work regardless of the control structure on the rest of the economy. Now, that implies that the phase 4 controls for health providers would enable hospitals and other parts of the health industry to pass through the rising costs that result from their purchase of goods and services, and of wage and salary increases to keep up with the rest of the economy. Yet phase 4 would continue, so far as we have been led to believe, with the same controls that they have. There are very stringent controls on salaries and the ability to pass through prices.

Now, there are some other confusing statements that I will also note, Mr. Chairman, for the record. But I shall conclude merely by saying this: The number of misleading and confusing statements contained in Dr. Dunlop's March 6 testimony before this committee substantially increases the anxiety of hospitals about continued controls in the health sector, because these statements evidence misunderstanding and confusion about the economics of the health industry, the provisions of the phase 4 regulations themselves, and a basic confusion about the nature of inflation in the health industry. His testimony strengthens the conviction in the American Hospital Association that the Economic Stabilization Act not be extended. Thank you, Mr. Chairman.

Mr. GETTYS. Thank you, Mr. McMahon.
Would Dr. Gehrig care to comment?

. Dr. GEHRIG. No; I will not add anything to that, Mr. Chairman. Mr. GETTYS. Thank you very much. Your subsequent statement will be received by the committee for the record.

[The following supplemental statement of Mr. McMahon was received by the committee for inclusion in the record:]

ADDITIONAL COMMENTS OF JOHN ALEXANDER MCMAHON, PRESIDENT, AMERICAN HOSPITAL ASSOCIATION

My original statement before the House Committee on Banking and Currency was prepared prior to the submission of the March 6, 1974 statement of Dr. John T. Dunlop, Director of the Cost of Living Council. Since Dr. Dunlop expanded on the COLC's arguments for continuing economic stabilization controls in the health industry, I would like to present the American Hospital Association's rebuttal to these arguments.

MISLEADING STATEMENTS

The Dunlop testimony contained a substantial number of misleading statements which must be corrected for the record. While Dr. Dunlop is an excellent teacher, as his record at Harvard University indicates, he is not as good a student, for Í and others have failed over the past year to teach him how the health industry operates in the care of patients and what is and what is not "inflationary" in the health industry. This is the only conclusion one can draw from the following

statements:

1. After making reference to post-Medicare bulge in hospital costs and prices, Dr. Dunlop concluded, "During more than two years of controls, however, the health care inflation rate has decelerated . . . While these measures are not conclusive, they support the judgment that controls have constrained cost increases.'

Fact. As my original statement demonstrates, the rate increase in hospital costs and prices began to fall quite dramatically prior to August of 1971. The hospital industry had absorbed the increase in demand for institutional health care services resulting from the implementation of the Medicare and Medicaid programs in 1969 and 1970, and it had adjusted wage costs as a result of the minimum wage legislation of the mid-1960's. We know only one independent research effort to quantify the impact of the Economic Stabilization Program on hospitals. That study, although incomplete, has been unable to establish any

statistically significant effect of the Economic Stabilization Program on hospital costs and prices.

2. Dr. Dunlop believes that "Despite this relatively good record [during the control program], the bealth care industry with the dominant form of payment through third-party financing would unquestionably produce an unacceptable surge of inflation if controls were lifted at this time."

Fact. There may be, as I pointed out in Appendix A to my statement before the Committee, a bulge in hospital costs and prices in 1974, but this bulge will stem from the increases in the prices hospitals must pay for goods and services they purchase in the general economy which continues to operate at a high rate of inflation. Third-party financing is not the cause of this anticipated bulge. Moreover, this bulge will be less than that for the rest of the economy, because of the many other federal and state restraints on hospital costs and charges.

3. Dr. Dunlop argues, "This automatic reimbursement system [employed by Medicare-Medicaid, and many Blue Cross Plans] was a prime cause of the dramatic rise in health care costs following the implementation of Medicare and Medicaid."

Fact. No hospital economics study has ever concluded that the method of hospital payment has more than a marginal impact on hospital operating costs. The COLC's economic consultant to the Health Industry Advisory Committee, Martin O. Feldstein (an associate of Dr, Dunlop's at Harvard), has concluded that "Increasing demand has been identified as the primary reason for the unusually rapid rate of cost increase [during the post-Medicare period]. Rising income and more comprehensive insurance coverage, both private and public, have increased patients' willingness to pay for more and better hospital care."

4. Dr. Dunlop also argued that two years of experience with the Stabilization Program has not forced "hospitals to reduce the quality of care and eliminate necessary services."

Fact. Chart III in my statement, based on COLC's own data, demonstrated that there has been reduction in the rate of increase in the quantity of services provided to hospital patients. If hospital operating margins continue to fall, many hospitals may soon be forced to reduce existing services.

5. Dr. Dunlop asserts that "Health provider controls can work despite the presence [I assume he means "absence"] of controls on other sectors providing they are allowed to cover unavoidable cost increases."

Fact. Dr. Dunlop's statement implies that the Phase IV controls for health providers contain a provision for a pass-through of costs hospitals incur in purchasing goods and services.

There is no such provision in the Phase IV regulations with only one exception, for 85 percent of increased fuel cost, a very small portion of the hospitals operating budget; and certainly there is no provision for increased wages to hospital employees above the previous 5.5 wage standard, and the COLC estimates of nonlabor cost increases is substantially below the Council of Economic Advisory forecast of rate inflation for these commodities.

CONFUSING STATEMENTS

In addition to the number of misleading statements included in Dr. Dunlop's testimony, there were also a large number of statements that I could not understand. The statements I question include:

1. While Dr. Dunlop argues that Medicare and Medicaid beneficiaries do not purchase health care services with any market place type constraints, he points out "That Medicare recipients, for example, now pay more out-of-pocket for their health care than they did before Medicare was passed."

Question. If the cost sharing incentives in the Medicare benefits program are inconsequential, how can the dollar level of expenditures have risen to such a great extent?

2. Dr. Dunlop asserts that the Phase IV regulations contain "provision for needed expansion and more flexibility for hospital management and medical staffs in selecting priority for new expenditures."

Question. In light of the fact that the 1972 Amendments to the Social Security Act contained a provision for area-wide health planning agencies review of hospital capital expenditures as a requirement for reimbursement for the Medicare-Medicaid programs, how can the duplicative Phase IV regulations enhance the flexibility for hospital management and medical staff?

3. Dr. Dunlop believes "The 'prospective budget' method of Phase IV is com

pletely consistent with similar decontrol of some suppliers from whom hospitals purchase.'

Question. How can any prospective budgeting approach overcome the hospitals' dilemma of purchasing goods and services in the market place at actual rates increasing close to 10 percent when the overall Phase IV regulations are based on increases of 6 percent?

4. Dr. Dunlop repeatedly refers to the "carefully designed" and "carefully developed" Phase IV rules.

Question. Why is it that, less than 30 days before the majority of providers must choose between the Phase II and Phase IV regulations, the providers still have not received a set of compliance forms for the Phase IV regulations?

The number of misleading and confusing statements contained in Dr. Dunlop's March 6 testimony before this committee substantially reinforces the high level of anxiety that hospitals have about continued COLC controls in the health sector. These statements evidence misunderstanding and confusion about the economics of the health industry, about the Phase IV regulations, and about the nature of inflation itself. The testimony strengthens convictions in the American Hospital Association's recommendation that the Economic Stabilization Act not be extended.

Mr. GETTYS. Now we will proceed to Charles W. Stewart.

Mr. Stewart, would you identify yourself, please, and proceed as you will?

STATEMENT OF CHARLES W. STEWART, PRESIDENT, MACHINERY AND ALLIED PRODUCTS INSTITUTE; ACCOMPANIED BY DONN MARSTON, STAFF COUNSEL

Mr. STEWART. I am Charles Stewart, president of the Machinery and Allied Products Institute which represents the capital goods and allied equipment industries of the United States. I am accompanied by Donn Marston, who is our staff counsel.

One very quick word about these industries. All of you, I am sure, know that capital goods are distinguishable from consumer goods in that they are producers' goods equipment. It should be understood, however, that capital goods are used across the economy, so that the industry is a supplier to almost every manufacturing industry, if not every such industry in the United States and some service areas, as for example grocery stores.

I ask and I assume the chairman's procedure calls for it-that our complete written statement be accepted for the record. Mr. GETTYS. Yes.

Your subsequent statement will be received for the record and I am sure the committee will be glad to have it.

Mr. STEWART. First of all, I was interested in the chairman's opening remarks before he was compelled to leave on other business. He mentioned the fact that he had introduced a bill which was a simple extender, but it did not necessarily reflect his conviction. But he wanted to have a piece of proposed legislation before this committee. I think that is a reassuring comment.

Second, I have a little bit different view about the fact that there are not more Representatives of the Congress present for these hearings. I think that everyone in the country, including many Congressmen and Senators, are beginning to recognize that price and wage control has been a debacle in this country. They have learned it in many ways, including the food situation, and maybe Members of Congress feel that they ought to check that conclusion

with some of their constituents. I therefore welcome the opportunity for them to go home and talk about it because I think I know what they are going to be told.

Secretary Shultz referred to phase 3 as a debacle for which he took personal responsibility. The whole program has been a debacle in our judgment.

Now, I am going to address myself primarily to the general situation as distinguished from special pleading in behalf of capital goods. But pleading in behalf of capital goods happens to be my responsibility, and therefore our statement, particularly beginning at page 6, explains why the capital goods industries are by their very nature not inflationary in character.

Indeed, the name of the economic game is productivity, and capital goods facilitate both the maintenance and the increase of productivity. So that I hope the committee will have an opportunity to examine that discussion, which I will not take the time to go through orally.

I also call attention of the committee to the section on shortages that are hobbling the economy which begins on page 3 of our statement. I do not believe that persons who have not had experience with manufacturing industry can appreciate the extent to which manufacturing industry is presently hobbled by shortages of many, many things which we identify in the statement. There are shortages in raw materials, in sizes of certain items, in components, in forgings, in castings, in bearings, and so forth. These shortages in our judgment have been largely contributed to by the system of price controls which has been imposed on industry.

One of the most interesting and at the same time complex things about our economy is the great number of interrelationships that exist between products in one area and products in another.

A good example is the fact that when you have a shortage in feed. stocks for petrochemicals you have a shortage in plastics, and when you have a shortage in plastics you have problems for plastic users to complete and sell their products, and when you have shortages in plastics you have an impact on sales of plastic machinery. So that the economy moves, overlaps, and interacts and no economist or no labor mediator is smart enough to know how one action in respect to one part of the economy will affect another part-the ripples, the overlaps, the interactions are so complex that no one, no matter how brilliant his background, can anticipate these effects which cause tremendous distortions and general shortages through the economy. Where are we in this country at the present time in terms of economic policy?

I refer to a statement presented by Herbert Stein, Chairman of the Council of Economic Advisers, and two of his other members of the Council to the Joint Economic Committee on February 7. He said it better than I can say it:

The United States is now at a critical point of economic policy. The key issue is not how we shall get through 1974. It is how we shall get through the next generation. The question is whether we shall restore and strengthen the free market, free price system which has provided the American people the highest standard of living in history, or whether we are going to be enmeshed in more and more controls, each one designed to remedy the problems created by the last one. The question arises most acutely with reference to the termination of price and wage controls. It is also encountered at every turn in dealing with the energy problem.

Now, that is not an overstatement, and Dr. Dunlop echoes it to some extent on page 5 of his statement before your committee when he referred to the conditions that exist in the economic environment of 1974. I will not take the time to read that, but it appears on page 5 of his statement. It is the second complete paragraph, and he explains in very effective language why price and wage controls must go down the drain in the economic environment of 1974.

The chairman referred to reading this morning's Post in connection with price increases. He also, I am sure, noted that the American Statistical Association together with the National Bureau of Economic Research have just completed a poll and an analysis of the business forecasting opinions of the leading economists in the United States. There was a consensus that we are already in a minirecession.

At this point I would like to make just a few quick comments about some aspects of the controls program that has been conceived and imposed on this country under the various phases. In order to give you an indication of why it must go-and when we say go we mean go as soon as possible, not later than April 30. Further we oppose any standby controls, and we oppose the mini-Galbraithian system post-April 30 which has been recommended by Dr. Dunlop. It would put a cloud over decisionmaking in American industry and also in collective bargaining and provide for harassment of business and labor.

He, you will recall, asked for termination except for health care, and I believe energy, but he goes on to set up a system of public hearings and monitoring.

Now, a quick few observations about our experience with this control mechanism, and I think these experiences are shared. But we have had a rather unique experience because of certain actions taken by the COLC. There have been two price rollbacks affecting capital goods because of improper definition of a "transaction."

These controls never work in the long run, and it is very difficult to make them work even in the short run. They quickly become counterproductive and we have long since passed that stage.

Second, even to the extent that such controls can be effective in a limited way, they cannot operate without a massive bureaucracy, and the administration had an option when it decided to go for controls. They had the option of developing a massive bureaucracy so that individual cases like the ones described to you could be heard and dealt with intelligently and relief granted when necessary.

They chose a small operation and there lies the dilemma. You cannot operate this kind of a mechanism even halfway effectively without masses of people. That has been our experience in prior control periods. Yet at the same time, the decision was made to hold down the bureaucracy, and this, of course, creates the kind of problems that were described to you this morning.

This type of price control has been administered through the technique of profit control, and on that score I have an interesting quotation which I will read, and then identify the spokesman:

Restraints on profit margins-I can understand the political appeal of that kind of restraint-destroy the prime discipline of the free enterprise system: the drive to hold down costs in order to increase profits. This restraint on profit margins has a quite superficial political appeal. That is, if wage rates are to be