTH FROM FREE

INTERNATIONAL TRADE WILL HELP CLEAN UP
COMPETITIVENESS WILL THE ENVIRONMENT
BENEFIT ALL
NAFTA supporters promised that the
"We must be internationally competi- trade agreement would mean increased
tive." This is the mantra now parroted by investment in environmental cleanup
 —
NO Anderson, Cavanagh, and Ranney / 367

and a decline in the concentration of was supposed to insure high levels of en-
maquiladoras along the already heavily vironmental protection and foster pub-
polluted U.S.-Mexico border. But as lic discussion. Yet the C.E.C. has re.

Public Citizen has documented, the only four petitions, three of which it has
increase in industrial activity in the rejected. It has also been asked to inves-
border zone has not been met by any tigate the mysterious mass death of birds
appreciable improvement in the disposal in a reservoir in Guanajuato, Mexico.
of industrial wastes or expansion of
health care facilities. Many communities
still lack access to both water and NAFTA has not, however, been a total
sewage systems. Today, only 10 percent of failure. Its most salutary effect was to cat-
Mexico's yearly output of 7 million tons alyze new coalitions that crossed borders
of hazardous waste receives adequate and political party lines, and embraced
treatment, with the rest poured into constituencies as diverse as workers,
clandestine waste dumps or municipal farmers, environmentalists, consumers
sewers. and one
religious groups. Unfortunately,
Nor are NAFTA's environmental would scarcely knowfrom press ac-
this
threats confined to the U.S.-Mexico counts. With its blinkered focus on of-
border. Standards established through ficialdom, the press gave credence only
the struggles of environmental groups to critics on the right. Hence, coverage
throughout each of the countries can now of NAFTA opposition focused on Pat
be challenged as "nontariff trade barri- Buchanan, who, although correctly cri-
ers/' Groups trying to protect these stan- tiquing the agreement, presented a racist,
dards will have to justify them according "America First" solution that called for
to the principles of "risk assessment" sealing U.S. borders to goods, capital and
the notion that health risks incurred be- people from other countries.
cause of lower standards must be great The progressive opposition to NAFTA,
enough to justify the cost of restrictions on the other hand, has rejected the pro-
on trade. Rather than the highest possible cess, politics and policies of the pro-
standards for a healthy environment, risk NAFTA forces. Opponents attacked the
assessment leads to standards that pose process because NAFTA was negotiated
on businesses.
the lowest restrictions secretly, without a hearing from ordinary
As with labor, the Clinton Adminis- citizens; opponents advocated a transpar-
tration used the handy device of a side ent process that would bring all parties
agreement to gain support of some en- to the table. They condemned the poli-
vironmental groups during the NAFTA tics because NAFTA's passage revealed
fight. A number of them —
dubbed "the how legislators' votes are often sold to the
—
shameful seven" acquiesced. Yet the in- highest bidder in a system corrupted In-

stitutions set up under NAFTA have corporate money. And on the policy level,
made little progress in addressing envi- they rejected thederegulatorv framework
ronmental concerns. The North Ameri- of NAFTA and the new protections tot

can Development Bank has yet to fund a corporations.

single cleanup project. Widely perceived The mam progressive citi/en networks
as ineffectual, the North American Com- in the \.\1 l.\ countries proposed alter-

mission for Environmental Cooperation native policies that would protect worker
368 / 19. HAS THE NORTH AMERICAN FREE TRADE AGREEMENT BEEN A SUCCESS?

rights, advance environmental standards In Mexico, a similar array of citi-

and food security, and promote sustain- zen groups, represented by the Mexi-
able energy and agriculture. This ap- can Action Network on Free Trade, has
proach was summed up in a document worked with others to draft a twelve-
titled "A Just and Sustainable Trade and point "Liberty Referendum," which out-
Development Initiative for the Western lines a national alternative to the gov-
Hemisphere" by the key networks in all ernment's neoliberal policies. At polling
three countries that fought NAFTA. places around the country, half a mil-
These groups continue to fight for lion Mexicans signed their approval by
better economic alternatives. The Action November 1995.
Canada Network, which includes a
broad array of social forces from the NAFTA has unleashed a major war
Canadian Labor Congress to cultural and in all three countries overour economic
indigenous movements, has helped forge future. While the pro-NAFTA forces won
an "Alternative Federal Budget" aimed at the opening battle, evidence continues to
creating jobs through public investment build that the agreement is not in the
and halting the dismantling of social interest of the vast majority of people
programs. in any of the three countries. And in
In the United States, the Alliance for their silence over trade issues, candidates
Responsible Trade, the Citizens Trade Clinton and Dole are acknowledging that
Campaign and many other groups from they face even more difficult battles in
the economic and environmental jus- new arenas: the trade deficit with China,
tice movements continue to monitor NAFTA expansion to other countries and
NAFTA's impact and promote bi- and tri- proposals to enhance the powers of the
national alternatives. World Trade Organization.
POSTSCRIPT
Has the North American Free Trade
Agreement Been a Success?
Krugman begins his assessment of NAFTA by identifying the perspective that
he uses to evaluate it: are things better with NAFTA than they would have
been without it? He states that the answer to this question should not involve
a comparison of current reality with the exaggerated economic claims made
on behalf of NAFTA by the Clinton administration when it sought support for
the legislation. Rather, Krugman believesthat the payoff to NAFTA involved
foreign policy In this regard, NAFTA should be considered a success because
it reinforced the process of Mexican economic
and political reform. According
to Krugman, without NAFTA Mexico would have turned away from reform
to radicalization.
Anderson, Cavanagh, and Ranney begin with an overview of their position
on NAFTA: it did not create all the economic problems facing the United

States, Mexico, and Canada, but it did exacerbate a number of them. To

support their position, they concentrate on debunking five myths. They assert
that NAFTA did contribute to the recent Mexican crisis; it has led to the loss
of some 75,000 jobs in the United States; it has given business firms more
control over wages and working conditions; it has facilitated attacks on social
and economic programs designed to help workers; and it has not improved
environmental conditions.
For a taste of the debate before the passage of NAFTA, both pro and con,
see NAFTA: An Assessment, rev. ed., by Gary Clyde Hufbauer and Jeffery J.
Schott (Institute for International Economics, 1993); "Grasping the Benefits
of NAFTA," by Peter Morici, Current History (February 1993); "The North
American Free Trade Agreement," Economic fay art of the President 1993; "The
High Cost of NAFTA," by Timothy Koechlin and Mehrene Larudee, Challenge
(September/October 1992); and "The NAFTA Illusion" by Jeff Faux, Challenge
(July/ August 1993). On the issue of the relationship between NAFTA and the
collapse of the Mexican peso, see "The Giant Sucking Sound: Did NAFTA
Devour the Mexican Peso?" by Christopher J. Neely, Review, Federal Re-
Bank of St. Louis (July/August 1996). For the Clinton administration's views
on the effects of NAFTA, see the 1996 and 1997 issues of Economic Report of the
President. For a more complete assessment of the negative position presented
by Anderson, Cavanagh, and Ranney, see their edited volume NA1
Two Years: The Myths and the Realities (Institute for Policy Stud
"NAFTA Shock," by James Cypher, Dollars and Sense (March/ April 1995) and
"Mexico," by Nora Lustig, The Brookings Review (Spring W96).

369
CONTRIBUTORS
TO THIS VOLUME

EDITORS
THOMAS R. SWARTZ was born in Philadelphia in 1937. He received a
B.A. from LaSalle University in 1960, an M.A. from Ohio University in 1962,
and a Ph.D. from Indiana University in 1965. He is currently a professor of
economics at the University of Notre Dame in Indiana and the director of the
Notre Dame Center for Economic Education. He writes in the areas of urban
finance and economic education and has collaborated with Frank J. Bonello
on a number of works, including Urban Finance Under Siege (M. E. Sharpe,
1993). In addition to Taking Sides, they have coedited Alternative Decisions
in Economic Policy (Notre Dame Press, 1978) and The Supply Side: Debating
Current Economic Policies (The Dushkin Publishing Group, 1983). Dr. Swartz
is also the coeditor, with John E. Peck, of The Changing Face of Fiscal Federalism

(M. E. Sharpe, 1990).

FRANK J. BONELLO was bom in Detroit in 1939. He received a B.S. in

1961 and an M.A. in 1963 from the University of Detroit and a Ph.D. in 1968
from Michigan State University. He is currently an associate professor of
economics and the Arts and Letters College Fellow at the University of Notre
Dame in Indiana. He writes in the areas of monetary economics and economic
education, and in addition to those publications he has coedited with Thomas
R. Swartz, he is the author of The Formulation of Expected Interest Rates and
the coauthor, with William I. Davisson, of Computer-Assisted Instruction in
Economic Education: A Case Study (University of Notre Dame Press, 1976).

STAFF

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David Brackley Developmental Editor
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Juliana Arbo Typesetting Supervisor
Diane Barker Proofreader
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370
 CONTRIBUTORS/ 371

AUTHORS GARY BURTLESS is a senior fellow in

the Brookings economic studies program.
He is coauthor,with Martin N. Baily and
ROBERT ALMEDER is a professor of
Robert E. Litan, of Growth With Equity:
philosophy Georgia State University
at
Economic Policymaking for the Next Century
and a member of the editorial board of
(Brookings, 1993).
the Journal of Business Ethics. He earned
his Ph.D. in philosophy at the University JOHN CAVANAGH is codirector of the
of Pennsylvania and is the coeditor of Institute for Policy Studies in Washington
Business Ethics (Prometheus Press, 1987). D.C
SARAH ANDERSON is a fellow at the THOMAS V. CHEMA is an attorney
Institute for Policy Studies in Washing- practicing in Cleveland, Ohio. He was ex-
ton, D.C. ecutive director of the Gateway Develop-
ment Corporation of Greater Cleveland,
RICHARD P. APPELBAUM is a profes- a development agency.
sor in and the chair of the Department
of Sociology at the University of Califor- COUNCIL OF ECONOMIC ADVIS-
nia, Santa Barbara. He is the author of ERS was established by the provisions
Karl Marx (Sage Publications, 1988) and of the Employment Act of 1946 and the
the coauthor, with John I. Gilderbloom, Full Employment and Balanced Growth
of Rethinking Rental Housing (Temple Uni- Act of 1978 to advise the president on
versity Press, 1988). the current economic status of the United
States.
ROBERT A. BAADE is in the Depart-
ment of Economics and Business at Lake CHARLES CRAYPO is a professor of

Forest College in Illinois. at Notre Dame University

economics in
Indiana.
DEAN BAKER is an economist at the

Economic Policy Institute in Washington, PAUL M. ELLWOOD JR. is president of

D.C The Jackson Hole Group in Teton Village,

Wyoming.
ROBERT M. BALL served as commis-
sioner of Social Security between 1967
MILTON FRIEDMAN is a senior re-
search fellow at the Stanford University
and 1973. He was a member of the 1994-
1996 Advisory Council on Social Security. Hoover Institution on War, Revolution,
and Peace. He received the 1976 Nobel
ALAN S. BLINDER is the Gordon Prize in economic science for his work in
S. Rentschler Memorial Professor of consumption analysis and monetary His-
Economics at Princeton University. He tory and theory and for demonstration of
formerly served as vice chairman of stabilization policy complexity. He and
the Federal Reserve Board and as a his wife, who also writes on economic
member of President Clinton's Council topics, are coauthors of several publica-
of Economic Advisers. tions,including Tyranny of the Statu
(Haicourt Brace Jovanovkh, \-
MICHAEL J. BOSKIN is the T. M. Fried-
man Professor of Economics at Stanford JAMES K. GALBRA11H a [

University in Stanford, California. of economics at the LBJ School oi Public

372 /CONTRIBUTORS

Affairs at the University of Texas at 1987) and The Life of the Party: Democratic
Austin. Prospects in 1988 (Penguin, 1988).

DAVID E GREENBERG is a professor in LESTER B. LAVE is a James H. Higgins

the Department of Sociology at New York Professor of Economics at Carnegie Mel-
University in New York City lon University in Pittsburgh, Pennsylva-
nia, with appointments in the Graduate
WILLIAM GREIDER is the national af- School of Industrial Administration, the
fairs editor for Rolling Stone. He is the au- School of Urban and Public Affairs, and
thor of Who Will Tell the People: The Be- the Department of Engineering and Pub-
trayal of American Democracy (Touchstone lic Policy. He received a Ph.D. in eco-
Books, 1993). nomics from Harvard University and was
a senior fellow at the Brookings Institu-
ARTHUR L. KELLERMANN is a pro-
tion from 1978 to 1982.
fessor in the Departments of Internal
Medicine, Preventive Medicine, and Bio- GEORGE D. LUNDBERG is the editor
statistics and Epidemiology at the Uni- of the Journal of the American Medical
versity of Tennessee in Memphis, Ten- Association.
nessee.
JOHN H. McARTHUR is a professor at
MICHAEL KINSLEY is a senior editor Harvard Business School in Cambridge,
for the New and the author of
Republic Massachusetts.
the weekly New column "TRB
Republic
MATTHEW MILLER is the economics
from Washington," which also appears in editor at the New Republic.
the Washington Post, the Los Angeles Times,
and the Guardian of London. He has been DAVID MOBERG is the senior editor of
the managing editor of the Washington In These Times.

Monthly and a columnist for the Wall FRANCIS D. MOORE is in the Depart-
Street Journal. His publications include ment of Surgery at Brigham and Women's
Curse of the Giant Muffins and Other
Hospital and at Harvard Medical School
Washington Maladies (Summit Books, in Boston, Massachusetts.
1987).
DANIEL D. POLSBY is the Kirkland
PAUL KRUGMAN is a professor of eco- and Ellis Professor of Law
at North-
nomics at Stanford University in Stan- western University in Evanston, Illinois.
ford, [Link] publications include He has also held academic positions
The Age of Diminished Expectations: U.S. at Cornell University, the University of
Economic Policy in the 1990s (MIT Press, Michigan, and the University of South-
1990) and Pop Internationalism (MIT Press, ern California. He has published numer-
1996). ous articles on a number of subjects re-
lated to law, including employment law,
ROBERT KUTTNER is a contributing
voting rights, broadcast regulation, and
editor for the New Republic, and he writes
weapons policy.
on social and political subjects. His pub-
lications include The Economic Illusion: DAVID RANNEY is a professor of urban
False Choices Between Prosperity and Social planning at the University of Illinois,

Justice (University of Pennsylvania Press, Chicago.

 CONTRIBUTORS/ 373

ROBERT RECTOR is the senior policy ests includeozone depletion and energy
analyst for welfare and family issues at and waste management technologies and
the Heritage Foundation in Washington, policies.
D.C. This is a public policy research
and education institute whose programs JOSEPH STIGLITZ is senior vice pres-
are intended to apply a conservative ident and World
chief economist at the

philosophy to current policy questions. Bank in Washington, D.C. He is currently

on leave from Stanford University, where
MARTIN A. REGALIA is vice president he is the Joan Kennedy Professor of Eco-
for economic policy at the U.S. Chamber nomics. He previously taught economics
of Commerce. Prior to that he was at Princeton University.
director of economics and research for
the Savingsand Community Bankers of LESTER THUROW is a professor in
America and a principal analyst in the the Sloan School of Management at the
Congressional Budget Office. Massachusetts Institute of Technology in
Cambridge, Massachusetts. He received
FELIX G. ROHATYN is the U.S. ambas-
M.A. degrees from Balliol College and
sador to France and a former partner in
Harvard University in 1960 and 1964,
an investment firm in New York City.
respectively, and he received a Ph.D.
ROBERT RUBIN is secretary of the from Harvard University in 1964. He is

U.S. Department of the Treasury. He the author of Poverty and Discrimination

previously served as assistant to the (Brookings Institution, 1969), for which
president for economic policy, directing he won the David A. Wells Prize from
the National Economic Council. Harvard University, and of Generating
Inequality: Vie Distributional Medianisms
THOMAS RUSTICI was a graduate
of the Economy (Basic Books, 1975).
student in economics at the Center for
the Study of Market Processes at George
WILLIAM TUCKER, a writer and social
Mason University, Fairfax, Virginia, when critic, is a staff writer for Forbes magazine.
he wrote this paper. An earlier version
His publications include TJie Excluded
of was awarded the 1984 Excellence in
it
Americans: Homelessness and Housing Poli-
Liberty Prize by the Institute for Humane
cies (Regnery Gateway, 1989), which is
Studies.
the winner of the 1991 Mencken Award
SYLVESTER J. SCHIEBER is vice pres- for best nonfiction, and Zoning, Rait Con-
ident and director with Watson Wyatt trol, and Affordable Housing (Cato Institute,
Worldwide, an economic consulting com- 1991).
pany. He was a member of the 1994-1996
Advisory Council on Social Security.
MICHAEL WISEMAN is a professor
of urban and regional planning at the
CYNTHIA POLLOCK SHEA is a senior University of Wisconsin-Madison and
researcher with the Worldwatch Institute, a visiting scholar at the Russell Sage
a research organization with an inter- Foundation.
disciplinary approach to global environ-
mental problem solving. She is a coau- EDWIN W. ZEDLEWSKI is a staff

thor of the Worldwatch Institute's State of economist for the U.S. Department of
the World publication. Her principal inter- Justice's National Institute of Justice.
 INDEX
accountability, managed health care and, 98-105 Cavanagh, John, on the success of North
Aid to Families with Dependent Children (AFDC), American Free Trade Agreement (NAFTA),
92, 252, 253, 256, 258, 262, 263, 269, 273, 275 363-368
alcohol abuse, domestic violence and, 30-35 Chema, Thomas V., on city subsidies for sports
Almeder, Robert, on social responsibility of and sports venues, 40-43; reaction to views of,
business, 10-18 44-^9
amendments, to the U.S. Constitution, and chlorofluorocarbons (CFCs), and controversy over
controversy over balanced budget, 208-216. global warming, 314-331
See also Second Amendment cities, controversy over benefits of professional
Anderson, Sarah, on the success of North sports teams to, 40-49
American Free Trade Agreement (NAFTA), Clean Air Act, 342, 352
363-368 climate change, and controversy over global
Appelbaum, Richard P., on rent controls causing warming, 314-331
homelessness, 87-94 Clinton, Bill, 100, 144, 178, 201, 227, 239, 242,

automation, 59-60 266, 268, 271, 272, 273, 301, 363, 364, 366,
367
Baade, Robert A., on city subsidies for sports and commercial culture, managed health care and,
sports venues, 44-49; reaction to views of, 106-112
40-43 community service, 122, 259-260
baby boomers, Social Security and, 163, 185 comparative advantage, 55, 289, 291
background check, for gun ownership, Brady Bill competition: economic growth and, 149-150, 152;
and, 23 environmental issues and, 350-351 managed ;

Baker, Dean, on the Consumer Price Index, care and, 98-105; NAIRU and, 236-240
198-203 computers, chlorofluorocarbons and, 318-319
balanced budget, 152, 241; controversy over Congressional Budget Office, 100, 210, 216, 227,
Constitutional amendment for, 208-216 275
Ball,Robert M., on Social Security, 162-172 Constitution, U.S., 23, See also balanced budget
banks, central, free trade and, 301-302 amendment
Bearden v. Georgia, 122-123 Consumer Price Index (CPI), 163, 165, 225,
Becker, Gary, 116-117 229-230; controversy over, 192-203
benefits, reduction in nonwage, minimum wage corporate responsibility, economic growth and,
and, 55, 57-59 155-156
bias, controversy over Consumer Price Index and, cost of living adjustment, 164, 194
192-203 cost-benefit analysis, of prison, controversy over,
Blinder, Alan S., 229; on pollution and markets, 116-138
336-344 Council of Economic Advisers, 235; on economic
Boskin, Michael J., 198, 225; on the Consumer growth, 144-151
Price Index, 192-197 Craypo, Charles, on abolishing the minimum
Brady Bill, 22, 23 wage, 65-74
bromine, 319, 322 crime: and controversy over gun control, 22-35;
bubble concept, emissions trading and, 341-343 and controversy over prisons, 116-138
Buchanan, Pat, 153, 310
Bureau of Labor Statistics, 192, 194, 196, 198, 201 debt, federal budget, and controversy over a
Burtless, Gary, on free trade, 304-310 balanced budget amendment to the U.S.
Bush, George, 127-128, 152, 213, 214, 265-266, Constitution, 208-216; structuralism and, 247
268 defined-benefit plan, Social Security as, 169,
182-186
capital substitution effects, minimum wage and, demographics, NAIRU and, 236-240
55, 59-60 deterrence, prison and, 120, 125, 135
capitalism, 8, 18, 346 discretionary payment, Social Security as, 166
carbon, greenhouse effect and, 325, 329 diversion of funds, managed health care and, 108
Card, David, 70, 71 247 , Dole, Robert, 363, 368
Carter, Jimmy, 229, 241, 263, 285-286 domestic violence, gun ownership and, 30-35

374
 I MUX 7 375

drug abuse, domestic violence and, 30-35 growth, controversy over economic, 144-157
gun control, controversy over, 22-35
Earned Income Tax Credit, 72, 269
education: economic growth and, 146-147, 155;
halons. 319. 322
minimum wage and, 72-73; welfare and, 259;
handguns. See gun control
work and, 309 Consumer Price Index and. 201-202;
health care:
efficiency argument, environmental issues and,
and controversy over managed care. 98-112
337-338
homelessness, controversy over rent control and.
economic growth and, 144, 150-151
efficiency,
78-94
Ellwood, Paul M., Jr., on managed health care,
housing regulations, controversy over
98-105
homelessness and, 78-94
emissions trading, controversy over environmental
human capital: economic growth and. 144,
issues and, 336-354
145-148; minimum wage and. 55, 61
employment effects, of the minimum wage, 54, 57
employment, NAFTA and, 364-365
hysteresis, NAIRU and, 237-238

enforcement argument, environmental issues and,

338-339 and controversy over
illegitimacy, reduction of.
entitlement program: Aid to Families with Wisconsin's welfare program. 252-276
Dependent Children as, 252, 272-273; Social income inequality, free trade and. 304-310
Security as, 164-167, 182 independent practice associations (IPAs), versus
environmental issues, and controversy over global managed health care, 99, 102
warming, 296-310, 314-331; and controversy Individual Accounts, Social Security and. 168-170,
over market issues, 336-354; NAFTA and, 179, 184, 185, 186
366-367 inflation, Federal Reserve Board and, 224-226.
expenditure-weighted index, Consumer Price See also NAIRU
Index as, 200 investment spending: government spending as,
209-210; structuralism and, 246
Fair Labor Standards Act, 55, 56, 65-66, 68 invisible hand, Smith's theory of, 12-14
Family Support Act of 1987, 253, 267, 269
Federal Reserve System, 167-168, 203, 241, 242,
Japan, trade and, 282-283, 284-285, 291,
243, 244, 358; controversy over, 220-229
fee-for-service medicine, versus managed care,
299-300
controversy over, 98-112 Job Opportunities and Basic Skills, 267, 269, 270.
fines, versus prison, 122-123, 125 273
fish, phytoplankton and, 317-318 juvenile justice system, 121-122

food stamps, 164, 262, 264-265, 269, 270, 272,

273, 276 Kellermann, Arthur, L. 24-25; on private ownership
401 (k) pension plans, 169, 179 of guns, 30-35
Free Trade Area of the Americas, 150 Kemp, Jack, 87, 227
freedom of speech, loss of, managed health care Keynes. John Maynard, 282. 283. 297. See also
and, 109 New Keynesian economic theory
Friedman, Milton, 236, 241; on social responsibility Kinsley, Michael, on protecting domestic industries
of business, 4-9; reaction to views of, 10-18 from foreign competition, 289-292
futility theorem, gun control and, 26-27
Krueger. Alan. 70. 71,247
Krugman, Paul, 228, 229; on the success of North
Galbraith, Jameson NAIRU (nonaccelerating
K.,
American Free Trade Agreement (NAFTA),
unemployment), 241-248
inflation rate of
358-362
General Agreement on Tariffs and Trade (GATT),
Kuttner, Robert, 68; on protecting domestic
284, 299, 300
industries from foreign competition, 282-288;
Gingrich, Newt, 201, 270
reaction to views of, 289-292
global warming, controversy over, 296-310,
314-331
Great Depression, 65, 68, 221 labor substitution effects, minimum wage and. 55.
Greenberg, David R, on more prisons as the 59
answer to America's rising crime rate, 127-138 Lave, Lester B., on global warming. 3.

greenhouse effect. 315, 322, 324-331 Learnfare. in the Wisconsin welfare program. 254
Greenspan, Alan, 203. 221, 226. 227. 229, 230 Lindbeck. Assa. 82-83
Greider, William, on free trade, 296-303 lower-level substitution bias, Consumer Price
Gross Domestic Product (GDP). 209, 213, 228 Index and. 193, 195. 199
376 /INDEX

Lundberg, George D., on managed health care, North American Free Trade Agreement (NAFTA),
98-105 150, 301, 304; controversy over, 358-368

macroeconomic issues: and controversy over Old Age, Survivors and Disability Insurance
balanced budget amendment, 208-216; and (OASDI), 173-187
controversy over Consumer Price Index, 71-72
oligopolies,
192-203; and controversy over economic Omnibus Budget Reconciliation Act of 1993, 210,
growth, 144-157; and controversy over Federal 213
Reserve System, 220-229; and controversy opportunity costs, of city subsidies of professional
over NAIRU, 234-248; and controversy over sports, 43
Social Security, 162-187; and controversy over Organization for Economic Cooperation and
Wisconsin's welfare program, 252-276 Development (OECD), 221, 298
Maintenance of Benefits program, Social Security ownership, private, and controversy over gun
and, 177-178, 179, 182, 184-185 control, 22-35
managed care, controversy over, 98-112 ozone, decline of atmospheric, and controversy
market basket, Consumer Price Index and, over global warming, 314-331
195-196
market process, distortion of, minimum wage and,
Pay for Performance, in the Wisconsin welfare
55, 61-62
program, 256, 259, 261, 267
markets, and controversy over environmental
Perot, Ross, 304, 310
issues, 336-354
Personal Responsibility and Work Opportunity
McArthur, John H., on managed health care,
Reconciliation Act, 262, 272-273, 274
106-112
Personal Security Accounts (PSAs), Social
Medicaid, 100, 145, 153, 175, 256, 263-264, 265,
Security and, 170-172, 179, 180-181, 182,
276
185, 186
Medicare, 98, 99, 101-102, 145, 153, 162, 164,
personnel, downgrading of, managed health care
170, 175, 176, 177, 178, 179, 201, 215
and, 108-109
methane, 315, 326
person-weighted index, Consumer Price Index as,
Mexico, and controversy over NAFTA, 358-368
201
microeconomic issues: and controversy over city
Phillips curve, 235, 238-239
subsidies for professional sports teams, 40-49;
physical capital, economic growth and, 144, 145
and controversy over gun control, 22-35; and
phytoplankton, fish and, 317-318
controversy over managed health care, 97-112;
Polsby, Daniel D., on private ownership of guns,
and controversy over minimum wage, 54-74;
and controversy over prisons, 116-138; and 22-29
poverty: environmental issues and, 296-303;
controversy over rent control, 78-94; and
controversy over social responsibility of
homelessness and, 87, 92; welfare and, 261,
business, 4-18 265, 275-276
prison, controversy over crime and, 116-138
Miller, Matthew, on the Federal Reserve as the
private ownership, of guns, controversy over,
cause of poor macroeconomic performance,
227-230 22-35
minimum wage, 247; controversy over, 54-74; free privatization, partial, of Social Security, 167-172
trade and, 302-303, 310 probation, versus prison, 123-124, 132-133, 134

Moberg, David, on pollution and markets, 345-354 NAFTA and, 365-366; NAIRU and,
productivity:

monopoly, managed health care and, 110 236-240; wages and, 222, 223, 230
Montreal Protocol, and controversy over global professional culture, managed health care and,
warming, 314-331 106-112
Moore, Francis D., on managed health care, professional sports teams, controversy over
106-112 benefits of, to cities, 40-49
Multi-Fiber Arrangement, 286, 287, 291-292 profits,versus social responsibility, controversy
Muskie, Edmund, 336, 340 over business and, 4-18
proportionality of punishment, prison and, 121

NAIRU (nonaccelerating inflation rate of protection, handguns as personal, 30-35

unemployment), 228; controversy over, protectionism, U.S. trade and, 282-288

234-248 punishment, and controversy over prisons,
National Recovery Administration, 55, 56, 61 116-138
minimum wage and, 65-74
neoclassic economics,
New Keynesian economic theory, 242, 243 quality, managed health care and, 98-105
Nixon, Richard, 98, 99 quality bias, Consumer Price Index and, 199-200
 i\nrx/377

quality of life factors, Consumer Price Index and, sulfur dioxide, 336, 337
202 Supplemental Security Income (SSI). 162. 171,
262. 264. 265. 273. 275
racial discrimination in hiring, minimum wage and, supply-side economics, 227
55, 60-61 Supreme Court, 55, 66, 122. See also individual
Ranney, David, on the success of North American cases
Free Trade Agreement (NAFTA), 363-368
Reagan, Ronald, 78, 93, 94, 224, 228 Tate v. Short, 122
recession, 228, 253 Tax Reform Act of 1986, 93
Rector, Robert, on adopting Wisconsin's welfare taxes: economic growth and, 154; environmental,
reforms, 252-276 322-323, 348; free trade and. 298-299
Regalia, Martin A., on a balanced budget Technology and Literacy Challenge initiative. 147
amendment 208-216
to the U.S. Constitution, technology, structuralism and, 246
regulation, environmental issues and, 350-351 Temporary Assistance for Needy Families
rent control, controversy over homelessness and, program, 262-263, 270, 273. 274-275. 276
78-94 textile industry, free trade and, 286-287
research and development (R & D), economic Thompson, Tommy, and controversy over
growth and, 148-149, 152 Wisconsin's welfare program. 252-276
restitution, versus prison, 122 Thrift Savings Plan. 167. 168
Ricardo, David, 282, 289 Thurow, Lester, 229-230. 290; on the Federal
riskavoidance, managed health care and, 108 Reserve as the cause of poor macroeconomic
Rohatyn, Felix G., 230; on economic growth, performance, 220-226
152-157 trade, free: controversy over, 282-292. 296-310;
Roosevelt, Franklin Delano, 55, 65, 186 environmental issues and. 314-331. 336-354;
Rottenberg, Simon, 56, 62 and controversy over NAFTA, 358-368
Rubin, Robert, on a balanced budget amendment trigger price mechanism, 285
to the U.S. Constitution, 213-216 Tucker, William, 87, 89. 90-92; on rent controls
rule utilitarianism, 13 causing homelessness, 78-86
Rustici, Thomas, on abolishing the minimum wage,
54-64; reaction to views of, 65-74 atmospheric ozone and,
ultraviolet radiation,
316-317
Schieber, Sylvester J., on Social Security, 173-187 unemployment compensation, 211
sea level, rise in, greenhouse effect on, 328 unemployment effects, of the minimum wage, 54.
Second Amendment, to the U.S. Constitution, 23, 55-57
29 unemployment, Federal Reserve Board and,
selective incapacitation, 120-122 221-222. See also NAIRU
Self-SufficiencyFirst, in the Wisconsin welfare unions, labor, 71-72, 224, 247
program, 255, 256, 259, 261, 267, 273 unskilled workers, free trade and. 305-309
Shea, Cynthia Pollock, on global warming, upper-level substitution bias, Consumer Price
314-331 Index and, 193, 195, 199
single-room occupancy hotels, 83-84 urban renewal, 84
Smith, Adam, 7, 11, 13,289 utilitarianism rule, 13
social costs, of crime, 116-120 utopianism, rent control and, 85-86
social responsibility: versus profits, controversy
over business and, 4-18; of medicine, 110 victims, of crime. 119. 121, 123. 129
Social Security, 72, 145, 153, 198, 200, 215, 273; violence, and controversy over gun control. 22-35
controversy over, 162-187
sports teams, controversy over benefits of wage aspiration effect, 236-237
professional, to cities, 40-49 wages: Federal Reserve Board and. 222-225,
standards, in managed health care, 111 230; free trade and, 300-301. 302-303
Stigler, George, 54, 62 waiting period, for gun ownership. Brady Bill and.
Stiglitz, Joseph, on NAIRU (nonaccelerating 23
inflation rate of unemployment). 234-240 Wal-Mart effect, Consumer Price Index and. 199
structuralism, 246-248 welfare, controversy over Wisconsin's program of.
subsidies, to professional sports teams, 252-276
controversy over cities and, 40-^49 West Coast Hotel v. Parrish, 55
substitution effects, Consumer Price Index and, Williams. Walter. 59. 60
193, 195, 199 Wisconsin, controversy over welfare reforms in.

suicide, guns and, 34 252-276

378 /INDEX

Wiseman, Michael, on adopting Wisconsin's World Bank, 301

welfare reforms, 262-276 World Trade Organization (WTO), 150, 300, 368
Women, Infants, and Children program, 262
Work and Responsibility Act, 268, 269 Zedillo, Ernesto, 362, 366
work, as requirement in Wisconsin's welfare Zedlewski, Edwin W., on more prisons as the
program, controversy over, 252-276 answer to America's rising crime rate, 116-126;
Work Not Welfare, in the Wisconsin welfare reaction to views of, 127-138
program, 255-256, 266-277 zoning laws, homelessness and, 84-85
working poor, 87
 Taking Sides: Clashing Views on Controversial Economic Issues, 8th edition, is a
debate-style reader designed to introduce students to controversies in economics.
The readings, which represent the arguments of leading economists and commen-
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For each issue, the editors provide a concise introduction and postscript
summary. The introduction sets the stage for the debate as it is argued in the "yes"
and "no" readings, and the postscript briefly reviews the opposing views and
suggests additional readings on the controversial issue under discussion.
By requiring students to analyze opposing viewpoints and reach considered
judgments, Taking Sides actively develops students' critical thinking skills. It is this
development of critical thinking skills that is the ultimate purpose of each of the
volumes in the widely acclaimed Taking Sides program.

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