possible to assist the committee in reaching its conclusions, and to present the basis of our experience over the past year and a half or so dealing with the stabilization program.

This morning, Mr. Chairman, I would like to concentrate primarily, since Secretary Shultz has summarized our recommendations, on two general parts of the testimony.

The first has to do with the background and reasons for the present state of inflation in this economy and in other countries, so that the committee may have it clearly in mind, and second, to briefly review the program and the consequences of the program on wage and price stabilization.

I will be referring from time to time, Mr. Chairman, to the text by page and to the appendixes by page as well.

Now, let me start then with the year 1973. It was, as I set forth starting on pages 2 and 3, a year of surprises. It was a most unusual year in economic terms. Inflation was worldwide. Domestic prices were also influenced by the change in the exchange rates affecting our country.

We had an inflation of which two-thirds was concentrated in food and energy. The profile of inflation was quite different than in other periods and it seems to me that this year showed us as never before the importance of drawing a distinction between measures to constrain prices or wages and measures designed to increase supply and increase capacity.

Now, just to be a little more specific about those features of the

year.

As we know, wholesale prices increased 20.8 percent in the period January 1973 to January 1974. Consumer prices increased 9.4 percent in the same period.

One of the other features of the year, Mr. Chairman, that I think we should make clear to everyone, is that these price increases were the more disturbing because they were largely unforeseen and largely unexpected by all analysts regardless of their economic or political peruasion.

Both Government and private forecasters were projecting inflation rates of about 3 percent. If you will turn, Mr. Chairman, to the appendix on page A-1, I believe, you will see the list of all the outside authorities who made those forecasts.

So I am saying it wasn't the case of only the administration's economists being baffled or surprised, the whole forecasting profession was found to be in error when the year was done.

That is a disturbing fact about the year and, Mr. Chairman, it raises very serious questions about the capacity of people to foresee the future.

I quoted in the testimony, at page 4, Mr. Heller's statement that, "Economists are distinctly in a period of reexamination. The energy crisis caught us with our parameters down. The food crisis caught us, too. This was a year of infamy in inflation forecasting." So it applied to everyone in the forecasting business.

Now, this year also I think underscores

The CHAIRMAN. Dr. Dunlop, will you suspend a moment.

We must have better order and please give attention to the witness and help the Chair maintain order so we can proceed expeditiously.

30-463 O 74-2

Dr. DUNLOP. Thank you, Mr. Chairman.

I shall try to be reasonably brief but the subject is an important one. I share your concern, Mr. Chairman, about longer term programs and longer term thinking. I would like you to know that throughout the year, on every occasion that has been possible, I have sought to be interested in the longer term and in just this respect now I point out at page 5 in the testimony that the Government set up a committee to review this experience in the shortfall of forecasting to find out why that took place. From that committee we have had some reports which I think are very helpful to us and to others.

I might say, as I do on page 5, that the most important single source of the underestimation of 1973 was the failure adequately to relate the U.S. economy to the world economy, particularly when large agricultural stockpiles no longer served as a buffer to short supply situations.

It must be recognized, however, that some uncertainty in food price forecasting will always remain as a result of weather crop disease, and the like. But we have taken steps, Mr. Chairman, to improve our forecasting, to see better resources applied to this area, and I would propose that that kind of activity should, of course, be continued.

At the bottom of page 5 I point out that this is an international inflation in a way that perhaps was not fully realized in the early months of 1973. It was the result of very high economic activity in Japan and Western Europe.

I happen to think that the very rapid rise in output in the economy in 1973 here and elsewhere was itself an independent factor, making for inflationary developments. Other special factors such as weather reduced the output and stock of agricultural commodities and the devaluation of the dollar and its further decline in international markets in those early months accelerated the price inflation in primary commodities to an enormous magnitude, as we know.

The world commodity prices in dollars increased 46 percent for all items in the year ending January 2, 1974. Food prices rose 38.6 percent; fiber, 21 percent; metals, 86 percent. Those are world indexes.

Immediately the question comes to mind as you think about the problem of constraining inflation: what can a single economy do if it wants those products in international trade and those world prices are rising at that rate?

Finally, of course, in the year, the energy prices rose at the end of the year at very great rates and so we have a year with this high concentration in food and energy.

At page 7. Mr. Chairman, you will see, however, that these very large price increases, nonetheless, permitted the United States to show a relatively favorable picture as compared to other countries.

I recognize people get no satisfaction out of it directly but it is nonetheless true that the country showed a moderate rise in consumer prices as compared to other countries, if you will look at those figures and those bar charts on page 7.

Anyone who has traveled in the world in the last year will also know it from his own direct experience.

We find then that the year was an extraordinary one in the magni

tude of the changes in the rate of inflation, in the fact that it was unexpected, and in its high concentration in food and in energy.

I submit to you, Mr. Chairman, that the perspective of the year also renders ludicrous the often-repeated view of the early months of 1973 that inflation could be curbed if only the stick were to be taken from the closet and applied to inflationary sectors or if the rules were made more stringent. I think that history belies that oft-repeated earlier

view.

Now, in that context, Mr. Chairman. the question is how to have used controls to the maximum positive extent possible. We, I think, tried to do that and let me run through briefly the principles that we tried to follow.

We recognized at the outset and before I came to the program, Mr. Chairman, the Secretary and his associates recognized that we were going to have a difficult year; food, health, construction, and petroleum would require special attention, and through the year those areas were kept under very tight special control.

In other words, in a sense the inflation is the more remarkable in those areas since we had recognized early that they were going to be the source of inflation, and they were themselves the subject of very substantial and very firm regulation.

We, second, Mr. Chairman, sought to mobilize Government activity to encourage larger supply and greater capacity. Nowhere was that more important than in the agricultural area where a whole host of measures were taken: The addition of acreage, the increase of imports of cheese and nonfat dry milk, and the removal of import limitations on beef are all illustrations of a very wide range of supply actions which we took.

Then in the industrial area, Mr. Chairman, we pursued a policy of a constraint on profit margins. We provided after the midyear, that we would allow for only cost-justified price increases; that this bulge of raw commodity prices should be spread out by a prenotification system in which costs were to be offset by productivity measures.

We even had a number of cases in which we used our reserve powers to not permit enterprises to place in effect fully cost-justified price increases, as we did in steel and in rubber tires and in the automobile industry.

However, we had our eye on the supply situation, and there were some industries where it was necessary to provide larger price increases than were justified by their costs; for example, in areas like copper and in aluminum, in order to be sure that those raw materials did not leave the country and that we could keep them in competition in foreign markets.

In the end, you know that it was also very necessary to do the fertilizer industry where otherwise, if we had kept those controls on, we would have lost a great deal more of our domestic fertilizer to the world market.

So we followed those policies of balancing always, Mr. Chairman, the interest in constraining prices, on the one hand, with the necessity to secure supply, on the other; and that, I grant you, is a narrow line to walk in some cases. But at each point in the year we have had those goals firmly in mind.

Then we proceeded at the direction of the President to follow a policy of gradual decontrol, as Mr. Shultz has said. If you note on page 12 of my testimony, there is a list of the items we have gradually decontrolled, and you can add to this list that yesterday we decontrolled two more industries of a small nature: Certain instruments and jewelry and silverware.

So as of this point, Mr. Chairman, we have an economy where no more than about 28 percent of the Consumer Price Index is subject to our controls today. If you would like to put it this way, we have asked, as you know, that the areas of oil and health continue under controls. Those two together constitute about 9 percent of the CPI, a little more; and so we have, as we see it, something in the neighborhood of 18 percent to go, and most all of that is food, Mr. Chairman.

So, for practical purposes, on the CPI, only food remains under control, and those controls on food, as you know, Mr. Chairman, are essentially margin controls. The retailer's margins are limited, and the manufacturer's margins are limited.

What has happened, of course, is that those food prices have risen during the year, and declined in a number of cases for certain periods, as the prices of raw agricultural products have gone up and down. The controls have been controls on margins.

You will also note, Mr. Chairman, that about 35 or 36 percent of the labor force remain under wage controls. About 5 percent of that is construction; about another 11 percent is in the area of State and local government. So we have, as you see, been coming down in coverage quite a lot.

Now, although I am not sure of the extent of the committee's interest, I would like to say a word or two about the themes of wage stabilization during this year as distinct from those on the price side which I have just been over.

Mr. Chairman, I have on occasion sought to write down my views on this general subject, and with your permission, I would like to introduce separately into the record a statement of mine called "Fundamentals of Wage Stabilization" which attempts to put what I know about this subject after 35 years of experience in nine pages.

The CHAIRMAN. Without objection, it will be entered in the record. [The statement referred to by Dr. Dunlop follows:]

FUNDAMENTALS OF WAGE STABILIZATION

1. The stabilization of compensation needs to be closely linked with dispute settlement under collective bargaining. In this country the development of wage policy and its implementation in particular cases is not likely to be viable without the use of tripartite machinery. If a wage stabilization program does not enjoy substantial support, participation and acquiescence from labor and management organizations, each work stoppage runs the danger of becoming a strike or lockout against the stabilization program and the government. A viable wage stabilization program requires some arrangement and understanding with labor and management leaders.

The tripartite structure is essential to maintain continuing communications with labor and management, to gather and to analyze the facts on wages, salaries, benefits and other economic conditions, to secure a degree of acceptance of policies and decisions, to correct inevitable mistakes, and to secure constructive attention to both short-term and longer run collective bargaining problems confronting the parties. Moreover, the terms for any continuation of a wage stabilization program need to be reassessed periodically with labor and

management representatives, and their views as to the viability of any program deserve the most serious consideration.

2. Constructive and reinforcing relationships need to be established between the wage stabilization agency and the mediation and dispute settling agencies of the government. In the "guidepost" era of the 1960's the relations between Council of Economic Advisers and the mediation agencies have been characterized as often indifferent or hostile. While mediators and arbitrators are understandably more likely to be interested in agreement and settlement outside of wage stabilization standards than in strict compliance with stabilization rules, they are nonetheless concerned with final resolution of disputes rather than continued controversy over stabilization standards. In these circumstances it is possible and essential-to establish close liaison and working relations between stabilization authorities and mediators so that dispute resolution is more in line with acceptable stabilization limitations.

3. An effective stabilization program cannot be developed by limiting attention to large companies or to collective bargaining agreements covering a thousand or five thousand workers. This view reflects no understanding of the interrelationships among wages or settlements among agreements in the same industry or locality. The higher the level of employment, the tighter labor markets and the more distorted wage relationships have become from traditional patterns, the less valid is the attention exclusively to the large firm or settlement. In some industries such as construction, newspapers and food retailing small units may set patterns which significantly determine wage decisions in far larger groups. Union rivalries, and at times those of management or their associations, may produce settlements in small units which are decisive for a whole industry. Indeed, the process of leapfrogging, whipsawing and setting new and higher patterns involves careful attention to wage leaders and followers. Size is often not a decisive determinant of pattern setting, particularly for some items of compensation.

4. Inflationary periods are fundamentally characterized by distortions in traditional or emerging wage and benefit differentials that are perceived by some parties to be inequitable. One craft, occupation, company or industry is found to be markedly higher or lower compared to others to which it has been conventionally compared. The task of wage stabilization is to achieve new and more stable or maintainable wage relationships appropriate to the future state of the labor market or industrial relations. The concepts of "wage inequities" and "appropriate stabilized wage or benefit differentials" among occupations, localities and product markets are at the center of the analysis of the process of wage inflation, the formulation of policy prescriptions, the design of an information system respecting wages and benefits, as well as central to the operations of an administrative agency charged with stabilization responsibilities. Indeed, the definition and restoration (or establishment) of appropriate wage and benefit relationships over some period is the central business of wage stabilization.

At the outset of a wage inflation period, some wage rates and benefits move first and further and others lag. Some collective bargaining agreements are typically fixed in duration with specified increases for two, three or even five years. Other wage rates and benefits under agreements or in the unorganized sectors may be free to move sharply, thereby changing traditional or economically appropriate wage and benefit differentials. The inflationary period may be associated with sharp changes in employment in particular sectors or substantial improvements in current or prospective profits in particular enterprises or in living costs. These changes in wage determinants may result in new wage and benefit levels which become targets for related groups to meet or exceed when other wage decisions are to be made.

The course of the average wage for the economy depends on the way the whole complex of wage rates change. In a decentralized national wage system, particular decisions are made about individual wage rates and benefits or clusters or contours of each. No one makes decisions as to the general wage and benefit level. 5. The resort to a single number, guidance or formula is an unacceptable basis for wage stabilization. A number such as 3.2 percent or 5.5 percent does not constitute a wage policy.

(a) A single figure becomes a floor at which collective bargaining negotiations tend to start, and employees come to believe that they are at least entitled to that number by grant of the government. Union representatives who settle agreements at such a figure or lower are seen by workers not to have been very effective or not to have done their job well.