2.

3.

The items most frequently cited as in short supply
are steel, castings of steel and iron, aluminum,
petrochemicals (e.g., plastic resins), copper, zinc,
scrap, and fasteners.

The availability of substitutes varies greatly
according to the type of material or product. In
most cases, however, adequate substitues were
reported as not being available. In those cases

where substitutes were available, they generally
adversely affected product-line costs.

4. Firms frequently have no alternative to accepting
products other than as stipulated: for example, in
the case of steel, different size and materials
specifications; in the case of grey iron, variations
in composition due to scrap shortages; in the case of
paper, different grades; etc. In still other cases,
quality has deteriorated. In almost every case this
results in higher prices being paid.

5. Planning--short- and long-range--is made difficult,
if not hazardous, because knowledge of delivery times
often is limited, prices of certain commodities fluc-
tuate significantly; the pricing structure of many
other items is "price as is known to be in effect at
time of shipments," and certain critical items may not
be available. At the minimum this calls for more
frequent and, at times, substantial changes in cor-
porate plans.

6.

In some cases, certain suppliers are booked to capacity
and will not accept additional orders for months.
For example, a number of foundries are already booked
for all of 1974.

Controls as a causal factor.--When we examine these findings, we think it is fairly obvious how price controls have been a causal factor leading to a number of the critical shortages faced by the economy today. Price controls have forced firms to concentrate more heavily on those products yielding higher profits and thus to reduce or eliminate certain products or product lines. As members of Congress have no doubt noted, in those cases where the elimination of certain products or product lines has become a matter of almost crisis dimensions, the Cost of Living Council has, of course, yielded and provided certain relief. For example, when the coal industry found it could not open new mines because steel roof bolts were not being manufactured, the Council granted certain steel firms price relief on the sale of these products. This concentration on products yielding higher profits explains in part why buyers frequently have no alternative but to accept products other than as stipulated.

In examining the items most frequently cited as in short supply, we can again see the distorting influence of the operation of the controls program. For example, the Cost of Living Council time and again has refused to allow steel, aluminum, and copper producers to obtain significant price relief even when such price relief was consistent with the rules then in effect. In the case of ferrous scrap, price controls resulted in a shortage only recently when in Phase IV the Cost of Living Council reversed a Phase II exemption for certain kinds of ferrous scrap.

In reviewing the findings from the survey, we note companies are now being confronted with a new difficulty; namely, a change in pricing practices so that items are being quoted at a price known to be in effect at the time of shipment. A review of the control regulations will quickly reveal that it is the shipped price which has been controlled for the most part throughout the life of controls. When considering this factor, coupled with the long and arbitrary lead times imposed on firms through the prenotification process, it is hardly surprising that more and more companies are unwilling to establish a fixed price at the time an order is taken.

If we review the problems of capacity plaguing the economy, we find another perverse impact of the controls program. The controls rules arbitrarily impose a base period profit margin limit as a backdoor control over prices. In cyclical industries, which are typical of the capital goods sector, when a firm is unable to achieve high profits during the "boom" part of the cycle, it may well be unable to weather the storm during the downturn. Further, a firm's ability to increase its capacity is greatly handicapped. The controls program record shows numerous cases where the Council has refused to grant relief in the face of industry and company arguments that increased profit recovery will permit a much needed expansion in the industry in question.

The survey findings also reveal that some shortages are the result of firms, selling abroad where world market prices are significantly higher than in the domestic market. The different prices are of course the result of a combination of controlled domestic prices and uncontrolled export and import prices. The domestic shortages are thus a logical result of the controls system.

Finally, the findings of the survey touch on another factor contributing to shortages; namely, the growth of "grey" and black markets. While respondents to our survey were not asked to provide details, this is an inevitable result of shortages and the system of price control which creates shortages.

Final observation on shortages.--We need not belabor the obvious. There is now a wealth of information available from a number of organizations documenting critical shortages. There clearly can be little doubt

that a key causal factor is the economic stabilization program.

We turn now to the special plight of the capital goods producers.

The Plight of the Capital Goods
Sector of the Economy

While we do not hold out the proposition that the posture of the capital goods industries as it relates to how this sector has been impacted by controls is sui generis, we do contend that in decontrolling the entire economy the measure of relief thus afforded will be very significant for this sector of the economy. In short, a case study of the capital goods producer's problems as a result of controls contains the full list of "horribles." We present here, however, only a small part of the capital goods litany:

1. This sector was not a contributor to the inflationary
spiral leading to the August 1971 imposition of
controls. In fact, for many industries in this sector,
the 1969-1971 period--the original profit margin
control period--were years of recession and in some
cases of depression.

2.

Capital goods do not enter into the cost of living
and have little effect upon it. Since capital goods
are purchased to improve productivity, they tend to
be noninflationary.

3. Typically, the firms in these industries compete in
highly competitive markets where the constraints
imposed by both sellers and well-informed buyers
provide built-in "price controls," so there has
never been a demonstrated need to "control" these
industries.

4. The firms in these industries employ large amounts
of capital which puts a premium on a "reasonable"
return on investment and makes ease of entry diffi.
cult. Thus, a "squeeze" leading to fewer firms in
a given industry will have very perverse effects in
the future.

5. Capital goods firms tend to be cyclical in nature.
Thus, periods of low profit must be offset by periods
of higher profits if the return on investment to the
stockholder owners is to be sufficient to attract
the capital necessary for current operations and,
obviously, for the expansion that is necessary to
alleviate some of the critical shortages that are
plaguing the economy.

6. Certain decontrol actions taken to date, for example,
the move to decontrol nonferrous metals, have aggra-
vated the disadvantage of user industries such as the
capital goods sector still under controls. Restated,

the concept that the consumer need not worry about
"lost" costs imposed by controls is totally in error.
Today's "lost costs" will be tomorrow's higher prices.

7. Capital goods, being a relatively "nonvisible" sector of the economy, have been ignored in the design and implementation of price controls. Also forgotten is that given the sensitivity of our economic interrelationships, government-imposed price controls exact a high penalty in terms of efficiency in all sectors and this result is inevitable whether intended or not. This is certainly the penalty being paid in the capital goods sector today which faces runaway costs from its suppliers and competitively applied dampers on price increases from customers in addition to price controls.

8. Capital goods firms are being asked to shoulder what appears to be a growing and never-ending cost burden in administering controls. A major part of the cost burden comes about because of the procedural shortfalls of the program which include lack of certainty or predictability, the vagueness of the standards imposed, and the lack of communication regarding what is intended by the federal controllers. (These points are spelled out in detail in the attached October 17, 1973 letter to Senator Mathias submitted in connection with the Senate Subcommittee on Separation of Powers Hearing regarding administrative procedures under the controls program. It should be noted that although the general thrust of our October 17, 1973 letter is still valid, a limited number of ameliorative actions have been taken.)

9. For most of the firms in the capital goods industries, the labor situation is such that wage increases tend to follow patterns set by the major collective bargaining settlements. Thus, these industries neither set inflationary wages in motion nor are they in a position to halt an inflationary spiral set in motion by trend setters in other sectors.

10. Capital goods firms traditionally face stiff international competition. Given limited options to respond to price controls, such as eliminating the manufacture of certain products or product lines, foreign competition is encouraged to grow by leaps and bounds and the U.S. industrial base is further eroded.

11.

Given 1974 concerns which include unemployment, it is
unfortunate that what might be a positive capital goods
sector response in anticipation of what still appears
to be a good year in 1974, is bound to be significantly
muted in terms of lost employment opportunities because
of the controls program.

As we said at the outset, we believe the entire economy should be decontrolled promptly. Certainly nothing can be gained by a continuation of wage and price controls as far as the capital goods sector is concerned. The adverse effects and inequities of having this sector "wait its turn" under a selective decontrol program suggests, in our view, why the meat-axe approach to controls which brought us Phase I should be employed now by Congress to get us out from under the latest version of these controls.

If necessary, we must accept the temporary discomfort of the resulting price "blip. The fact that the economy has entered a period of reduced growth should help to ensure that the market will provide a certain discipline on price increases.

Strategy for economic stabilization.-With the immediate dismantling of controls our national goals should be fourfold:

1. Minimum government intervention in wage and price
decisions;

2.

Major reliance for controlling inflation on fiscal
and monetary policies;

3. Structural (as contrasted with aggregative) ap-
proaches to ease problems of unemployment; and

4. Voluntary efforts to achieve the best possible
trade-off between inflation and unemployment.

Economists are agreed that the economy is slowing down and that whether or not we have a recession, unemployment will be a major concern in 1974. To offset unemployment, most often we have paid a penalty in inflation. We believe that total decontrol will, as noted above, lead to some inflation but accompanied by a call for voluntary effort it represents the best trade-off between inflation and unemployment.

Hopefully, with major reliance on fiscal and monetary policies we will have a better year in terms of inflation in 1974 than we did in 1973 when a tough control program was being relied upon to hold the line. It is unlikely we can do much worse.

We turn now to a review of the Administration's recommendations.