Removing Obstacles to Economic Growth [Reprint 2016 ed.] 9781512808209

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Removing Obstacles to Economic Growth

Edited, with an Introduction, by Michael L. Wächter and Susan M. Wächter

University of Pennsylvania Press Philadelphia

1984

Removing Obstacles to Economic Growth

T H I S BOOK IS B A S E D O N T H E S E C O N D ( 1 9 8 3 ) WHARTON/RELIANCE SYMPOSIUM C O S P O N S O R E D BY T H E W H A R T O N S C H O O L OF T H E U N I V E R S I T Y OF P E N N S Y L V A N I A A N D R E L I A N C E GROUP HOLDINGS, I N C . , WITH A G R A N T FROM RELIANCE INSURANCE COMPANY

Copyright © 1984 by the University of Pennsylvania Press All rights reserved Library of Congress Cataloging in Publication Data Main entry under title: Removing obstacles to economic growth. Includes bibliographical references. 1. United States—Economic conditions—1981— Addresses, essays, lectures. 2. United States—Economic policy—1981—Addresses, essays, lectures. 3. United States—Economic conditions—1971-1981— Addresses, essays, lectures. 4. United States—Economic policy—1971-1981—Addresses, essays, lectures. I. Wachter, Michael L. II. Wachter, Susan M. HC106.8.R461984 338.973 83-23523 ISBN 0-8122-7923-9 Printed in the United States of America

CONTENTS List of Participants

viii

Preface

xv

THE SETTING FOR A PRO-GROWTH STRATEGY: AN INTRODUCTION

Xvii

Michael L. Wachter Susan M. Wachter

PART ONE VIEWPOINTS ON STRATEGIES FOR GROWTH 1

Responses to the Slowdown in Growth Reginald H. Jones

3

2

Removing Structural Barriers to Growth Alan Greenspan

10

3

The Economic Policy Failure of the Past and a Policy Agenda for the Future Alan Cranston

15

4

The Government Debt-Imposed Ceiling on Economic Growth Peter G. Peterson

20

5

Why Labor Unions Do Not Accept the New Economic Policy William W. Winpisinger

6

The Need for a Long-Term Perspective in GovernmentBusiness Relations Ian MacGregor

28

34

PART TWO POLICY AREAS LABOR PRODUCTIVITY AND DEMOGRAPHICS

7

The Training Component of Growth Policies Michael L. Wachter

41

Contents v

8

Tax Policy and Unemployment Insurance Effects on Labor Policy Jerry A. Hausman

Discussants Isabel V. Sawhill Bernard E. Anderson Ray Marshall Malcolm R. Lovell

Robert W. Lundeen

Summary Report Robert C. Holland

70 97

111

MANAGING MOTIVATION AND THE NEW TECHNOLOGIES

9 10

The Need for New Private and Public Policies Franklin A. Lindsay Jerome S. Rubin Richard L. Cohen

115

The Work Ethic and Economic Vitality Daniel Yankelovich John Immerwahr

144

Discussants Phyllis A. Wallace Stan Lundine

Thomas J. Murrin

John T. Joyce

Summary Report F. Gerard Adams

171

183

SAVINGS AND INVESTMENT

11

Saving in the U.S. Economy John B. Shoven

187

12

Investment, Taxation, and Growth Alan J. Auerbach

224

Discussants G. Morris Dorrance, Jr. Justine Farr Rodriguez

Rudolph A. Oswald

Summary Report Jean A. Crockett

251

261

MANAGING THE GOVERNMENT DEFICIT AND BUSINESS CYCLE

13

Managing the U.S. Government Deficit in the 1980s Benjamin M. Friedman

14

Using Monetary Control to Dampen the Business Cycle: A New Set of First Principles Robert J. Gordon

Contents vi

265

302

Discussants Gar Alperovitz Lacy H. Hunt William Poole Robert Edgar

Gerald W. McEntee

Summary Report Marshall E. Blume INTERNATIONAL ECONOMIC AND FINANCIAL STABILITY

15

International Banking: Vulnerability and Crisis Jack M. Guttentag Richard J. Herring

16

In Search of an Optimistic Scenario for the 1980s Lawrence R. Klein

Discussants Veronica A. Haggart George M. von Furstenberg Jerry J. Jasinowski Robert E. Hall Bill Frenzel Summary Report Robert H. Mundheim

Stewart A. Schoder

PART THREE THE POLITICAL AND INTERNATIONAL SETTING: A SUMMING-UP 17

The Role of Increased International Trade in Long-Term Economic Growth William E. Brock

18

Foreign Policy and Economics Henry A. Kissinger

19

Do We Need an Industrial Policy? Edwin L. Harper

ROUNDTABLE Alfred E. Kahn Nancy H. Teeters Lester C. Thurow Charls E. Walker Murray L. Weidenbaum Henry Wendt

LIST OF PARTICIPANTS F. GERARD ADAMS is Professor of Economics and Finance and Director of the Economics Research Unit of the University of Pennsylvania. He also serves as Secretary and Senior Consultant of Wharton Econometric Forecasting Associates, Inc. GAR ALPEROVITZ is Co-Director of the National Center for Economic Alternatives, a Washington-based research organization. He is also Professor of Economics at the University of Notre Dame and has served as Legislative Director in the U.S. House of Representatives and the U.S. Senate. BERNARD E. ANDERSON is Professor of Industry at the Wharton School of the University of Pennsylvania currently on loan to the Rockefeller Foundation, serving as Director of the Social Sciences Division. ALAN j. AUERBACH is Associate Professor of Economics at Harvard University and a Visiting Professor of Economics at Yale University. He is also a Research Associate at the National Bureau of Economic Research. MARSHALL E. BLUME is Howard Butcher Professor of Finance and Chairman of the Finance Department at the Wharton School of the University of Pennsylvania. He also serves as Associate Director of the school's Rodney L. White Center for Financial Research. WILLIAM E. BROCK, the United States Trade Representative, chairs the Cabinet-level Trade Policy Committee and serves as Vice-Chairman of the Overseas Private Investment Corporation. He is a member of the Export-Import Bank and of the National Advisory Committee on International Monetary Financial Policies. RICHARD L. COHEN is Director of Jobs Projects for the Public Agenda Foundation with special responsibility for workplace issues posed by the new technologies. ALAN CRANSTON, Democratic Senator from California, has served in the Senate since 1968. He is the Senate Democratic Whip and serves

List of Participants viii

on the Banking, Housing and Urban Affairs, Foreign Relations, and Veterans Affairs committees. JEAN A. CROCKETT, Professor of Finance at the Wharton School of the University of Pennsylvania, recently served as Chairman of the Directors of the Federal Reserve Bank of Philadelphia. She is currently a Director of the National Bureau of Economic Research and the American Finance Association. G. MORRIS DORRANCE, JR., is Chairman and Chief Executive Officer of the Philadelphia National Corporation and the Philadelphia National Bank. He is an overseer of the Wharton School of the University of Pennsylvania. ROBERT EDGAR, Democratic Congressman from Pennsylvania, has served in the House of Representatives since 1974. He is Chairman of the Congressional Clearinghouse on the Future and is a member of the Public Works and Transportation Committee, the Veterans Affairs Committee, and the Northeast/Midwest Coalition. BILL FRENZEL, Republican Congressman from Minnesota, is a seventerm veteran of the House. He serves on the Ways and Means Committee and the Budget Committee and is ranking Minority leader of the House Administration Committee. BENJAMIN M. FRIEDMAN is Professor of Economics at Harvard University. He directs the financial markets and monetary economics research at the National Bureau of Economic Research and serves as Associate Editor of the journal of Monetary Economics. ROBERT j. GORDON is Professor of Economics at Northwestern University and Research Associate at the National Bureau of Economic Research. He is Treasurer of the Econometric Society and is on the Executive Committees of the American Economic Association and the Conference on Research in Income and Wealth. ALAN GREENSPAN is Chairman and President of Townsend-Greenspan

& Company, Inc., an economic consulting firm in New York City. He served as Chairman of the President's Council of Economic Advisers under President Ford and recently chaired the National Commission on Social Security Reform. JACK M. GUTTENTAG is Professor of Finance and Robert Morris Professor of Banking at the Wharton School of the University of Pennsylvania. He serves as a director of several private financial institutions and professional societies. VERONICA A. HAGGART, a Commissioner with the U.S. International Trade Commission, was a co-founder and Senior Partner in the Wash-

List of Participants ix

ington, D.C.-based law firm of Heron, Haggart, Ford, Burchette and Ruckert. She previously served as Special Assistant to an Assistant Secretary of Agriculture and also as Special Assistant to the Deputy U.S. Trade Representative. ROBERT E. HALL is Professor of Economics and Senior Fellow of the Hoover Institution at Stanford University. He also serves as Director of the Research Program on Economic Fluctuation of the National Bureau of Economic Research and is a Fellow of the Econometric Society. EDWIN L. HARPER is Assistant to the President for Policy Development. He previously served the Reagan Administration as Deputy Director of the Office of Management and Budget and Assistant to the President from 20 January 1981 to 1 March 1982. As Deputy Director, he was also Chairman of the President's Council on Integrity and Efficiency. JERRY A. HAUSMAN is Professor of Economics at Massachusetts Institute of Technology and a Research Associate of the National Bureau of Economic Research. He is a Fellow of the Econometric Society. RICHARD j. HERRING is Associate Professor of Finance and Director of the Wharton Program in International Banking and Finance at the University of Pennsylvania. He has been an International Affairs Fellow at the Council on Foreign Relations and an IBM Postdoctoral Fellow. ROBERT c . HOLLAND is President of the Committee for Economic De-

velopment. He served as a member of the Board of Governors of the Federal Reserve System and is an overseer of the Wharton School of the University of Pennsylvania.

LACY H. HUNT is Executive Vice-President and Economist at CM&M Group, Inc., and President of CM&M Asset Management Company,. Inc., a Philadelphia-based investment management firm. Until recently, he served as Executive Vice-President and Economist at the Fidelity Bank in Philadelphia. JOHN IMMERWAHR is Associate Professor of Philosophy at Villanova University and Senior Project Consultant at the Public Agenda Foundation in New York. JERRY J. JASINOWSKI is Senior Vice-President and Chief Economist of the National Association of Manufacturers. He served as Assistant Secretary for Policy at the United States Department of Commerce under President Carter.

List of Participants X

REGINALD H. JONES is the former Chairman and Chief Executive Officer of the General Electric Company. He is a member of the Executive Committee of the Business Council and an honorary member of the Policy Committee of the Business Roundtable. Currently he serves on the board of directors of numerous corporations. He has been a trustee of the University of Pennsylvania since 1963 and also Chairman of the Board of Overseers of the Wharton School. JOHN T. JOYCE is President of the International Union of Bricklayers and Allied Craftsmen. He is Co-Chairman of the International Masonry Institute and serves on the Board of Directors of the National Academy of Science's Advisory Board for the Built Environment (ABBE) and of the Corporation for Public/Private Ventures. ALFRED E. KAHN, best known as President Carter's "inflation czar," served as Chairman of the Council on Wage and Price Stability from 1978 to 1980, before which he had served as Chairman of the Civil Aeronautics Board and as Chairman of New York State's Public Service Commission. He left public service to return to his chair in economics at Cornell University. HENRY A. KISSINGER, former Secretary of State and Assistant to the President for National Security Affairs, is currently University Professor of Diplomacy at the School of Foreign Service and Counselor to the Center for Strategic and International Studies, both at Georgetown University. LAWRENCE R. KLEIN, winner of the 1980 Nobel Prize in Economics, is Benjamin Franklin Professor of Economics and Finance at the University of Pennsylvania. He is the founder of Wharton Econometric Forecasting Associates, Inc. FRANKLIN A. LINDSAY is a founder and Chairman of Engenics, Inc., a

California-based biotechnology firm, Vice-Chairman of the Committee for Economic Development, and former Chairman of Itek Corporation. MALCOLM R. LOVELL serves as Under Secretary of Labor and was recently appointed Guest Scholar at the Brookings Institution. He had previously been President of the Rubber Manufacturers Association. ROBERT w. LUNDEEN is Chairman of the Board of The Dow Chemical

Company. He serves as a trustee of the Committee for Economic Development, a member of the Advisory Council on Japan-U.S. Economic Relations, and a director of the U.S.-U.S.S.R. Trade and Economic Council.

List of Participants xi

STAN LUNDINE, Democratic Congressman from New York, has served in the House of Representatives since 1976. He is Chairman of the Task Force on Industrial Innovation and Productivity and serves on the House Committees on Banking, Finance and Urban Affairs, and Science and Technology. GERALD w. McENTEE is International President of the American Federation of State, County and Municipal Employees (AFSCME). He is a member of the Executive Council as well as a Vice-President of the AFL-CIO, a member of the Democratic National Committee and its Labor Council. IAN MACGREGOR is Chairman and Chief Executive of the British Steel Corporation. He is a past President of the International Chamber of Commerce and a past Chairman of the United States European Economic Community Businessman's Council. RAY MARSHALL is Bernard Rapoport Centennial Professor of Economics and Public Affairs at the University of Texas and President of the National Policy Exchange in Washington, D.C. He served as Secretary of Labor under President Carter. ROBERT H. MUNDHEIM is Dean and University Professor of Law and

Finance at the University of Pennsylvania, The Law School. He has served as General Counsel for the U.S. Treasury. THOMAS j. MURRIN is President of the Energy and Advanced Technology Group, Westinghouse Electric Corporation. He is a member of the Defense Policy Advisory Committee on Trade and the Aerospace Industries Association of which he has served as Chairman of the Board of Governors. RUDOLPH A. OSWALD was appointed Director of Research for the AFL-

CIO in 1976. He has long experience with the trade union movement and has served on a number of governmental advisory committees.

PETER G. PETERSON is Chairman of the Board and Chief Executive Officer of Lehman Brothers Kuhn Loeb, Incorporated. Under President Nixon, he served as Assistant to the President for International and Economic Affairs, and Secretary of Commerce. WILLIAM POOLE is a member of the Council of Economic Advisers and a Professor of Economics at Brown University, currently on leave. He has served as a consultant to the Federal Reserve Bank of Boston and is a senior adviser on the Brookings Panel on Economic Activity. JUSTINE FARR RODRIGUEZ is Senior Economist with the U.S. Office of

Management and Budget. She was previously Economist with the

List of Participants xii

Chase Manhattan Bank, Corporate Secretary of Chase Econometrics, and a staff member of the National Bureau of Economic Research. JEROME s. RUBÍN is a Group Vice-President at the Times Mirror Company and a founder and former president of Mead Data Central, creator of LEXIS, NEXIS, and other leading on-line informationretrieval services. ISABEL v. SAWHILL, Senior Fellow at The Urban Institute, is also CoDirector of the Institute's project, Changing Domestic Priorities. Previously she was Program Director of the Institute's Employment and Labor Policy and Director of the National Commission for Employment Policy. STEWART A. SCHODER is a doctoral candidate in Business Economics at The Wharton School and a research fellow at the Center for International Banking and Finance there. He was for five years a commercial banker in the Middle East and Africa. JOHN B. SHOVEN is Professor of Economics at Stanford University. He is also Director of the National Bureau of Economic Research's program to study private and public pensions. NANCY H. TEETERS joined the Federal Reserve Board in 1978. Previously she was Assistant Staff Director and Chief Economist for the Committee on the Budget of the House of Representatives of the U.S. Congress. LESTER c . THUROW is Professor of Economics and Management at Mas-

sachusetts Institute of Technology and a Contributing Editor of Newsweek. He was a presidential appointee to the National Commission for Manpower Policy (1978-79) and has served on the NAACP Economic Advisory Council.

GEORGE M. VON FURSTENBERG is Chief of the Financial Studies Division at the International Monetary Fund. He served as Senior Staff Economist on the President's Council of Economic Advisers (1973-76) and will become the Rudy Professor of Economics at Indiana University in September 1983. MICHAEL L. WACHTER is Professor of Economics and Management at

the Wharton School of the University of Pennsylvania. He is currently a member of the National Council on Employment Policy and a Senior Adviser to the Brookings Panel on Economic Activity, and he has served as a Commissioner on the Minimum Wage Study Commission. SUSAN M. WACHTER is Associate Professor of Finance at the Wharton School of the University of Pennsylvania. She has served as a consul-

List of Participants xiii

tant to the Council of Economic Advisers, the Federal Trade Commission, and the Department of Housing and Urban Development. CHARLS E. WALKER, former Deputy Secretary of the Treasury, heads his own Washington-based consulting firm. He is a member of President Reagan's Economic Policy Advisory Board and an overseer of the Wharton School of the University of Pennsylvania. PHYLLIS A. WALLACE is Professor of Management at the Sloan School of Management, Massachusetts Institute of Technology. She is on the Board of Trustees of the Brookings Institution. MURRAY L. WEIDENBAUM is Mallinckrodt Distinguished University Pro-

fessor and Director of the Center for the Study of American Business at Washington University in St. Louis. He served as President Reagan's first Chairman of the Council of Economic Advisers. HENRY WENDT is President and Chief Executive Officer of SmithKline Beckman Corporation and an overseer of the Wharton School of the University of Pennsylvania. WILLIAM w. wiNPisiNGER is International President of the International Association of Machinists and Aerospace Workers. He serves on the Executive Council of the AFL-CIO, is founder and President of the Citizen/Labor Energy Coalition and Co-Chair of the United States Democratic Socialist Organizing Committee. DANIEL YANKELOVICH is founder and Chairman of Yankelovich, Skelly & White, Inc. He is the author of many works on foreign affairs, the labor market, youth attitudes, and the social implications of economic policy making. In 1975, Yankelovich was co-founder of the Public Agenda Foundation.

List of Participants xiv

PREFACE The unsatisfactory economic performance of the United States economy over the past decade has generated considerable debate over potential new directions for economic policy. This volume, the result of the second Wharton/Reliance Symposium, presents and analyzes a range of economic policy options. In many respects it serves as a companion study to Toward a New Industrial Policy?, the volume based on the first Wharton/Reliance Symposium held in Philadelphia in March 1981. That volume examined the economic relationship of government to business, and the extent to which government policy failure contributed to economic slowdown. Based on the conclusions reached in that volume, it was possible to focus, in this volume, on some crucial areas where policy changes might be helpful. Given the range of issues covered and the alternative viewpoints presented, this volume does not search for an overall policy consensus. To focus on consensus would have required narrowing both the subject matter and the distinctive viewpoints that were presented. Our interest was in presenting and having an open discussion of a set of existing and innovative policy options. The conference that formed the basis for this volume was cosponsored by the Wharton School of the University of Pennsylvania and Reliance Group Incorporated and was held at the Wharton School in May 1983. The Symposium brought together approximately 300 business, labor, government, and academic leaders. The papers presented in this book were prepared for and discussed at that Symposium. The comments of the discussants represent their remarks at a panel discussion on the respective topic areas; the summary comments attempt to provide some insight into the nature of the debate that took place. Funding for this Symposium and the volume, as for the first, was provided by a grant from Reliance Insurance Company. The Symposium and this volume once again represent the work of many individuals. Certainly, as coeditors, our job would not have been possible without the ongoing support of Dean Donald C. Carroll and Karen Freedman of the Wharton School; Saul P. Steinberg of

Preface xv

Reliance Group; Reginald H. Jones of the General Electric Corporation; Daniel Yankelovich and Larry Kaagan of Yankelovich, Skelly and White; and William A. Pollard and Richard J. Guilfoyle of Reliance Insurance Company. Finally, many thanks are owed to those too many to name without whose help both the Symposium and the book would never have become realities. MICHAEL L . WACHTER

Philadelphia, Pennsylvania

Preface xvi

SUSAN

M.

WACHTER

THE SETTING FOR A PROGROWTH STRATEGY: AN INTRODUCTION Michael L. Wachter

Susan M. Wachter

The Wharton/Reliance Symposium focused on potential policy remedies for the economic problems of slow real output and productivity growth. It was assumed at the outset of the conference that faster economic growth is desirable. Given the state of world economies in May 1983, this orientation is not difficult to justify. This paper describes some of the background issues for a policy agenda geared to removing obstacles to economic growth. The first section sketches out the recent growth performance in the United States using both output and productivity indexes to measure economic growth. Both indexes performed poorly over the past ten years. The choice of 1973-74 as the starting point for the slowdown in economic growth is discussed briefly. Although there is some evidence that growth rates may have turned downward slightly in the late 1960s, this can largely be explained by demographic and cyclical adjustments. After 1973, the growth slowdown is pervasive and quantitatively large. The second section compares the growth record of the United States with the records of some other major industrial economies. The data indicate that a common view that the United States has done worse than its European trading partners is incorrect. Output growth in the United States over the past ten years was greater than for most European economies. The European countries did achieve higher proThis research was supported by grants from the General Electric Foundation and the National Institutes of Health. The authors wish to thank Peter Pauly and William L. Wascher for their helpful suggestions, and Rodrigo Quintanilia and Nancy Zurich for research assistance.

Introduction xvii

ductivity and real wage growth, but this was largely at the cost of rising unemployment and changes in their guest worker programs. The third section discusses some specific explanations for the slowdown. Particular attention is devoted to the effects of energy prices, the possibility of a shortfall in the nation's capital stock, the impact of continuing rapid increases in the size of the labor force, and the role of cyclical fluctuations. The fourth section indicates the caveats that must accompany a pro-growth policy agenda. All policies have associated income distribution effects that are incidental to the main policy purposes. For a variety of reasons, pro-growth strategies tend to widen the income distribution. These effects, however, can be minimized or offset. Progrowth strategies also seem at times to conflict with concerns about the environment or about quality of life. This need not be the case, but requires attention. The difficulty is largely a result of "incomplete" markets; for example, some national resources (such as clean air, public lands) do not have market prices and are not included in the growth accounting. Finally, since growth-promoting policies involve the intertemporal distribution of resources, the growth rate targeted by policymakers needs to reflect the economy's production potential in shifting resources intertemporally as well as the society's preference between current and future consumption. The final section summarizes the various explanations for the growth slowdown and describes the optimistic scenario for faster economic growth over the next decade. This favorable outlook is due not only to the cyclical bonus inherent in any economic recovery but also to the slowdown in the growth rate of the labor force, the possible reversal of negative supply-side shocks, and the associated reduction in inflation rates.

THE U.S. EXPERIENCE THE MAGNITUDE OF THE SLOWDOWN

The slowdown in economic growth is now ten years old. Its impact has been pervasive, affecting most sectors within the economy. The decade-long secular slump has been marked by two major recessions, 1974-75 and 1981-83. What makes the current cyclical downturn in economic activity so troublesome is not only its severity but also the fact that it comes after a decade of slow secular growth in real gross national product and productivity. Whereas the United States GNP grew at an annual rate of 4.2 percent between 1960 and 1973, growth between 1973 and 1982 averaged only 1.8 percent. In fact, as shown in table 1.1, real GNP has now declined in four of the last ten years.

Introduction xviii

Gross national product in 1982 was actually below its 1979 level. Productivity growth has declined along with output growth. The 3.1 percent growth in output (value added in the business sector) per manhour between 1960 and 1973 has given way to a mere 0.5 percent growth rate between 1973 and 1979, and zero growth over the past three years. Over the last ten years, productivity growth has been negative three times and below 1 percent five times. Real wages have also declined in five of the last ten years. See table 1.1. Similar patterns appear in evaluations of either labor or total factor productivity growth. Whereas the former is calculated by dividing output by total manhours, the latter is calculated by dividing output by a weighted sum of labor, capital, and other factor inputs. Few industries escaped the slowdown in total factor productivity growth (see table 1.2). Some of those with the largest slowdown—manufacturing, public utilities, and mining—have traditionally been sectors of rapid productivity growth. The decline in total factor productivity indicates that other factor inputs besides labor have been faced with productivity slowdowns. This point, as will be seen below, is important in helping to identify TABLE 1.1 United States Economic Performance: Growth Rates from 1970 to 1982 Real Wages Productivity (Nominal (Output Per Wages Hour Nonfarm GNP Unemploy- Nominal Deflated Business Year Real GNP Deflator ment Wages by CPI) Sector) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982

-0.2 3.4 5.7 5.8 -0.6 -1.2 5.4 5.5 5.0 2.8 -0.4 1.9 -1.8

5.4 5.0 4.2 5.8 8.8 9.3 5.2 5.8 7.4 8.6 9.3 9.4 6.0

4.9 5.9 5.6 4.9 5.6 8.5 7.7 7.1 6.1 5.8 7.1 7.6 9.7

6.6 7.2 6.2 6.2 8.0 8.4 7.2 7.6 8.1 8.0 9.0 9.1 6.8

0.7 2.7 3.0 -0.1 -2.8 -0.7 1.4 1.0 0.5 -3.1 -4.0 -1.0 0.8

0.3 3.3 3.7 2.4 -2.5 2.0 3.2 2.2 0.6 -1.3 -0.9 1.4 0.2

SOURCE: U.S., Council of Economic Advisers, Economic Report of the President (Washington, D.C.: U.S. Government Printing Office, 1983).

Introduction xix

TABLE 1.2 The Slowdown in Total Factor Productivity Industry Agriculture Mining Construction Manufacturing Railroads Non-Rail Transportation Communications Public Utilities Trade Finance and Insurance Real Estate Services

Post-1973 Slowdown* -0.35 -4.93 -3.73 -1.70 -1.81 -1.40 1.12 -3.97 -1.93 -0.63 -0.32 0.09

SOURCE: Martin N. Baily, "Productivity and the Services of Capital and Labor," Brookings Papers on Economic Activity 1 (1981): 1-50. "Differences between growth rates 1973 to 1981 and 1953 to 1973.

some of the causes of the slowdown while ruling out other possible explanations. While the above indicates the depth of the secular slowdown, the short-run predicament is also severe. Unemployment has only recently declined from its highest level since the end of the Great Depression, and capacity utilization has only recently increased from its lowest level since statistics were first collected. The threat of an international banking crisis and a large government deficit creates the risk of another sharp downturn in the economy. Alternatively, there is a risk that the recovery may be maintained by monetary policy shocks in the form of high rates of increase in the money supply. Because of the difficulties of interpreting money supply aggregates in a world of rapidly changing financial instruments, however, any inflationary consequences of the Federal Reserve policy shift that began in the summer of 1982 are difficult to judge ex ante. THE TIMING OF THE SLOWDOWN

The above discussion indicates that the slowdown in economic growth began in 1973. A possible alternative dating of the slowdown would be in the middle to late 1960s. The published numbers for aggregate output and manhours do suggest slower productivity growth be-

Introduction XX

tween the late 1960s and 1973 than in the preceding five or ten years. But much of this slowdown can be explained by adjusting productivity growth rates for cyclical forces and compositional shifts in the labor force. During the late 1960s and early 1970s the labor force profile was shifting heavily toward young and female workers. This factor is explained below in the section on labor force effects on productivity growth. That these sectoral shifts within the aggregate labor force were responsible for much of the decline is also supported by analyzing sector-specific productivity growth rates. Within the manufacturing sector, for example, one of the sectors least affected by labor force shifts, productivity actually grew above its trend rate during the 1965 to 1973 period. A correction for cyclical fluctuations in the economy removes most of the remaining productivity decline before 1973. At issue is the size of the cyclical correction to use for the years 1969 through 1972. The years 1969 and 1970 encompass a high cyclical peak and a weak recession when productivity growth slowed. The recovery in 1971 and 1972 generated a strong rebound with output per manhour growing at an annual rate of 5.5 percent in manufacturing and 3.3 percent in the nonfarm business sector. Although other recessions generated stronger cyclical recoveries in productivity, 1971 and 1972 were respectable given the shallowness and shortness of the 1970 downturn. Whereas the productivity slowdown is relatively minor before 1973 and explainable by labor force compositional and cyclical control variables, this is not true after 1973. As indicated above, the slowdown is both much larger and more pervasive (across industries and countries) after 1973 than before 1973. It is apparent from the data that productivity growth declined very sharply during the recession in 1974. At the time, the drop was viewed as a cyclical problem that would be made up in the next recovery, but productivity growth during the next recovery did not make up the lost ground. Productivity growth again slumped badly during the late 1970s and early 1980s. Dating the decline at approximately 1973 is important since that timing highlights the potential causal role of energy and raw material prices in the output decline in 1974-75. Even for this issue, however, the exact timing is not vital. Raw material price indexes turned upward in the early 1970s because of excess demand for food and industrial materials, and the upswing accelerated in late 1973 with the OPEC oil embargo. This correlated behavior of raw material price indexes and the productivity slowdown could be a coincidence or both could be the result of a separate third factor. The evidence on this issue is discussed below.

Introduction xxi

COMPARISONS WITH OTHER COUNTRIES Although our primary attention is on the United States, the experience of other industrialized economies can be instructive. First, the economic performance of the United States is often compared unfavorably to that of other Organization for Economic Cooperation and Development (OECD) countries. Second, all OECD countries have experienced some reduction in growth rates over the past decade. Consequently, any explanation of the slowdown has to be compatible with international trends, and policy remedies must be cognizant of the international aspects of the problem. PRODUCTIVITY AND REAL OUTPUT COMPARISONS

Before analyzing the OECD data, it is important to distinguish between productivity growth and real output growth. Both variables can be used to measure economic growth, but the two terms do not cover the same turf. Either variable alone can be misinterpreted as a measure of a nation's living standards and economic vitality. The size of a nation's output or gross national product is not in itself important. Whether a nation's GNP is viewed as either high or low depends upon the size of the population that is supported by that output. A slowdown in the rate of growth of output thus may not be a problem if it is simply due to a slowdown in the growth rate of manhours or of the labor force; productivity and real standards of living could still be increasing at their historical pace. In the 1970s, however, the long-run labor supply pressures were strong as the baby boom cohort and increased numbers of female workers entered the labor force. These same demographic phenomena are also relevant, but to a lesser extent, for most European economies. Given the underlying labor supply growth, rapid output growth was called for. It did not, however, occur. The reason that economic analysis of growth tends to focus primarily on labor productivity rather than output is that productivity provides a measure of the living standards of the workforce. The rate of productivity growth, however, can also be misleading. Given the labor supply pressures indicated above and the presence of sluggish output growth, a number of outcomes or productivity-output growth configurations are possible. One path allows downward real wages flexibility which permits higher levels of employment. The result, however, is lower productivity growth. Alternatively, a path of relatively high real wages and productivity growth is also possible. In this instance, it is the decline in employment that allows for the observation of high labor productivity. The degree to which economies exhibit downward real wage inflexibility and downward employment flexibility depends upon a

Introduction xxii

number of factors. Among them are the rules of implicit or explicit labor contracts, the earnings replacement rate provided by unemployment insurance, the responsiveness of the labor supply in the short run, and the industrial mix between industrial production and service output. Another major factor in the productivity-output nexus is government policy toward immigrant labor. The guest workers in Europe and the illegal aliens in the United States provide for a significant endogenous component in the labor force that responds to shifts in job availability and the willingness and ability of governments to alter their (implicit or explicit) policies as domestic employment changes. COMPARISONS WITH EUROPEAN ECONOMIES

An analysis of the experience of other industrialized economies yields a very different view of the problem from that seen from the perspective of the United States. While the relatively poor United States productivity pattern is certainly confirmed by the data, relative output growth rates indicate that a more complex phenomenon is at work. The abysmal United States productivity performance has been well documented. United States productivity growth had been slower than the other major OECD countries even before 1973. Whereas the United States averaged 3.0 percent growth between 1960 and 1973, the ten other major OECD economies had productivity growth of 6.4 percent. After 1973, our growth rate diminished to 1.8 percent, whereas the ten other OECD economies averaged 4.7 percent. Although the decline was widespread, it is still true that the OECD economies were experiencing healthy productivity gains.1 If the manufacturing productivity indexes are set at 100 in 1972, the last decade can be isolated to illustrate the poor performance of the U.S. with respect to the major OECD countries (see fig. 1.1). By 1981, Japan's index had increased to 180.5 and that of the eight European countries to 147.5, but the United States had reached only 115.4. The output growth performance of the United States compared to other major OECD countries, however, tells a very different story. As can be seen in figure 1.2, United States output grew slightly faster than did output for Germany and an index of eight European countries, and much faster than output for the United Kingdom. Only Japan maintained both high output growth and high productivity growth. Consequently, figures 1.1 and 1.2 analyzed together suggest that the United States has not performed poorly compared to the European economies over the last decade. The European economies achieved rapid productivity growth largely by holding back manhour growth. It should not be assumed that the European economies had slower

Introduction xxiii

FIGURE LI Manufacturing Productivity Index: 1973 to 1981 (1972 = 100)

SOURCE: Commission of the European Communities, "Annual Economic Report 198283," European Economy, no. 14 (November 1982); Organisation for Economic Co-operation and Development, Main Economic Indicators (December 1982).

manhour growth because of inherent slow growth in the population. At the time of the first oil shock and the steep recession in 1973-74, the European economies responded by attempting to export their guest workers. This measure was only partially successful, but it did reduce the growth of manhours and thus buttress productivity. After that, productivity growth was maintained at the cost of high unemployment. Whereas the United States succeeded in reaching the same unemployment rate in 1979 as it had in 1974 and was only slightly above its 1973 level, this was not true for other major OECD economies. As

Introduction xxiv

FIGURE 1.2 Manufacturing Output Index: 1973 to 1981 (1972 = 100)

s o u r c e : S e e figure 1.1.

shown in table 1.3, the United States had a lower percentage point increase in unemployment between 1973 and 1979 than did any of the other major OECD economies except Japan. In fact, unemployment rates more than doubled in Belgium, Denmark, France, and the United Kingdom. The unfavorable unemployment rate comparison between the United States and its major industrial trading partners, conspicuous in 1973, was reversed by 1982. These trends in productivity and output are mirrored in real wage changes. Real wages, as predicted by neoclassical models, follow productivity improvements. In fact, the European economies did main-

Introduction XXV

TABLE OECD

1.3 Unemployment

Rates

Belgium Canada Denmark France Germany Italy Japan Netherlands United Kingdom United States

1973

1979

1982

2.9 5.3 0.7 2.3 2.6 4.8 1.4 2.8 2.5 4.9

8.7 7.5 5.3 6.0 3.8 7.5 2.1 4.1 5.3 5.8

16.7 11.3 6.9 9.2 8.0 8.8 2.3 12.9 12.0 9.7

source: See figure 1.1.

tain real wage improvements, especially in comparison to the United States. Hence, the other OECD economies—with one exception, Japan—maintained productivity and real wage growth, but accomplished that at the cost of increasing unemployment. Analysts who study European economies tend to have a different perspective from those who focus on the United States. The former are more likely to argue that the 1973 to 1982 slowdown represents an ongoing structural recession or an incomplete cyclical recovery in output. The inflexibility of real wages is viewed as part of this problem. In this respect, the Europeans' relatively "healthy" productivity growth is not applauded.2 The severity of the downturn between 1981 and 1983 has even begun to shift the focus of studies of the United States economy. Output growth over the past ten years has been anemic for the United States. That the Europeans have done even worse with respect to output growth—while maintaining productivity growth above 4 percent—indicates that slow output growth as well as slow productivity growth need to be studied. POTENTIAL CULPRITS IN THE SLOWDOWN STORY ACCOUNTING FOR THE PRODUCTIVITY SLOWDOWN

The traditional way of measuring productivity trends is through a growth accounting framework. All of the measurable inputs that are used directly (such as capital goods) or indirectly (such as research

Introduction xxvi

and development) in the production process are counted. To add up these various factor inputs, a weighting scheme must be adopted. The weights that are used are the market returns, prices, or wages of the inputs that in equilibrium are equal to the respective marginal productivity of each input. In this framework, the growth slowdown can be attributed to a slowdown in the rate of increase of the inputs themselves, a decline in the contribution or marginal return per input, or a decline in technological change or the residual term. The approach is similar to estimating an aggregate production or output supply function for society and then decomposing aggregate growth into the growth of each component factor weighted according to some index. If the economy's technology conforms to a Cobb-Douglas production function, output can be attributed to a weighted average of the quantity and quality of the various factor inputs, where the quality can be associated with the observable average productivities of the various factors. Using a translog production technology, Norsworthy, Harper, and Kunze, for example, found that labor productivity growth between 1973 and 1978 had slowed by -1.12 percent. 3 Of this they attributed - 0.54 to a slowdown in the growth of the capital-labor ratio. The total capital effect, inclusive of the above, was -0.79. Labor, in particular interindustry shifts, contributed -0.18 and the residual was -0.15. Other researchers attribute a larger percentage to a residual category. The residual reflects a slowdown in the general advance of knowledge and techniques of production which thus may be a significant factor in the labor productivity slowdown.4 Growth accounting frameworks are just that—accounting systems for measuring goods. Although they bear implications for the "causes" of the slowdown, they do not identify causation per se. In particular, if the capital-labor ratio grows more slowly than previously, that part of the slowdown will be attributed to capital. The variables that may have caused capital to grow more slowly than labor are the underlying causes of the productivity slowdown, and they are not fully identified in the growth accounting framework. Whereas there is broad agreement on how to specify the production function, the same is not true of the factor supply functions and the disequilibrium adjustment processes. In these instances the supply functions for the factor input or for the market adjustment equations may provide the necessary link to explain the growth slowdown. ENERGY PRICES AND USAGE

Attempts to identify causes of the slowdown vary according to the structural models devised to represent the causal links in the economy

Introduction xxvii

and the types of causality tests that are used. Blame has focused on energy and raw material prices because of the timing of the output and productivity decline. The presumed mechanism through which this has occurred takes various forms. First, an increase in imported raw material prices creates an adverse effect on the terms of trade. More goods and services need to be exported to pay for the same number of imports. At their higher price level, the imported raw materials cause a profit squeeze and reduce the level of output consistent with profit maximizing behavior. In turn, firms respond wherever possible by substituting now less expensive inputs for the raw materials that increased in price. The increase in the relative price of the raw material input and the associated reduction in energy usage thus feed back on other factor inputs, in particular labor and capital, through an output and a substitution effect. The decrease in output, ceteris paribus, generates a decreased demand for all other capital and labor inputs. The change in relative prices, ceteris paribus, generates a decrease in demand for inputs that are complementary and an increase in demand for inputs that are substitutes for raw materials. It is typically assumed that labor is a substitute for raw material inputs such as energy. Differentiating between skilled and unskilled labor, empirical results indicate that the substitution effect would be greater for unskilled than for skilled labor. In fact, unskilled labor and energy are assumed to be gross substitutes, so that the positive substitution effect outweighs the negative income effect. The result is that the employment of unskilled labor increases and, furthermore, the composition of employment shifts in favor of unskilled workers.5 According to this explanation for the slowdown, increased prices of raw materials created an employment shift that was magnified by ongoing demographic changes. Labor supplies were continuing to reflect the impact of the baby boom cohort and the increasing number of female workers. Thus the labor supply itself was tilting toward less skilled workers. The underlying labor supply factors are briefly discussed below. Although unskilled labor and energy are viewed as substitutes, capital and energy appear to be complements. Hence, as energy usage declined, capital usage declined as well (reflecting both the decreased level of output and the change in factor prices). The decline in capital and energy growth alone would have reduced productivity growth. The impetus to the employment of unskilled labor provided a further negative to output per manhour. This relationship, the complementarity between energy and capital, would help to explain why energy usage declined slowly rather

Introduction xxviii

than precipitously after 1973. If capital has an important putty-clay element (that is, factor ratios are embodied in the technology when first built and are difficult to change after being set), then firms could not shift quickly away from energy intensive processes without shutting down part of their capital stock. As time passed, however, the decline in energy usage accumulated as more capital vintages were built that reflected the increase in energy prices and thus embodied energy-saving technology. Since energy is only a small component of total factor inputs, in the overall economy, energy prices have only a limited effect on the overall productivity slowdown. Energy prices can have a major effect, however, in certain key sectors of the economy, such as manufacturing, public utilities, and transportation, where energy and raw materials constitute a large share of total inputs. 6 CAPITAL STOCK AND INVESTMENT

A second explanation for the productivity and growth slowdown concerns a shortfall in capital accumulation or rates of investment. In public policy discussions, this is perhaps the most frequently heard explanation for the slowdown. Labor productivity is heavily dependent on the amount of capital available to workers. The higher the capital-output ratio, the higher the rate of labor productivity. As noted above, some researchers have attributed as much as onethird of the slowdown in productivity growth between 1973 and 1978 to a slowdown in the rate of growth of the capital-labor ratio. This does not in itself, however, mean that there has been a shortage of capital and that that shortage has been a cause of the productivity slowdown.7 In order to conclude that a shortfall in capital accumulation has caused the slowdown in labor productivity growth, there should be evidence of an increase in the productivity of capital. A capital shortage presumably is defined by an increase in the return on capital. The data suggest, however, that the opposite effect has occurred; the capital stock has grown more rapidly than output over the past decade, that is, the ratio of output to capital—the average productivity of capital—has decreased. 8 It is this decline in the productivity of capital, in combination with the decline in the productivity of labor, that is behind the decline in the growth rate of total factor productivity. Although the decline in the growth rate of the capital-labor ratio has contributed to the growth slowdown, a full explanation of the problem must account for the decline in the average productivity of capital. Within the growth accounting framework, note that the effect of capital on output growth

Introduction xx ix

can be divided into changes in the quantity and quality (average productivity) of capital. The above argument states that it is the decline in the quality of capital that is at the heart of the problem. Several explanations have been offered for the apparent decline in the average productivity of capital. Attention has been devoted primarily to the effects of energy price increases and the associated decrease in energy use. Other factors include shifts in international trade, changes in final consumption patterns, and regional population shifts. In addition, pollution abatement regulation may have lowered the average productivity of capital in terms of measurable output, although this effect does not seem to have been large.9 It is argued that these factors have been associated with a loss of efficiency or an increased rate of obsolescence of the existing capital stock. Since the capital stock measure is constructed using historical costs rather than current market value and a fixed depreciation schedule, the above types of changes cause the true rate of economic depreciation to be understated. Because economic depreciation has been understated, the size of net investment flows and, hence, the size of the effective capital stock have been overstated. By reducing the return on existing capital, but not on new capital, these structural changes have driven a wedge between the marginal and the average productivity of capital. Thus, the tendency of capitaloutput ratios to grow—that is, the tendency of investment, as a percentage of national product, to remain high throughout the late 1970s— can be interpreted as an attempt by firms to construct a cost efficient capital stock based on the new array of factor prices and terms of trade. But it was only gross and not net investment that grew rapidly. According to this model, the immediate cause of the productivity slowdown can thus be attributed to a decline in net but not in gross capital accumulation.10 For policy purposes, it is important to differentiate between the return on existing capital and the return on new capital; that is, to differentiate between the average and marginal productivity of capital. The policy debate involves the issue of whether incentives should be provided to increase investment or new additions to the capital stock. The return on that new capital, in the form of higher output, is equal to the marginal and not the average productivity of capital. According to the above explanation, it is only the average and not the marginal productivity of capital that has declined. The reduced efficiency of the old or existing capital stock does not imply reduced efficiency for new capital stock additions. Unfortunately, direct testing of this hypothesis is very difficult and has not been done. The problem is the difficulty of estimating the

Introduction XXX

value of the capital stock and, particularly for the 1973-83 period, the rate of economic depreciation of the capital stock.11 LABOR FORCE

It does not seem likely that factors emanating from the labor market could be important independent factors causing the productivity slowdown. 12 On the other hand, underlying demographic factors in the form of rapid labor force growth created an environment that required rapid output growth. When rapid output growth did not occur, the increase in the labor force was largely employed, but at low real wages and low productivity. Labor force factors are very important in understanding the presumed productivity decline in the late 1960s and early 1970s. Whereas the labor force grew at only a 1.29 percent annual rate between 1948 and 1965, it grew at a 2.19 percent rate between 1965 and 1973. See table 1.4. In addition, the percentage of youth in the labor market increased rapidly during the 1960s and early 1970s. Since we are attempting to explain the change in productivity growth, it is the change in the labor force growth that matters. The changing demographics in the labor force between 1965 and 1973 are thus crucial in explaining the behavior of the productivity growth rate in that period. Thereafter, the labor force grew rapidly but only slightly faster than in the 1965 to 1973 period. Consequently, the sharp deterioration in productivity that occurred after 1973 is not attributable to labor force demographic factors in themselves. Nevertheless, by historical standards, the labor force growth rate has been very high even since 1973, with most of the growth consisting of young and female workers. Moreover, an increase in the number of illegal aliens is believed to have rendered the observed labor TABLE 1.4 Annualized Growth Rate of Labor Force: 1948 to 1983 with Projection to 1990 1948 1965 1973 1983

to to to to

1965 1973 1982 1990P

1.29 2.19 2.28 1.48

SOURCE: U.S., Bureau of Labor Statistics, Employment and Earnings 30, no. 1 (January 1983); U.S., Bureau of Labor Statistics, Bulletin 2121, Economic Projections to 1990 (March 1982). NOTE: P = projected.

Introduction xxxi

force growth understated. The continued rapid growth in the labor force, not matched by a concomitant increase in the net capital stock, resulted in a slowdown in the growth of the capital-labor ratio. More generally, to the extent that the economy's potential output grew less rapidly after 1973 than before 1973, the continued high growth rate of the labor supply acted as a depressant on labor productivity growth. Two important components of labor force growth are acyclical: the population age structure and long-run trends in patterns of work for males and females. In addition, there is a strong trend element in potential output growth, often attributed to changes in technological growth, that appears to be independent of the specific growth rates of the factor inputs such as labor. During the 1970s, the underlying labor supply pressures created an imperative for continued rapid potential output growth. When potential output was negatively affected by such factors as oil shocks and long and deep business downturns, and when the capital-labor ratio declined, continued high growth rates in the labor supply resulted in slower productivity growth. In the 1980s, the labor supply trend environment will change dramatically. Specifically, over the next decade the labor force will grow much less rapidly, and the percentage of the labor force consisting of young workers will decline significantly. Consequently, the labor supply can have an important and positive causal role in allowing faster labor productivity growth in the 1980s.13 RECESSIONS AND INFLATION AS CAUSAL FACTORS

The notion that the cyclical downturns in business activity are responsible for the decline in productivity must be treated carefully. At least two cyclical explanations for the productivity slowdown are possible. The first is the traditional one which seeks to adjust productivity growth for deviations in capacity utilization or for deviations by unemployment rates from their equilibrium levels. The second involves changes in the equilibrium rates themselves that are associated with the business cycle. An at least superficially appealing viewpoint is that contractionary monetary and fiscal policies resulting in the recessions of 1974-75, 1980, and 1981-82 caused part of the productivity decline. The traditional Keynesian view would interpret the high unemployment and low output growth as signaling slack aggregate demand. Acccording to this type of model, demand growth was not only below par during the obvious recessionary years (when output was actually declining) but also continued below average during the recovery. Chronic slack demand would eventually cause potential output to grow more slowly as investment in plant and equipment and

Introduction xxxii

embodied technological change declined as well. Given the spillover from a demand shortfall to a low potential output growth rate, it is difficult to separate supply and demand arguments.14 There are a number of factors that, at least for the United States, suggest flaws in the chronic demand slack viewpoint. Unemployment did decline to pre-oil shock levels in 1979. If the low unemployment level of 1979 indicates that aggregate demand as a percentage of potential had returned to 1973 values, then any demand and hence any resulting productivity shortfall in the middle 1970s had been recouped by 1979. In other words, if the economy had returned to its potential output level by 1979, then the secular slowdown between 1973 and 1979 could not be explained by recessions or cyclical downturns in factor utilization rates. In addition, price increases accelerated in the late 1970s. In a strict Keynesian demand framework these general price increases are indicative of excess demand pressure. Some of the inflation pressure could be attributed to "cost-push" factors such as the raw material price shock. The concomitant occurrence of rising inflation rates and declining (and reasonably low) unemployment rates, however, is the quintessential ingredient of aggregate demand overheating. The demand argument is particularly weak if one attempts to interpret it as having the usual policy implications. In particular, if demand is slack, expansionary monetary and fiscal policies might be useful. On this point the evidence is strongly negative. The rate of inflation was already increasing so that expansionary monetary and fiscal policies, especially in 1978 and 1979, contributed to and validated those high inflation rates. In this environment, demand pressure was unlikely to have had a positive spillover into increased aggregate supply. Consequently, attempts to use expansionary demand policies led largely to higher inflation rates and not to higher levels of output (or potential output or both). Observed levels of output or GNP can represent: equilibrium points when output demand equals supply; supply constrained points when the economy is operating below potential; or demand constrained points when demand is greater than supply. Declining output growth is thus compatible with any combination of these three possible outcomes. The evidence suggests that between 1973 and 1979, output growth was constrained, in large part, by supply factors. The notion that it was potential output growth that had slowed between 1973 and 1979 is also supported by the arguments advanced above—namely, the changing array of factor input prices, increased relative energy prices, increased relative employment of low-skilled labor, and decreased capital-labor ratio growth rates. On the other hand, there is little doubt that an important compo-

Introduction xxxiii

nent of the output growth slowdown between 1979 and 1983 has been the recessions of 1980 and 1981-82. Utilization rates are still considerably lower than they were in 1979, and thus actual output is considerably below potential output or the economy's aggregate supply. In addition, both labor productivity and total factor productivity growth have slowed since 1979, in part because of the recent recessions. Although manhours have been reduced by increasing unemployment, many workers are treated as quasi-fixed factors of production. The above discussion focuses on the output shortfall caused by having the economy operate below capacity. The capacity rate compatible with full utilization or the unemployment rate compatible with full employment is defined as that rate at which the inflation rate is stable, neither accelerating nor decelerating. For example, if the unemployment rate is 9 percent and the equilibrium unemployment rate is 7 percent, the labor input shortfall due to cyclical factors is 2 percent. A second avenue through which changes in utilization or unemployment rates can influence output and productivity growth is through changes in the equilibrium rates themselves. For example, it is generally agreed that whereas the equilibrium unemployment rate was approximately 5 percent in the late 1960s, it is between 6 and 7 percent today. Of that 2 percent increase in the equilibrium rate, approximately 1 percent can be attributed to demographic and labor market factors. In other words, an unemployment rate of 6 percent today means approximately the same, in terms of labor market slack and downward pressure on wage increases, as did a 5 percent rate two decades ago. The other 1 percent increase in the equilibrium unemployment rate arises from the tendency of inflation rates to accelerate earlier in a recovery for reasons independent of labor market tightness. Several different explanations have been offered for this development. Episodic events such as the oil shocks of the 1970s have received most of the attention for the increase in the equilibrium rate of unemployment. These discrete price shocks have also highlighted the potential role of inflation itself as a cause of the increase in the equilibrium rate. Recent econometric time series studies have found some evidence for the notion that changes in inflation rates cause productivity growth rates to change in the opposite direction. These studies have not attempted to uncover the mechanism through which this effect takes place; rather, they have concentrated on the econometric time series problem of causality. Hence, it is unclear whether the effect works through a change in the unemployment rate or directly through output. 15 There are, however, potential conceptual links between inflation

Introduction

xxxiv

and equilibrium unemployment rates or, more specifically, links between the variance in wages and prices and equilibrium unemployment rates. Typically, an increase in wage and price variation accompanies higher rates of inflation. If this explanation were to hold, then the long-run Phillips curve or tradeoff between inflation and unemployment (or the variance in inflation and unemployment) would be upward sloping rather than vertical as is true in the standard neoclassical model. A link between inflation variance and equilibrium unemployment rates can be explained in several different ways. In an economy where product and labor market contracting is pervasive, higher rates of price variation result in an increase in contracting costs. More specifically, for fixed contract periods, an increase in the variance in wages and prices will lead to higher rates of unemployment of labor (or capital, or both) over the length of the contract. Although contracting yields important efficiency gains, it also generates costs, costs that are rooted in the rigidity of the wages and prices set by contracts.16 The greater the underlying inflation rate, the greater the variation in market clearing wages and prices and hence the larger the discrepancy between the fixed and the market clearing set of wages and prices. Inefficiencies, and specifically unemployment rates, tend to be positively correlated with the gap between actual and market clearing wages and prices.

SOME CAVEATS ON THE VIRTUES OF FASTER GROWTH Some of the factors that affect overall economic and productivity growth can be influenced through public policy. A maintained assumption in this volume is that faster economic growth is desirable. This assumption, however, carries with it three caveats. The first is that all policies, whether or not geared to increasing growth, have associated income distribution effects. To the extent that the desired policy is only to increase growth rates, changes in the income distribution should be minimized. This may not be simple to accomplish. Using the private market system to increase growth means that increased incentives for savings and investments targeted toward business plant and equipment may have to be developed. These incentives would be largely in the form of increases in after-tax rates of returns to marginal increments in savings and in the capital stock. Since the wealthy members of society do a disproportionate percentage of the savings and investment in plant and equipment, increased rates of returns, even on the marginal units, suggest a tilt in the income distribution toward the higher-income individuals. Policy measures, however, that are efficient and Pareto optimal in

Introduction XXXV

strict economic terms require that no members of society be made worse off in absolute terms while others are made better off. The theory suggests that lump sum transfers be made from those who benefit from a policy to those who lose because of that policy. These types of transfers, which do not in themselves distort savings and investment rates OT the labor supply, are difficult to construct. Virtually all of the tax systems currently in effect create disincentives for those factor inputs (capital and labor) that are the building blocks of growth. 17 Consumption taxes with the same gradient of progressivity found in the current income tax structure are one of the possible partial escapes from the dilemma of how to increase savings rates without altering the income distribution. To compensate those at the bottom of the income distribution, special programs targeted toward this group may be necessary. These types of programs, however, are currently under attack. Social welfare programs, for example, do not themselves improve the prospects for economic growth, and the deficits or taxes created by these programs raise interest rates or reduce savings rates or both. The end result is to crowd out investment. A major problem for policymakers is to modulate pro-growth policies so that changes in the income distribution are minimized. The second caveat is that many factors that are involved in the quality of life and economic well-being cannot be quantified and hence do not enter the economic data used to account for and measure economic growth. In addition, where such externalities are present, it is difficult to determine efficient output levels. In efficient markets, relative prices convey all of the information that is needed to allocate factor inputs to maximize output. Where a market is lacking or imperfect, the efficient relative prices are missing. Alternative schemes must therefore be adopted to provide this allocation function. Shadow prices are needed to value resources in order to mimic the price mechanism generated by extant markets. True economic growth rates include goods and services from imperfect markets as well as the traditional market goods. For example, income growth is generated from a capital stock and that capital stock includes factor inputs such as government-owned timber lands and clean air. Clean air is certainly an element in the health and thus value of the labor input. Those factors, if consumed in current production, may actually lower long-run growth potential. This issue has been debated at length in the press and in Congress. The ferocity with which this debate is conducted illustrates the inherent difficulties in deciding upon the value or price to be attached to goods from imperfect markets.

Introduction xxxvi

Third, economic growth itself provides an allocation function. Specifically, the rate of economic growth measures the rate at which the economy chooses future over current consumption. Intergenerational transfers are performed by the capital markets. In the textbook equilibrium, the rate of interest equals the rate at which consumption in the future period must be increased to compensate for a reduction in consumption today. A country can be in equilibrium at either high or low rates of economic growth. A high rate of time preference means that a country, to postpone a unit of current consumption, must receive a large increase in future consumption. This position will result in a relatively low rate of economic growth. It is depicted by point a in figure 1.3. Curve TT represents the time preference of the country, and its steep slope at the point of equilibrium indicates a high rate of time preference. Curve PP' is the production possibility frontier of the economy and depicts its technological capability of turning capital or net investment into future consumption. At equilibrium point a, the marginal rate of productivity of capital is also high and equal to the high rate of time preference. The resulting pattern is given by current consumption c, and future consumption/,. 18 The concern over economic growth reflects an interest in improving future consumption streams even at the cost of reducing current consumption. This indicates that the rate of time preference of policymakers, if not for the country as a whole, has shifted more toward the shape of curve TV. The result is less current consumption c2 and higher future consumption f 2 . The policy issues created by changes in the marginal productivity of capital can also be evaluated in terms of figure 1.3. Suppose it were decided that the marginal productivity had, in fact, declined. The lower productivity of capital would signal a lower return to savings and investment. For a given social welfare function of the shape depicted in figure 1.3, such a decline would yield a lower desired equilibrium growth rate. Additional incentives to savings and investment would not be needed. If the government pursued a fixed output growth target, irrespective of the return on capital or the cost in terms of current consumption, however, the opposite would hold. The reduced "bang-for-the-investment-buck" would mean that even faster capital accumulation would be needed to satisfy the growth target. The opposite would hold, if the marginal productivity of capital had actually increased. Clearly, higher growth is not always preferable to lower growth. As society chooses higher growth paths, that is, higher / and lower c values, it becomes increasingly costly in current consumption to attain

Introduction xxxvii

FIGURE 1.3 Transferring Income Potential Across Time

Current Period

PP1 = society's production possibility frontier. Society, using efficient production techniques, can produce any combination of current and future period income along PP 1 . TT' = society's preference between current and future period income.

higher growth. In moving upward and to the left along PlP, the marginal productivity of capital declines. Given the underlying assumption of diminishing returns, it is clear that society faces an increasingly difficult choice: Not only do most societies prefer current to future consumption, but also the tradeoff becomes increasingly unfavorable at higher growth rates. CONCLUSION Although many factors have contributed to the productivity and output growth slowdown, we have discussed four of the most important.

Introduction xxxviii

First, the series of raw material price shocks and particularly the oil shocks of 1973 and 1979 resulted in a reduction in potential output and an array of factor prices compatible with a lower labor skill and productivity mix in production. Second, a number of factors, including the rise in relative raw material prices, caused the quality of the capital stock to decline. Third, continued rapid growth in the labor force, not matched by a concomitant increase in the net capital stock, resulted in a slowdown in the growth of the capital-labor ratio. Fourth, the steady rise in inflation in the context of an upward sloping longrun Phillips curve resulted in a decline in the economy's potential output compatible with nonaccelerating inflation. If these factors have indeed been important, the near- to intermediate-term outlook for growth and productivity appears favorable. First, outside of the short-run cyclical effect, labor market trends should support faster productivity in the 1980s. The peak age group will be in its most productive years, and the retirement problem implied by the demographics will still be a decade away. In addition, the labor force growth, after exhibiting 2.2 percent average growth over the past seventeen years will decline to approximately 1.4 percent annual growth between 1983 and 1990. Capital-labor ratio growth rates will thus improve even at current rates of investment. If net capital accumulation also improves, capital-labor ratios will benefit further. Second, raw material prices appear more favorable, although the outlook is very uncertain. To an extent, any relative or real price reduction in raw materials should lead to an unwinding of the supply shock effects of 1973 and 1979. The output effect should be positive as a result of an "implicit tax rate decrease" from OPEC.19 Substitution effects are more complicated but also strongly positive. In the putty-clay world, where incorrect factor-price vintages become obsolete, both very new and old vintages would have to be depreciated more steeply. For example, if the oil price settled at $29 per barrel, new investments based on $38 per barrel would suffer a decline in market value. In fact, the newest and oldest investments would have economic depreciation greater than accounting depreciation. Old investments would recover some of their previous lost value; some of the capital made obsolete by the oil price increase could be returned to use. On balance, the effective capital stock would increase, thus generating increased output and, for a given labor supply, increased productivity as well. In addition, the tilt toward less skilled labor would be reversed, and this would also cause productivity to rise. Third, inflationary expectations have been revised downward, probably for the first time in a decade. Although the mechanism through which inflation affects potential output and productivity is still not

Introduction xxxix

well understood, the empirical evidence supports a negative causal effect of inflation on economic growth rates. Finally, the adjustment path that the economy follows over the next several years is important. Any secular increase in productivity growth rates requires output to be close to its equilibrium level compatible with stable inflation rates. Increased savings and investments will obviously increase future growth rates whether or not they caused the slowdown. A fiscal and monetary policy mix that features a high "full employment" deficit will act to dampen long-run growth rates in the private sectors of the economy.

NOTES 1. Commission of the European Communities, "Annual Economic Report 1982-83," European Economy, no. 14 (November 1982); Organisation for Economic Co-operation and Development, Main Economic Indicators, December 1982. 2. For a discussion of the experience of some European countries and Japan, see J. Waelbroeck and H. Glejser, eds., "International Seminar in Macroeconomics," European Economic Review 18, nos. 1 - 2 (May/June 1982). The role of real wages has been stressed by Jeffrey D. Sachs, "Wages, Profits, and Macroeconomic Adjustment: A Comparative Study," Brookings Papers on Economic Activity 2 (1979): 269-319. 3. J. Randolph Norsworthy, Michael J. Harper, and Kent Kunze, "The Slowdown in Productivity Growth: Analysis of Some Contributing Factors," Brookings Papers on Economic Activity 2 (1979): 387-442. 4. See, for example, Edward F. Denison, Accounting for United States Economic Growth, 1929-1969 (Washington: Brookings Institution, 1974), and "Effects of Selected Changes in the Institutional and Human Environment upon Output Per Unit of Input," Survey of Current Business 58 (January 1978): 21-44; and John W. Kendrick, Postwar Productivity Trends in the United States, 1948-1969 (New York: National Bureau of Economic Research, 1973). 5. Energy effects on productivity and potential output have been stressed in a series of articles by Ernst R. Berndt, Dale W. Jorgenson, Robert H. Rasche, and John A. Tatom. See, for example, Berndt and David O. Wood, "Engineering and Econometric Interpretations of Energy-Capital Complementarity," American Economic Review 69, no. 3 (June 1979): 342-54; Berndt, "Energy Price Increases and the Productivity Slowdown in United States Manufacturing," in The Decline in Productivity Growth, Conference Series no. 22, Federal Reserve Bank of Boston (1980), pp. 60-89; Barbara M. Fraumeni and Jorgenson, "Capital Formation and U.S. Productivity Growth, 1948-1976," in Productivity Analysis: A Range of Perspectives, ed. Ali Dogramaci (1981), pp. 49-70; Edward A. Hudson and Jorgenson, "Energy Prices and the U.S. Economy, 1972-1976," National Resources Journal 18, no. 4 (October 1978): 877-97; and Rasche and Tatom, "Energy Price Shocks, Aggregate Supply and Monetary Policy: The Theory and the International Evidence," in Supply Shocks,

Introduction xl

Incentives and National Wealth, ed. Karl Brunner and Allan H. Meltzer, 14 (Spring 1981): 9-94. 6. See, for example, Berndt, "Energy Price Increases"; and Jeffrey M. Perloff and Michael L. Wachter, "A Production Function-Nonaccelerating Inflation Approach to Potential Output: Is Measured Potential Output Too High?" in Carnegie-Rochester Conference Series on Public Policy, ed. Karl Brunner and Allan H. Meltzer, 10 (1979): 113-67. 7. Norsworthy, Harper, and Kunze, "The Slowdown in Productivity Growth." 8. For a statement of the argument against capital shortfall, see Barry P. Bosworth, "Capital Formation and Economic Policy," Brookings Papers on Economic Activity 2 (1982): 273-317. 9. Marvin H. Kosters argues that the "new" regulation policies of the 1970s (e.g., clean air and water) did not themselves impose a large penalty on productivity growth. The current system of regulations, however, could be accomplished with greater efficiency through a straightforward reliance on mechanisms that mimic the market price system ("Government Regulation: Present Status and Need for Reform," in Toward a New U.S. Industrial Policy? ed. Michael L. Wachter and Susan M. Wachter [Philadelphia: University of Pennsylvania Press, 1981], p. 321-42). 10. This point has been made by Martin N. Baily, "Productivity and the Services of Capital and Labor," Brookings Papers on Economic Activity 1 (1981): 1-50. 11. In suggesting this basic hypothesis, Martin N. Baily, for example, used an indirect approach in noting that the decline in the stock market's valuation of the capital stock occurred at the same time that energy prices were increasing sharply. Baily, "Productivity and the Services of Capital and Labor." 12. Jeffrey M. Perloff and Michael L. Wachter, "The Productivity Slowdown: A Labor Problem," in The Decline in Productivity Growth, pp. 115-42. 13. The fact that policy is concerned with both output and productivity growth is particularly relevant when considering labor market policies. Most such policies, stripped of their detail, have the intended effect of increasing the size of the labor force. For example, training programs are designed to prepare low-skilled individuals, who are unemployed or out-of-the-labor-force, for employment in low-skill occupations. Similarly, retraining programs for those displaced by technological change or international trade competition are geared to returning workers to the same type of market from which they were displaced. In these instances, the average newly employed worker, even when trained or retrained, will be of below-average skill. Consequently, successful programs will increase output but decrease observed productivity. 14. The role of cyclical factors is stressed by Michael Bruno and Jeffrey Sachs, "Input Price Shocks and the Slowdown in Economic Growth: The Case of U.K. Manufacturing," Review of Economic Studies 49, no. 159 (1982): 679706; and Michael Bruno, "World Shocks, Macroeconomic Response, and the Productivity Puzzle," National Bureau of Economic Research Working Paper no. 942 (July 1982).

Introduction xli

15. Peter Pauly and Michael L. Wachter, "The Culprit in the Growth Slowdown: Price Shocks, Inflation, or Monetary Policy," mimeo, 1983. 16. For a discussion of an upward-sloping, long-run Phillips curve, see Stephen A. Ross and Michael L. Wachter, "Wage Determination, Inflation and the Industrial Structure," American Economic Review 63, no. 4 (September 1973): 675-92. For recent empirical evidence, see Richard Startz, "Unemployment and Real Interest Rates: Econometric Testing on Inflation Neutrality," American Economic Review 71, no. 5 (December 1981): 969-77. 17. See below, chapter 8. 18. Some of these issues are stressed by William D. Nordhaus, "Policy Responses to the Productivity Slowdown," in The Decline in Productivity Growth, pp. 147-72. 19. This book does not cover policies with respect to the energy markets themselves. On the basis of results presented in the first Wharton/Reliance Conference, three policy measures with respect to the oil market can be supported. First, the decontrol of energy prices has been largely accomplished and has been and remains imperative. Price controls that had held down the price of energy postponed the needed adjustment in the demand for oil and energy in general. That has largely occurred and seems to have contributed, as expected, to energy conservation on the demand side. See, for example, Robert S. Pindyck, "Energy, Productivity, and the New U.S. Industrial Policy," in Toward a New U.S. Industrial Policy? pp. 176-201. To buttress that development, a tariff on imported oil would be valuable, especially at a time of at least short-run instability in OPEC. This would be an incentive to domestic energy production. In addition, the build-up of a strategic reserve would serve as an important buffer given the political instability in many of the oil-producing countries. If the real price of raw materials holds steady, it will contribute to an environment that would be conducive to stronger productivity growth. See, for example, the paper by William W. Hogan, "Energy and Security Policy," in Toward a New U.S. Industrial Policy?, pp. 202-21.

Introduction xlii

PART ONE VIEWPOINTS ON STRATEGIES FOR GROWTH

1.

RESPONSES TO THE SLOWDOWN IN GROWTH Reginald H. Jones Many years ago when I was between managerial assignments at General Electric I was given a one-man research project for the president of the company. The charter for that endeavor was so broadly written that when my associates asked me what I was doing, I blithely replied, "Oh, looking at the universe and other things." I am reminded of that study when I reflect on the topics tackled by the Wharton/Reliance Symposiums. No one can accuse us of being small thinkers. The first Symposium addressed the subject "Toward a New U.S. Industrial Policy?" and the second, "Removing Obstacles to Economic Growth." Before I tackle this second subject, it seems worthwhile to recall what was said at the first Symposium and then to comment on some of the significant changes we have witnessed in the intervening two years. The first Symposium was held in March 1981, the centennial year of the founding of the Wharton School of the University of Pennsylvania. When Joseph Wharton established the school in 1881, the United States launched into a century during which it rose swiftly to a position of economic, military, and political leadership in the world. And that rise was supported, in fact driven, by a broad consensus on the lightness of our goals, values, policies, and actions. We were a confident people. But as we met in 1981, what a difference there was between the faith and unity of our people the preceding century and the skepticism and dissension of America in the spring of that year. At that first symposium I remarked, "There will always be differences in a democracy, but today our only shared belief is that America is over the hill. And judged objectively by our declining competitiveness in world markets, our loss of influence in world affairs, and our inability to deal with the most obvious national perils such as the energy problem, it is hard to disagree with the world opinion that the United States is not what it used to be." 1

Responses to the Slowdown in Growth 3

We had been struggling to deal with a number of economic discontinuities: first, the decline in productivity, and second, the decline in capital formation as witnessed by the reduced stock of physical capital per worker in this country. Third, our economy was becoming increasingly internationalized as exports and imports amounted to 24 percent of our national economy in contrast to 12 percent just ten years earlier. The fourth discontinuity was that OPEC (the Organization of Petroleum Exporting Countries) had ended the long era of cheap energy. Then too, we had a major problem with chronic inflation that was rising to still higher levels. All of these structural changes supplemented the normal dynamics in an evolving industrial society—the long trend toward services, the demographic changes, the shifts in comparative advantage in world trade, the changes in consumer preferences, and the redefinitions of social objectives that alter our mix of industries and send some regions into sharp decline while others surge ahead. It was against that backdrop that we discussed approaches to industrial policy. In summing up that first Symposium, Daniel Yankelovich made these comments. The message of this Symposium is that, after several years of confusion and stock-taking, the nation's leadership is no longer as divided and unresponsive as it was in the 1970s. It has passed successfully through the first phase of the "working through" process. It acknowledges that there was something wrong with America's economic policies in the 1970s. It knows that we cannot continue to live beyond our means. At the same time, it knows that Americans do not want to settle for less, to resign themselves to economic stagnancy just because the challenge is more difficult than it was in the postwar era. It knows that most Americans will support a program of economic revitalization, if the sacrifices to launch it are fair and equitably distributed. This Symposium did not produce a new industrial policy or a new economic program. What it did do is advance the thinking on which such programs must be based. And that we must judge as a significant accomplishment.2

There have been some significant changes in the economic conditions that obtained at the time of the first Symposium. On the favorable side, remarkable progress has been made in the fight against inflation. Instead of double-digit annual rates, we are witnessing changes up and down each month that are measured in the tenths of a percentage point. Interest rates that crippled both consumer spending and investments in plant and equipment have fallen drastically with expectations that they will continue to decline somewhat in the months immediately ahead. Conservation and recession have weakened the stranglehold of the oil exporters, and energy prices have

Viewpoints on Strategies for Growth 4

slowed their sharp rise. The national economy has bottomed out after three years of lackluster performance, and there is increasing evidence of a slow but steady recovery. The financial markets are signaling renewed confidence in our economic future. The Social Security compromise legislation, while not all that was hoped for, indicates a realization that we must put some curbs on our governmental spending programs. But there are still too many severe and unresolved problems to permit complacency. We have yet to face up to the problems of our Federal government deficit spending. Martin Feldstein has pointed out that without legislative action the budget deficit will remain at about 6 percent of the gross national product. Since we customarily save about 7 percent as a nation, such deficits will take almost all of this and leave little for the capital formation that is needed to enhance productivity and international competitiveness. Sizeable deficits put upward pressure on interest rates, thus keeping the dollar high and damaging our trade balances. In just the last twenty years we have seen government spending on domestic programs, excluding national defense and interest, rise from 8 percent of GNP to over 15 percent of GNP. Medicare alone cost us $10 billion in 1973, $50 billion this year, and is projected to grow to $100 billion in five years. Such figures point up the magnitude and urgency of the task of tackling governmental spending. We have placed a far greater burden on monetary policy than on fiscal policy in our fight against inflation, and this has cost us dearly in American export competitiveness. According to the Institute for International Economics, the resultant strong and overvalued dollar has cost more jobs and created more unemployment than have the crises in the steel and the automobile industries combined. I am greatly concerned that the lack of economic growth throughout the world has driven nations to export their own unemployment. This is done through a host of subsidies and incentives to their own manufacturers with accompanying nontariff barriers to protect home markets. The world stands on the brink of a trade war and an era of protectionism. And all this at a time when the United States has no clearly defined international economic policy. We take actions without regard to their international trade consequences, and when we do address a trade problem, it is simply on an ad hoc basis. We have problems not only in international trade but also in international finance. The problems of debtor nations, overextended commercial banks, and the funding requirements of our international financial organizations are so well publicized as to need no further comment here. As a nation we still have been unable to develop a long-range

Responses to the Slowdown in Growth 5

energy program, which is vital to our economic health into the next century. Here too, we are overwhelmed with contentions on shortrange problems. Secular changes in our demographics have presented us with extremely difficult employment problems. Between 1970 and 1982 we created 21 million jobs in our economy, an increase of more than 25 percent, yet we have unemployment in double-digit figures. The maturing of the baby boom generation coupled with an increase of almost 50 percent in the number of employed women at the same time that some of our older manufacturing industries were declining has left us with pockets of severe unemployment. With that recitation of some of our troubles there can be little argument that the topic "Removing Obstacles to Economic Growth" was indeed timely and well chosen. For the easing if not the full solution to most of the problems I have just outlined lies in higher levels of economic growth. Michael Novak has coined the term democratic capitalism to describe the political economy of the United States. He argues that democratic capitalism is a unity of three systems: (1) a political system, namely, democracy; (2) an economic system, namely, a market and incentive mixed economy; and (3) a moral-cultural system, namely, a liberal and pluralistic culture. To my mind, we shall need to look for modifications in all three of these systems if we are to achieve our potential for economic growth. It will not be enough to concern ourselves solely with political and economic considerations. Principally because of changes occurring in our moral-cultural system during the affluent period following World War II, we shifted our national emphasis from the creation of wealth to the distribution of wealth. We changed our demands from equality of opportunity to equality of outcome or result. Entitlements shifted from a privilege accorded by a beneficent society to a right. Our overly responsive government was quick to see the political advantages of this so-called sharing of the wealth, but slow to see the need for conditions that support the growth of wealth. These shifts in our culture have now placed our economic system in danger, for it fails to meet these heightened expectations of the electorate. The period during which we ate both the corn crop and the seed corn is over. Both business and responsible government leaders realize this, despite some of the rhetoric from Washington. But the development of special interest politics has reached such levels of efficiency that only an informed and outspoken majority of the electorate can effect the needed changes. To secure such action by the voting public may be the most difficult challenge facing us. Irving Kristol's so-called new class made up of the more left-leaning "intel-

Viewpoints on Strategies for Growth 6

lectuals" are in positions of influence in government, the arts, the media, and academia. They see change in our system to their advantage. Only recently have we seen them challenged successfully by more "centrist" or conservative thinkers and opinion leaders. The battle is engaged but the outcome far from certain, and it deserves our best efforts. I am also concerned that we have yet to develop in the United States a truly effective working relationship between government and business, which would be of inestimable value in our quest for economic growth. In a book published recently, Joseph L. Bower of Harvard contrasts the two styles of management—political management in government, and what he labels technocratic management in business. We use political management to distribute costs and benefits of our society's activities so that we can also enjoy stability and a sense of legitimacy. . . . [We use technocratic management] to achieve a higher degree of efficiency in domains where we are less concerned with equity or freedom. . . . Our compelling present need is to understand how to use the two different systems of management to improve the performance of the society while preserving the integrity and character of our institutions. 3

And near the end of his book he makes this important point: In an era when equality has achieved a meaning almost synonymous with equity . . . it is probably dangerous to suggest that it is good that political management systems and technocratic management systems are so very different. But in a way that is the most important conclusion of this book. The genius of the constitutional fathers is that they anticipated and valued the diversity of U.S. society at the same time that they distrusted the ability of any central technocratic structures to manage the affairs of the society. Hence they sought to provide the potential for strong political leadership of the country side by side with unfettered management of technocratic institutions. [P. 259]

It seems to me that it is our responsibility today to insure that politicians do not place fetters on business and that they alter their priorities between the creation and distribution of wealth. But it is incumbent on businessmen to recognize the difficulties facing our political leaders, to assist them in every possible way to achieve public acceptance for the needed changes in public policy, and to perform their own economic function in an exemplary fashion. To accomplish these objectives our business leaders must be able to anticipate public policy issues and not simply react to them. They must be open and frank, available to the media, and capable of convincing our citizenry that their positions are in the national interest and are not merely self-

Responses to the Slowdown in Growth 7

serving. They must seek allies in labor, the professions, and academia. They must be skilled negotiators and adept in the art of compromise. I have one further observation to make as we consider the climate most conducive to economic growth. For more than a decade I have been sorely troubled to see us develop into the most litigious society in the history of civilization. True, we are an adversarial society rather than a consensus society and I see no change in that. Our national psyche thrives on combat. But I deplore our tendency to take all our differences to the courts. We have so overloaded our judicial system that the result is often injustice rather than justice. And still we continue to graduate more lawyers who thrive on this nonproductive conflict. In 1970 we graduated 17,000 electrical engineers and 17,000 lawyers, but in 1980 we graduated 17,000 electrical engineers and 34,000 lawyers. While it is true that lawyers are needed to lubricate the wheels of progress, regrettably they are more concerned with the distribution of wealth than with its creation. Our judicial system encourages resort to the courts for settlement of disputes because it permits contingent fees and allows legal costs to fall where they may rather than to be charged to the loser. While we shall wish to retain the egalitarian features of our system, we must improve judicial management and place restraints on duplicative procedures. I am encouraged to learn that the Supreme Court will shortly issue changes in the Federal rules of civil procedure to improve our methods of handling litigation. We must find ways to reduce nonproductive litigation through negotiation, mediation, arbitration, and compromise. As we study the workings of our legal system let us also consider the advisability of modifications in our antitrust stance. Existing legislation and its applications are holdovers from a far different time. We seem to be more concerned today with protecting competitors than with protecting consumers. We forget that competition is no longer domestic, it is worldwide. While our government spent eleven years trying to break up IBM, one of our most successful high technology companies, other nations were subsidizing IBM's competitors in an effort to gain an increased share of the market. Ask yourself what other government would break up the most technically advanced telephone system that offers the finest and fastest service on the globe. And look at our difficulties in competing with the export consortia formed in other nations. Ask yourself how we rationalize the fact that with such troubled industries as steel we disallow cooperation among the leaders of the industry. They cannot even discuss such sensitive subjects. We are still hung up on the old belief that bigness is badness despite the findings of such economists as Oliver Williamson.

Viewpoints on Strategies for Growth 8

If all of this leaves you with the feeling that there is much to be done if we are to achieve economic growth, then allow me to repeat the quotation from Margaret Thatcher that I used to end the keynote address of the first Symposium: "The road to recovery is paved not with good intentions but with hard decisions." I believe we are capable of the leadership required to make those decisions.

NOTES

1. "Toward a New Industrial Policy," in Toward a New Industrial Policy?, ed. M. Wächter and S. Wächter (Philadelphia: University of Pennsylvania Press, 1981), p. 9. 2. Yankeiovích and Larry Kagan, " 'Working Through' to Economic Realism," in Toward a New Industrial Policy?, p. 514. 3. Bower, The Two Faces of Management: An American Approach to Leadership in Business and Politics (Boston: Houghton Mifflin, 1983), p. 3.

Responses to the Slowdown in Growth 9

2.

REMOVING STRUCTURAL BARRIERS TO GROWTH Alan Greenspan

We are now well into the first phase of a recovery, but one that essentially reverses a major inventory liquidation and creates, as a consequence, a significant rebound. Because this rebound, in and of itself, creates higher levels of production, it also creates higher real income which in turn brings consumer markets with it. The economy thus has considerable momentum behind it, and I believe that those who fear that it is going to peter out are incorrect. The recovery is not going to be reversed in the near future, because the process is still only in its initial phase. The uncertainty arises when we get into the next phase of the recovery. To date, the recovery process is essentially running on what I call short-lived assets, that is, inventory, soft-goods consumption, and elements within the economy that are largely unrelated to addressing the long term. To carry the recovery into 1984, we have to start into the longer-lived assets, mainly capital goods. In a very complex industrial society such as ours, there can be no major expansion and economic activity that does not in effect increase the longer-lived asset base. This increase in the capital stock is needed in order to facilitate economic growth and performance over, for example, the next 10 to 25 years. One can find the reasons for the shortfall in economic activity in the capital goods market, specifically, in the areas of replacement and modernization. The slow rate of activity has clearly had a major impact on the failure of capacity expansion to take hold. You do not need plant and equipment facilities if the demand for your product is not there. In the areas where cost-saving capital equipment is critical, the rate of operation in the economy is the major determinant of investment demand. The reason is that there is a whole series of rates

Viewpoints on Strategies for Growth 10

of return associated with replacing a low-cost facility with a high-cost facility. The risk in meeting those needed rates of return is really quite modest—but only provided you know that the facility is going to work or operate. It makes no sense to replace a high-cost nonoperating facility with a low-cost nonoperating facility. In effect, that is the reason why the economy and indeed the whole capital goods market caved in during 1981-82. Therefore it is fairly obvious that one necessary condition to keeping the recovery going is to maintain the momentum of the economy itself. That leads us to two major constraints that are relevant to expansion of the economy. The first is the abnormally high level of interest rates, specifically long-term rates. The second and related constraint is the decline in liquidity and the excessive debt which hobbles business balance sheets and depresses business investment. The first question, that of long-term interest rates, is largely an issue of inflation expectations. I know there are a lot of people who say that the real long-term interest rate is high. I disagree; although if I did not disagree, I would not know how to prove it. Note that the definition of the real long-term interest rate is not the nominal interest rate adjusted for the current inflation rate. That is, it is not the purchasing power of the coupon. The relevant consideration in calculating real interest rates is different. The appropriate inflation expectation which is embodied in long-term interest rates must reflect the full maturity of the debt instrument to which it applies. As a consequence, the inflation expectation that is affecting 20-year U.S. Treasury issues is the average 20-year inflation forecast. Thus, to calculate the real rate of interest, one must first know the unobservable expected rate of inflation over the long run. That long-term inflation expectation is dependent, but only to an extent, on the current rate of inflation. The impact of current inflation on real interest rates works through the effects of recent inflation on long-term inflation expectations. There is no question that the sharp and very credible decline in the inflation rate in the last year or two has had a major effect on 20-year inflation forecasts. There are a lot of people whose implicit, if not explicit, forecast of inflation is simply an extension of what happened in the most recent past. That is one of the reasons why there has in fact already been a fairly significant decline in long-term interest rates. There has also been some impact on long-term rates coming from the decline in short-term rates. There are a number of people, mostly in the investment business, who have no long-term inflation view. Basically, they endeavor to maximize the current yield on their investments, given some diversification to reduce risk. Thus, when short-

Removing Structural Barriers to Growth 11

term rates fall relative to long-term rates, they shift funds from the short end of the market into the long end of the market. This has been happening over the past year. Even given the above, you cannot explain why nominal long-term U.S. Treasury issues are in excess of 10 percent without adverting to the fact that there is a major fear of long-term inflation not only among investors in the United States but also among all investors in dollardenomination issues around the world. It is a world market, and that world market, in my view, is essentially confirming that the long-term inflation expectation is being driven by the fear that the U.S. Treasury deficit will effectively force huge Treasury borrowings. The Federal Reserve will respond to these borrowings either by accommodating them, which historically is the more likely consequence, or by permitting a significant degree of crowding out with some real rise in longterm rates. In either event, no matter how it comes out, it clearly is the critical element in the long-term rate structure. To resolve the problem requires that the Congress and the administration somehow mediate their conflicting priorities for the long term. This will eventually happen, because it must happen. If it is done in a manner that is credible to the financial community around the world, then the long-term inflation expectations embodied in long-term interest rates will fall. Nobody likes to be left out when he perceives the fact that interest rates in the longer end of the market wül decline. The result will be a huge rush of money into long-term investments. That will have an extraordinary effect on capital investment and the economy generally for a number of reasons, not the least of which is the fact that it is the only immediately available solution that is capable of being implemented and the only immediately available solution that will resolve the balance-sheet problem. The second question I referred to earlier concerns the balancesheet problem. Succinctly stated, in the United States and in other industrial countries, we have in the last couple of decades extended the asset side of the balance sheet. These largely fixed assets have been financed by a level of net new short-term borrowing. That strategy did not appear to be particularly risky at the time it was being used. Nor was its rate of expansion particularly troublesome to the banking industry. The problem, however, is that the inexorable process of short-term debt creation has resulted in a level of short-term to long-term debt that is now having strong adverse economic effects. In addition, as a consequence of years of high inflation, there has been a dramatic decline in equity to debt ratios. Over the past decade, the flows of financing seemed to be reasonably balanced, but they were not. The economy has finally run up against a roadblock; that

Viewpoints on Strategies for Growth 12

is, a balance sheet that does not allow flexibility in the financing of new investment. What this has done is to create a high-risk premium in the total economic system. This is a serious problem for those who have to focus on long-term capital expansion, on methods of building new plants, creating new markets, developing new facilities, or creating new technologies. There is a growing fear within the corporate financial establishment in the United States that one cannot finance these long-run capital needs. There is a growing recognition that what must occur first is a rebalancing, a reliquifying, a restructuring of the balance sheets of individual firms. This must be done in a way that will enable them to readdress the long term; that is, to rethink how one would finance and do the number of things that are required. The inexorable pressures of the arithmetic accounting thus created a situation where the economy could no longer maintain the continuing growth of short-term borrowing ratios, both to total assets and to equity financing. Short-term borrowing had to decline and equity financing had to rise or the whole system would have come to a halt. And indeed what we are now finding is that that is where we are. The economy is now at a point where major changes in corporate finance are a precondition for economic growth and economic recovery. The dramatic rise in stock prices is largely the result of the expectation that somehow we are going to permanently reduce the inflation rate. That rise in stock prices is also a crucial link in how the financing problem is going to be solved. First, it marks up the market value of existing assets, which itself is a major factor in the financing and expansion attitudes in American business. In addition, it has a significant impact on new equity financing and has, in effect, created a dramatic rise in new equity issues. Problems, however, remain: until we get a major funding of short-term liabilities, until we convert a significant amount of short-term borrowing already on the books into long-term issues, the risk premiums in investment will continue to retard economic growth. This is due to uncertainties in the interest obligations of firms that have either floating or just general short-term debt. The tremendous uncertainties about interest costs, and hence about profitability, continue to pose a very large risk premium on the investment process. It is only when that short-term debt can be funded that the balance sheets can be put in the position to finance future growth. That is the reason it is critical to reduce long-term interest rates. If that happens, say by 2 or 3 percentage points off the long-term corporate rate, there will be a massive shift into long-term money so as to allow for longterm borrowing and a rebalancing of the financial structure. This problem exists around the world. It is part of the problem in

Removing Structural Barriers to Growth 13

the developing countries' debt structure difficulties. In effect, world economic activity has expanded through debt growth at an unsustainable rate. But you can debt finance only if balance sheets are in balance. When the debt structure is out of balance, as indeed it is in many places, it creates pressures on the central banks to fund the liquidity problems. The result, if this does occur, is renewed inflation. Inflation, in turn, further exacerbates instability, uncertainties, and risk premiums. As difficult as are our growth problems and as seemingly intractable as is the whole solution to the world problem, there is a way out. For the United States, the way out is to fundamentally address the Federal budget problem. Unfortunately, we cannot reverse the cause and effects; it would be nice if we could resolve the budget issue by increasing the rate of economic growth. But a necessary condition to increasing growth rates is to bring the budget under control first. Regrettably, an alternative, in my judgment, is not available.

Viewpoints on Strategies for Growth 14

3.

THE ECONOMIC POLICY FAILURE OF THE PAST AND A POLICY AGENDA FOR THE FUTURE Alan Cranston If I were to be partisan, I would say that the first obstacle to growth that we need to remove is the administration of Ronald Reagan. But I am not going to be partisan here. So I will pay tribute to Ronald Reagan. Socrates taught us that negative insights are the first steps to wisdom—knowing what is not it. In terms of learning what not to do, we owe a real debt to Ronald Reagan. Reagan has certainly shown us how not to get economic growth. First, we cannot balance the budget by depleting our government's revenue base and promoting a runaway arms budget. Second, we cannot improve American productivity by preaching a work ethic but then accepting unemployment as a cure for inflation. The result is that 20 million Americans are now unable to find regular work—a national scandal when you consider all the work that needs to be done in our cities and throughout our society. Ronald Reagan has also shown how the government should not relate to business, labor, and the marketplace. He talked about cooperation, but called off the promising tripartite efforts under way in the steel industry to bring business, labor, and government together in effective partnership, without undue government intervention. But this is a forum for suggesting ways to solve problems, not just to criticize. So let me move from the negative insights of Reaganomics to positive proposals. First, I believe the time has come when we as a nation must finally, seriously commit ourselves to achieving a full-employment economy in which the official unemployment rate is not larger than 4 percent.

Policy Failure of the Past and a Future Agenda 15

That means an economy of full production and steady economic growth—an economy that provides real productive work for all willing and able Americans, to meet the growing needs of our nation. I believe this goal can be achieved without rampant inflation. The president, in my view, should concentrate on two overriding purposes: One is ending the arms race that is burdening our budget, undermining our economy, and threatening our very existence; the other is achieving full employment in an economy of steady growth. The president must focus on a few central purposes, otherwise he is distracted and overwhelmed by the demand of the moment and the crisis of the day, and all he becomes is a manager of whatever comes along. He thus squanders his short time in power. The two problems of the arms race and the economy are inextricably linked, but even with the present state of deadly arms competition, we can and must start moving toward full employment. This will require a mix of forceful, immediate measures and long-term programs. I will outline some of the steps I believe are necessary. First, we must reevaluate the role of the American worker in our economy and in our society. Today we give generous tax credits for buying new industrial machinery, but little tax incentive for the most precious industrial asset of all—a well-trained worker. Any policy for long-term economic growth must recognize the importance of the individual worker. We must have an increased investment in job training and retraining for both blue-collar workers and middle management, involving both the public and the private sectors. To increase worker productivity, new forms of compensation must be found and encouraged— including profit-sharing and stock ownership that give workers a greater stake in the products they produce and the companies they work for. Productivity, by itself, is meaningless to the average worker if he or she cannot share in it. Daniel Yankelovich explains elsewhere in this volume that one of the problems with American industrial competitiveness is not that American workers do not want to produce better products, more efficiently. His studies show that American workers seek personal satisfaction in the quality of their work product. The problem lies in the absence of incentives. Government cannot provide these incentives. They must come from the leaders of industry who will profit from a skilled and competitive workforce and who need workers who are unafraid of technological change because of the new opportunities it will bring. Government can help, with retraining and relocation assistance, but it is only business leaders who can bring workers into the deci-

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sion-making process, thus giving them a greater sense of involvement, and providing greater incentives to produce. The second step I propose is the establishment of a Public Development Bank—a new Reconstruction Finance Corporation—with the responsibility to serve as an independent investment and development agency for reindustrialization. The corporation would be financed by selling tax-exempt bonds to private individuals and pension funds. The capital raised would be used to finance private projects such as plant modernization or loan guarantees for venture capital. The first priority of the Reconstruction Finance Corporation must be to retool and restore to competitiveness our basic industries. An America that is dependent upon foreign steel and machine tools is just as vulnerable as an America that is dependent upon foreign oil. Another priority for the corporation must be to provide seed money to help explore new technologies that will produce jobs, not joblessness. The third step we must take is to better coordinate our fiscal and monetary policies. Ronald Reagan tried to speed up the economy with a tax cut while the Federal Reserve was jamming on the brakes with a tight money policy. Those two policies collided and canceled each other out. The losers have been America's businesses and families who are unable to finance new investments because of high interest rates. The fourth important step toward long-term economic growth is to expand our export markets. We must take effective international action to promote worldwide policies of economic growth and to assure fair and free terms for world trade. With economic growth, Japan and other nations must be led to remove unfair obstacles to American imports. With lower intererst rates, we can bring down the exchange rate for the dollar from the disastrous increase of 25 percent in recent years. And with a coordinated government effort to help our export companies—such as the Export Trading Act enacted by Congress last year—we can give American business the tools to be more aggressive in the international marketplace. Fifth, an essential part of any full-employment, full-production program must be measures to check inflation. As their contribution to a full-employment economy, we can ask labor and business, as a part of this rounded program, to show the wage and price restraints necessary to avoid inflation. We must also put other forms of anti-inflation insurance in place, such as grain reserves, oil reserves, and an effective energy program to reduce our dangerous and costly dependence on foreign oil.

Policy Failure of the Past and a Future Agenda 17

Sixth, we should move to reduce the mammoth budget deficits. We need new revenues but they must be fair and they must not inhibit investment and growth. Our entire tax system must become more equitable and more efficient so that it stimulates productive investment instead of promoting tax shelters, corporate takeovers, windfall profits, and transfer of factories to "cheap labor" countries. Also, government should be more aggressive in collecting the taxes that are owed but not paid—estimated to run into billions of dollars each year. Seventh, a public jobs program—flexible in its dimensions—is needed to provide transition work for those who have become dislocated while the economy retools, and to help those who have never known regular employment move into the mainstream of the job market. I am not proposing make-work jobs. There is real and productive work that needs to be done in our country—rebuilding our infrastructure of roads, bridges, and sewers; cleaning up chemical waste and doing all that is necessary to protect our environment; and caring for the elderly, the sick, and the handicapped. Eighth, a large-scale, voluntary national service program should be developed to engage at least one million young people—as well as elderly men and women. A national service program could draw on the experience of the Peace Corps and Vista—and the Civilian Conservation Corps of Franklin Roosevelt's day. Instead of putting youth into competition with older workers—as would President Reagan's proposal for a subminimum wage for teenagers—voluntary national service would take young people out of the marketplace and enlist their energy and talents in serving the common good. And it could help us meet our military personnel needs without resort to the draft as unemployment recedes. Ninth, and finally, since education is the foundation of a quality workforce, a competitive economy, and effective self-government, we must take action on all levels of government to guarantee greater support for educators and educational institutions. The National Commission on Educational Excellence recently reported that American education has deteriorated so drastically in the last 20 years that " o u r very future as a nation and a people" is threatened. The Commission stated: "We have, in effect, been committing an act of unilateral disarmament." Our response to the report must be wise, strong, and immediate. I do not believe that any single item just outlined will bring about sustained economic growth. But I am convinced that, taken as a whole program, it will bring results. To do all of these things, we must be like Alexander the Great, who, when faced with unraveling the intricacies of the Gordian knot,

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did not attack it one thread at a time, as countless others had tried to do. Instead, he took one bold and sweeping action, cutting it with his sword and unlocking the treasures of a kingdom. We must be bold and do all that is necessary to fire up the engines of our economy—and put Americans back to work so that never again do we resort to mass unemployment as the way to stop inflation. If we are to succeed, it will take a cooperative effort by business, labor, and many other groups. The president should lead the way to a consensus on a full-employment, full-production program for our economy. He should appoint a Council on Full Employment and Economic Growth, consisting of the best minds in business, labor, education, and government. The president should chair the council, and he should set a deadline so that he can submit the program for full employment to the Congress and the country as soon as possible. Simultaneously, the nation should concentrate upon the overriding problem of our time—ending the arms race before it ends us. We must launch negotiations with the Soviet Union, the like of which we have never seen before—all-out, serious, constructive, creative, and fair—to achieve major mutual and verifiable reductions in our toobloated arsenals of death. President Reagan has proposed that we spend $2 trillion on the military in the next five years. I know the necessities of defense. But we have overleaped the bounds of reason. By winding down the arms race, we can get America back to real work—productive, useful work. Our Federal budget can then reflect—more realistically—our defense needs and our domestic priorities. Our scientific, human, and capital resources will be put to work rebuilding our economy, our cities, and our homes, and providing better for all our people. If we can lift the shadow of the arms race, we can enter the sunshine of a new world, one in which economic growth can be a reality for our entire nation and for all people.

Policy Failure of the Past and a Future Agenda 19

4.

THE GOVERNMENT DEBTIMPOSED CEILING ON ECONOMIC GROWTH Peter G. Peterson In academic circles five or ten years ago, I seem to recall zero growth was a very popular subject. It was usually presented as a rather abstract hypothetical, academic alternative designed primarily to debate alternative value systems. I do not think anybody took zero growth very seriously. Yet in looking back over the last ten years, in a very real sense, in real income per worker, I see that in the U.S. we have achieved, however unintentionally and however inadvertently, zero growth. In looking around the world over the same decade, I have been focused on the Japanese experience. We all know what has happened to their growth. I think we need to focus also on another aspect of growth, growth in world market share. During the decade of the seventies when their foodstuff imports when up $30 billion and their raw materials another $15 billion, when they imported 99.5 percent of their oil, they still managed, somehow, to have a significant trade surplus. How? By an utterly astonishing achievement in their manufactured goods sector. This surplus went up $80 billion more than ours during that decade—clearly creating a few million job opportunities. In high technology products, which used to be our domain, we started the decade with a much larger trade balance in these technology intensive products than any other country in the world. By the end of that decade, we found Japan enjoying 50 percent larger trade surpluses in technology intensive products than we had. So, confronted with far more serious problems of physical resources than we, their economy somehow did far better in growth, inflation, unemployment, and trade—across the board. There are many factors in that exceptional achievement. Wharton is a conceptual

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cradle, I suppose, of some of the newer managment concepts, theory "Z," new kinds of management-labor relationships, and so forth. These factors are certainly important. But I am also struck with something else. The Wharton/Reliance Symposium is a conference on economics. Economics has something to do, I recall, with allocating scarce resources. How has that economy, over that ten-year period, allocated resources compared to the way we allocated ours? For example, in net new plant and equipment after depreciation, the Japanese invested nearly 10 percent of the gross national product in new plant and equipment. We invested 3.8 percent. They installed in their plants during that period, two-thirds of the world's robots. Their manufacturing plants are about half the age of ours. Even today, they order half the robots in the world. Adlai Stevenson used to talk about new clichés; I guess one of the newest clichés is the "crumbling public infra-structure." It may surprise some of us to know that in the decade of the seventies, Japan invested a net 5 percent of their gross national product in public infrastructure, whereas we invested 0.7 percent; that is, they invested seven times as much as we did. They invested 20 percent more than we in nondefense R&D. Perhaps the ultimate form of investment in the future is human capital investment, that is, education and training. The Japanese have been investing about three times as much as we in science education for their young. At high school levels, something like 30 percent of their high school graduates now have computer-related instruction; 30 percent have taken calculus, versus 4 to 5 percent in our country. So, wherever I look, it seems to me that the Japanese economy, whatever its other virtues, has simply been investing at levels much higher than ours has. While I am not an economist, I do recall the inexorable, if painful, law of economics that you cannot consume more and save more of your available income at the same time. Most of us would like to be able to do that, but we have not yet found out how. And in order to invest, we must of course save. I have discovered, however, that when we talk in specific terms about reducing consumption now so that we can invest more in our future and thereby consume more later, it is a bit like Russell Long's famous image of taxes, "Don't tax him and don't tax me, tax that fellow behind the tree." So when we ask the rude and brute question in American political economics, "Whose consumption are we talking about reducing so that we can save more, so that we can invest more?" we are told to look behind trees. A great deal of the virtually unanimous, bipartisan

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rhetoric for capital formation somehow vanishes when the rhetoric of capital formation confronts the politics of consumption. Nowhere is the politics of consumption more evident than in our unprecedented outyear deficits—as far as the eye can see. President Reagan started out in March 1981 saying that he expected to reduce spending and revenues to 19 percent of the gross national product, and to give us a balanced budget in 1984. Those of us in the business community strongly concurred because we wanted to release more resources to the private sector. What in fact has happened? Alas, by 1985 we will have reduced revenues to 19 percent of the GNP, but our spending will approach 25 percent of the GNP, leaving us with absolutely unprecedented structural deficits of 6 percent or more, even in the context of three straight years of growth. What do these deficits have to do with the prescription for investment, as one of the answers to economic growth? Well, it finally dawns on one that deficits are really a form of negative savings. They are drawing heavily from our already shallow pool of savings, more like a puddle. For example, it now appears that by 1985 these grotesquely large deficits, if we permit them to happen, will take somewhere around 50 to 70 percent of the net savings of the United States. That is double the highest share of savings ever consumed in Japan by their deficits; this share hit a high of 31 percent of net savings in Japan in 1979. The deficits have led to, among other things, very high long-term real rates of interest. I do not even know what the concept of the longterm real interest rate means. Clearly it involves some speculation about the future inflation rate. I do remember having been told at the University of Chicago that these long-term real rates should be around 2 percent or 3 percent. We are now looking at numbers like 7 or 8 for real interest rates vis-à-vis current inflation rates. This tells us something about future inflationary and interest rate expectations. Many people say they do not understand the financial markets. I am certain I do not really understand the financial markets. But, permit me to say a word about the financial market's point of view about these deficits. Financial analysts usually argue that these deficits mean one of two things: either a nonexpansionary, noninflationary monetary policy will lead to a confrontation between the public and the private credit demands that will drive up real rates or, alternately, the Federal Reserve will buckle, monetize these deficits, and inflate money stock and the economy along with it. Let us look at our recent experiences with recessions and why some of us are concerned about the effect of these deficits on both the depth and the quality of recovery. If we go back to the last recession,

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1975 through 1977, private sector borrowing at that point, by businesses and households, accounted for 54 percent in 1975, 69 percent in 1976, and then 78 percent of the available savings in 1977. Public borrowing was the mirror image, that is, took 22 percent of the credit in 1977. If, however, we permit these deficits to indeed happen, the public sector will preempt about 55 percent of all these funds in 1983 and will stay at between 50 and 60 percent in the 1985 period. This means that less than 50 percent of the credit will be left to be divided among all of us in the private sector, when in 1977 we consumed 78 percent. Thus, if we look at past recoveries, we see that this private sector in the second or third year of the recovery has usually demanded a dominant share of the total credit. It is this new fiscal/monetary collision that is worrying many thoughtful financial people and one reason why they demand such a high interest rate premium. One of the concerns is not simply the effects of high interest rates per se, but the effect of interest rates on the capital investment side of the recovery, the balance of the recovery, or the happy phrase Jack Welch of General Electric uses, the "quality" of the recovery. The high real interest rates have other effects as well. There are profound effects on the global competitiveness; the effects on the dollar. Clearly, we are in a situation today where an overvalued dollar, by almost any definition I know, in trade competitive terms, has had utterly extraordinary effects on this economy. If you look at the drop in the real GNP between the first quarter of 1981 and the last quarter of 1982, you can explain almost three-quarters of the drop in the real GNP by the collapse of our net export sector. We talk about the JOBS program that allegedly might add 200 thousand jobs. I think you can easily demonstrate that this total collapse of our net export position has cost this country at least 1.5 to 2 million jobs, and that by the end of this year we will have an unprecedented merchandise trade deficit of up to $60-$70 billion. Next year, the outlook for the trade deficit is even worse, perhaps up to $100 billion and even more jobs lost. We see a dollar that, on a global basis, is probably about 25 percent overvalued on a trade competitive basis vis-à-vis currencies in general and vis-à-vis the yen probably more than that. The Institute for International Economics has estimated that for every 1 percent we lose in price competitiveness it costs us almost $3 billion in our trade balance. Now this factor has an utterly profound effect, it seems to me, on unemployment, on growth, and so forth. These deficits are therefore, in our view, the view of our Bipartisan Appeal Group, having a whole series of serious negative effects on

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the quality and depth of the recovery. I know there are those who say we are going to grow out of this recovery. Our group has simulated estimated deficits with a variety of assumptions about growth and inflation rates. Even with 5 percent real growth annually, the most optimistic scenario we could envision, we see base-line deficit estimates between $192 billion and $236 billion by 1985. So we do not believe we are going to grow out of this problem in the next two to three years, or longer. This leaves us with the question of how much to cut the deficits. We have at least a conceptual model. The model says we want the deficits down enough as a percentage of the GNP to leave enough for private investment to get back to at least the investment levels we had in the dolorous seventies. That requires the deficits to be, as a percentage of GNP, in the range of 2 percent or less. If you have 6 or 6.5 percent deficits and you want to get them down to 2, and you have a Federal budget that approaches $1 trillion, you will find we are talking about a deficit reduction of almost 18 percent of this budget. If you then look at the major elements of the budget, you will find something like the following: about 40 percent of this budget has barely been touched at all, specifically, the non-means-tested entitlement programs that have no means test or income test as a criterion. There are other programs, such as grants to cities and states, that have been cut even in nominal terms, but the non-means-tested programs (Social Security, retirement, Medicare, Federal and military pensions, and the like) are still, I am sorry to say, relatively untouched. In 1981, the means-tested programs, however, were reduced at a rate three times that of the non-means-tested programs. These non-means-tested programs are adjusted 100 percent of the cost-of-living index; and they have been growing at 15 percent a year for nearly two decades. By 1985, these non-means-tested programs will approach something like $400 billion or about ten times as much as all of our companies spend in this country on private R&D. The next element is defense, with about 28 percent of this budget. Finally, interest payments, which by 1985 will hit the staggering number of about $120-$125 billion, represents another 12 percent of the budget. Thus, 80 percent of the budget is in those three items. The balance of the budget has already borne the brunt of the budget axe. It seems to me that the lesson we have rediscovered from our recent experience is that it is far easier to distribute pleasure (i.e., cut taxes) than it is to distribute pain (i.e., cut spending), particularly if it is for politically powerful groups. It is essential, if we are really serious about the politics of capital formation, to discuss very realistically how we are going to distribute the pain.

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That is the issue that our political system does not want to talk about. For example, we treat the entitlement programs as though they were a form of fiscal, or perhaps political, herpes—Social Security, Medicare, Federal and military pensions, and the like. The defense budget, some allege, is utterly untouchable; every dime of it is essential, and even ten cents less would result in a dangerous deterioration of America's national security. A large group of us in the Bipartisan Budget Appeal have looked at this defense budget. We who believe strongly in a sustained defense buildup believe it is quite possible to take $25 billion out of $275 billion in 1985, have a more coherent, sustained, and gradual buildup, and in that way end up really with the country stronger for many reasons. First, because the economy is stronger, our foreign policy will be stronger. I do not know of a country that has had strong foreign policy with a weak economy. Second, what is happening now with the annual defense budget battle, in which programs are predictably cut more or less on a piecemeal basis, is absolutely the wrong signal to send to the Soviet Union in terms of the president's having a strong, credible long-term negotiating position. I think we would be far better off to agree as a country, on a bipartisan basis, on a four- or five-year steady, if more gradual, buildup. As I said, I also think we would have a more coherent defense program. Most important, a gradual buildup will provide a more practical political basis for getting reductions in the entitlement program. I see very little way that this will ever happen unless the defense budget shares in the budget-cutting process. Our bipartisan program calls for $60 billion of nondefense spending reductions in 1985; the most important being entitlements going largely to the elderly. Even the concept of entitlement I find more than a bit troublesome. It implies we can buy or even mortgage our future rather than invest in it and earn it. Let us look at the fiscal future of these entitlement programs. Joseph Califano has estimated what proportion of the Federal budget has and will be spent on the elderly at various times. Let me give you the trends. They are as unambiguous as they are sobering; 13 percent of the budget went to the elderly in 1960, 25 percent in 1980, a projected 35 percent in the year 2000, and a totally unsustainable 65 percent in the year 2025. We are already spending three times as much per capita on the elderly at all levels of government as we are on our young. We have barely begun to conceptualize what we mean by human investment in education and training and retraining. But I submit that as we do that, we should also ask the question: Where are these resources going to come from?

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These entitlement programs are 100 percent indexed to the costof-living. We see no way that you can get this budget under control without doing something to reform, to cap this 100 percent indexation process. The fiscal problems are really much worse than we realize because of the American budget system of not accruing, not funding our liabilities: none of the entitlement programs for Social Security and Federal and military pensions are funded. We have a staggering $6 trillion of unfunded liabilities in Social Security and another $1 trillion of civil service and military pension liabilities. Were Federal pensions to be funded in the way that private companies are required to fund pensions under ERISA, the annual Federal budget in 1983 would be about $115 billion higher than it is now. Herbert Hoover, when he was secretary of commerce, once said, "Blessed are the youth, for they shall inherit the debt." They shall inherit a great deal more than that. Finally, I would like to discuss the revenue side of the Federal budget, which many of us in the business community would rather not discuss. Our group believes that large spending cuts are substantially more important and clearly deserve the top priority; spending reductions must be the centerpiece of fiscal reform. However, having cut spending in our bipartisan program much more than anyone else's, we are still left some $60 billion shy in 1985 of our deficit reduction target. We believe this need for revenues is also an opportunity to review the structure of the tax system of the United States and make this tax system coherent or supportive of an economic strategy that focuses on investment. It makes little sense to increase taxes in such a way that we diminish the very savings we are trying to preserve. If you study the American tax system, you will discover two or three things about it. First, vis-a-vis the other seven industrial countries in the world, we are the only country to allow unlimited interest deduction; we have the most proborrowing, proconsumption, antisavings, anti-investment tax system in the entire industrial world. We gather much less of our Federal revenues from taxes on consumption. We gather much more from taxes on savings and production. While our rhetoric is that of capital formation, we have a variety of provisions in our tax laws that really penalize savings. If you were to take a Japanese family with $40,000 to $50,000 of income, compare how interest income is taxed, look at the deductibility of interest, look at what happens to dividends, and look at what happens to capital gains, you will see profound differences. Thus, we believe that part of the economic prescription for this country is to move toward a tax system that encourages investment and savings.

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I would like to comment only briefly on one aspect of the very troublesome Third World debt burden. I am a little troubled, frankly, by the notion that if only the United States grows, somehow we will achieve the requisite world growth that is required for the Third World to be able to earn and repay these debts. For every 5 percent real growth in the United States (something I do not consider plausible on a sustained basis given our structural deficits), there is about 1 percent for the rest of the OECD countries. Also, increased access to our markets is another essential ingredient in Third World viability. My question is: How likely are we to open up our markets further, in the context of $100 billion or even $70 billion trade deficits? The overall message here is that I do not see how anyone can be serious about investment, about capital information, without taking a strong position on getting these structural deficits down, getting these real interest rates down, and doing something to invest more in our future, and without taking this opportunity to restructure our tax system to encourage more saving. Finally, I think it is going to be very important in any agenda over the next five or ten years to look at the global exchange rate system. A good deal of our so-called problems of competitiveness, in my judgment, are caused by a system in which the exchange rate is profoundly affected by financial flows that have nothing to do with unit labor costs and trade competitiveness. I think the time is coming for us to discuss the exchange rate system seriously. We are now being plagued by what I am told is the leading indicator of protectionism in the world, an overvalued currency. As I said, some are now predicting a $100 billion trade deficit in 1984, a presidential election year; that could be protectionist dynamite. To sum up, I am simply saying that if we do not do at least these things and more, we will be a much poorer country than we might have been; a much less generous country, a less outward-looking country than we should be, and with that, a much more divided country than we have been, as we spend our time deciding how to split a pie that is not growing; and, finally, a much less important country than we might have been. Henry Kissinger has often discussed the sensitivity of foreign policy to economics. He implies, and I certainly agree, that a country with a weak economy is never going to have a sustained, strong foreign policy. And if this country does not get its economy under control, I do not know which other countries in the world are going to take that indispensible global leadership position. We are too young, and indeed too rich a country, to let all this happen.

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5.

WHY LABOR UNIONS DO NOT ACCEPT THE NEW ECONOMIC POLICY William W. Winpisinger The Machinist Union proposal for rebuilding America is most aptly introduced by the words of that immortal British philosopher and political economist, John Stuart Mill, spoken in 1848, "When society requires to be rebuilt, there is no use in attempting to rebuild it on the old plan." We can be reasonably certain that most of corporate America would not object to that thesis. When we look around at the domestic and global economies, when we see the changes being wrought in our workplaces—in those that are not shutdown or abandoned—we know corporate America is trying to rebuilt, or at least restructure, the economy and therefore society. Or we might call it economic implosion. However, the question is not, Will a rebuilding and restructuring take place? It obviously is taking place. The questions are: Who is doing the planning? Who is making the decisions? Upon what ethic and value system are they based? Answers to these questions can either inhibit or facilitate the kind and quality of economic growth we all want. The Machinists Union has been doing a lot of thinking about rebuilding and restructuring our economy to achieve economic growth and all the desirable objectives that should accompany it—full employment, price stability, free flowing international trade and aid, a more equitable distribution of wealth and income, and a fair tax system, among others. The day Ronald Reagan was elected president by 28 percent of the electorate, we assigned an in-house staff committee to put together an alternative economic program. It was not difficult to predict what was going to happen under the new Republican administration. Mil-

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ton Friedman had just won the Nobel Prize in economics and was just publishing his Darwinian jungle theory. He had also just come home from the United Kingdom, where he was the principal architect of Margaret Thatcher's economic disaster, and we all know that whatever Thatcher does, Reagan does. And vice versa. That committee of the International Association of Machinists and Aerospace Workers has spent the past two and one-half years observing, researching, studying, and finally designing a framework within which the economy could be restructured and rebuilt. We call it Rebuilding America and we will soon have it ready for publication, too. Let it be known that we dismiss as unworthy of discussion one of the points outlined in the ten policy areas covered by the Wharton/ Reliance Symposium. That is that hackneyed phrase, the "declining work ethic." It is a bogus issue and can be rejected out of hand, if for no other reason than it is hypocritical for anyone in this country, particularly employers, free-market economists, and political conservatives to preach the work ethic and simultaneously implement policies and programs designed to create unemployment and cheap wages. We say to those who persist in declaiming the work ethic to knock it off. It is childish, immature scapegoating and unproductive. As the Machinists Union sees it, if one is serious about rebuilding America to achieve economic growth or to remove the obstacles to economic growth, then there are at least eight major areas where restructuring must take place. The first concerns the corporate animus itself. Corporations have been permitted to arrogate sovereignty unto themselves. This is certainly true for multinational corporations. The remedy is to make them publicly responsible to the communities and nations where they do business. Under Article 1, Section 8, of the U.S. Constitution, the Congress has the authority to define and create corporations. We propose that the Congress exercise its authority by federally chartering corporations engaged in interstate and foreign commerce and by including in those charters an economic and social clause that will bind and commit each corporation to a minimum code of civilized and decent behavior, which can be violated only on pain of revocation and Federal seizure, following the due process of law. That economic and social clause would require, also, that federally chartered corporations annually pay into a specially created Federal Investment Reserve Fund, an economic and social dividend equal to one percent of after-tax profits. For that growing roll call of corporations that do not pay Federal corporate income taxes, the economic and social dividend would be levied against net income as a "voluntary" contribution in lieu of taxes. The economic and social dividend

Labor Unions and the New Economic Policy 29

can be justified on a number of grounds. One way to look at it is, it is the price the nation as a community exacts for continued unrestricted mobility of capital. Whenever and for whatever reason a corporate entity privately decides to pack up and leave town or leave our shores, the economic and social dividend would provide some means of making stranded workers and communities economically viable and whole. Should the Federal Investment Reserve Fund be in surplus, it could be used to provide capital, through stock purchases, to those firms that experience start-up or chronic capital shortages for one reason or another. History is replete with demonstrations of the fact that, if left to their own devices and so-called self-regulation, American corporations inevitably self-destruct in extreme self-interest. Since only a few hundred of them transact nearly three-quarters of all business in this country and take nearly the same share of total profits, then unfortunately, when they self-destruct, they tend to significantly damage and destroy the national economy too. As to corporate social irresponsibility, the list of serious offenses is so well known and so extensive we need not recite them here. Even without our going back to the Watergate era, those offenses of the past three or four years would fill a thick ledger. So our first order of business is to make the interstate and multinational corporation publicly accountable and socially responsible. The law of the jungle's survival of the fittest code can be and is a serious obstacle to economic growth, in quality and quantity. The Machinists' Rebuilding America framework also provides for an industrial policy program, not to supplant the existing "invisible hand" method, but rather to supplement and support it. We would have the Congress create a Labor Industrial Sector Board as an independent agency. That board would be a working executive agency, much like the Federal Reserve Board. It would be comprised of a representative from each of 32 basic industrial sectors running through the alphabet from aerospace and air lines, through steel, railroads, and utilities. Our Labor Industrial Sector Board would not be tripartite. There is nothing sacred or infallible about tripartism. On the contrary, our experience demonstrates it to be less than balanced, and certainly it is clumsy. If the objective and task of an industrial policy is to rebuild, rejuvenate, and restructure the nation's industrial base—and this is an assumption the Machinists make—then we are much less concerned with the theory of political symmetry. Rather, we are more concerned with an Industrial Sector Board that has hands-on production, entrepreneurial, financial, marketing and economic-develop-

Viewpoints on Strategies for Growth 30

ment organizing skills. Thus, the Industrial Sector Board could be made up of members from trade unions, members from corporate management, members from the professions—if they have had handson production experience in the sector they are appointed to represent. And just to insure that this is the way the board would be made up, the chair could be required to be a bona fide trade union member who has hands-on production experience, collective bargaining experience, and union administration experience. Since the goal is economic growth with full employment, it is proper that the board be chaired by a trade unionist, as a representative of the human factor of production. In any program that includes an industrial board, whether it be ours, Felix Rohatyn's, Lane Kirkland's, or the Business Roundtable's, a trade union chair with appointive powers is the price the Machinists will demand for greater labor-management cooperation. We have been tokens on too many boards and too many tripartite committees to subject ourselves to those forms of dupery again. We have cooperated with management too many times in the workplaces, only to be mugged, raped, or stabbed in the back outside the plant gate by adverse decisions directly affecting our lives and our livelihoods, to fall for the old ploy again. Cooperation is a two-way street, and it runs outside the workplace, in the political economy and the community at large, as well as inside the workplace. There is no doubt in the mind of the Machinists Union that labor and management representatives can function together on an Industrial Sector Board if corporate America gives up its diversionary, expensive, wasteful anti-trade union crusade and subterfuge. There is no doubt in our mind that if trade unions are given a central role in the industrial policy planning and investment decisionmaking processes of this nation—upstairs with the big boys as well as down on the shop floor with supervisors and middle managers— without having to protect our backs and flanks from sneak attacks and double dealing, then we can rebuild America along the lines that our major international trade competitors, particularly those from Western Europe and OECD countries (Organization for Economic Cooperation and Development), have been using so effectively. So when the question is asked, "What will it take to achieve greater labor-management cooperation?" this is what it will take. There are other parts to our Rebuilding America program including reorganization of our jerry-built international trade apparatus under a one-roof concept. We would establish a development bank under the authority and control of the Industrial Sector Board and endow it with pension-fund deposits to be used by business and corporate

Labor Unions and the New Economic Policy 31

supplicants for at-cost loans and risk capital. Those pension funds would be secured for the workers they belong to, by the full faith and credit of the United States. In return, those enterprises that might avail themselves of the support of the Industrial Sector Board and Pension Fund Development Bank would be required to subscribe to an economic and social clause prescribing certain rules of conduct in their economic and social behavior. We would convert the existing Federal Financing Bank, which serves primarily to promote foreign military sales, into a full-fledged funding mechanism for America's cities to rehabilitate their infrastructures and launch neighborhood housing and business and industrial development projects. Again, an economic and social clause would operate to prevent the exploitation that has too often characterized such programs in the past, and that is certain to characterize the Reagan administration's "free enterprise zones." Our goal is not to reduce American environmental, work, income, and living standards, but to improve them. A viable Rebuilding America program also requires a restructuring of labor policy in light of the new technology rapidly coming into the manufacturing and service sectors of the economy. Clearly, technological unemployment is already a major phenomenon. At the bedrock level, we call for allocation of jobs through a reduced workday, from eight to six hours, with overtime penalties and no loss in worker incomes. In addition, we would attempt to get a handle on the rate of introduction, the manner of implementation, and the effect on endusers of new technology, by adopting the Norwegian Technology Control program. Unquestionably, the Norwegian program is the most well-developed and advanced effort to cope with the new technology—with all of its economic and social ramifications—of any existing in the industrialized world. Finally, we would restructure the energy industry. We would reintroduce the TVA competitive yardstick principle and get back to the notion that low-cost energy, conservation, and the development of safe, renewable energy sources are not incompatible, if done in the public interest. In the public interest, that is, as opposed to a purely private and profit-motivated interest. Energy is so basic to the reindustrialization of America and economic growth, we can no longer afford to pay the price of a privately monopolized system. Of all industries, this one most keenly exposes the fraud of monopoly and oligopoly masking behind free market principles. The keel for this rebuilding program would be the restructuring of the Federal individual and corporate income tax system. It would be on some time-tested principles that are being perilously eroded, such

Viewpoints on Strategies for Growth 32

as ability to pay, ease of administration, and neutrality with respect to investment, and it would be equitable with respect to reaching all sources without being confiscatory. We would even lower the topbracket rates for individuals and corporations. Here, then, is a trade union view of how we can promote economic growth and remove major obstacles now impeding it. We know it will work, for most of those countries, now outperforming us in international trade, are employing some or all of its parts and principles.

Labor Unions and the New Economic Policy 33

6.

THE NEED FOR A LONGTERM PERSPECTIVE IN GOVERNMENT-BUSINESS RELATIONS Ian MacGregor I would like to address some of the implications of the wrenching changes that our economies are now experiencing. My perspective is that of an executive in the world steel industry, having served approximately fifty years in industry and business. There has been, first of all, a dramatic shift in our ambitions about capital. This has come forcefully to my attention in my current role in the steel business. According to Dave Roderick, chairman of the board of U.S. Steel, 70 percent of all steel produced in the world goes into capital goods and only 30 percent into consumer goods, such as automobiles and appliances. The world steel industry came to a grinding halt, essentially, during the middle of the 1970s and has not recovered. In fact, it is still declining and it is going through the agony of restructuring. The U.S. industry has not yet been seriously affected by this restructuring, but it will. To succeed, the industry must be allowed to become more efficient. The U.S. steel industry needs a breathing spell after suffering two decades of government intervention. During the 1960s the steel industry operated under de facto price controls. During the 1970s when the Nixon price controls were finally eliminated and the industry did start to generate some cash flow, it was siphoned off to satisfy the requirements of the Environmental Protection Agency. As a result, American industry is not modern, and it is far behind the rest of the world in its equipment. It is also very high cost in terms of labor, and it needs help, during the next year or two, to bridge the gap until it can develop some cash flow.

Viewpoints on Strategies for Growth 34

Capital spending, which used to advance at the rate of 4 to 5 percent worldwide per annum, is now showing a zero or negative rate of increase, and there is no apparent sign of that changing. The simplistic solution is that we spend more and save more, but as Alan Greenspan points out in another chapter, even if people had money, it is doubtful whether we would see a resurgence of capital spending in the world. I served in business in an era when 5 percent was regarded as a high rate of interest, and therefore the planning and development of projects for the future could be done with some degree of certainty about the economic outcome. Even as recently as the late 1960s I was involved in arguments about whether my company's rate should be 4.75 or 4.63 on a twenty-five-year loan to build a new factory. So these high interest rates are relatively recent. But today, because nobody knows what is going to happen in the future, it is very difficult for the average business leader to envision making investments of any magnitude. I recently attended a meeting in Boston at M.I.T. for the inauguration of an organization called the Society for Macro Engineering. The society has been organized to help bring together the ideas that have developed over the years on how to handle very large engineering projects that may be multinational and multidisciplinary and require enormous amounts of finance. In the opening address, Jay Forrester reminded us of the Konderatieff cycle and expressed the view that we are now within the end of one such fifty-year cycle. Since we are still on the down side of this cycle, or wave, we should not count on any reversal in this downward trend in capital spending in the world in the short term. As Greenspan emphasizes, we are up against barriers to investment. The most basic of these is that there is no pressure on capacity, and I think that we are not going to see a very rapid change in this. I see two fundamental problems as I look over the scene in the world, and each of these is summarized in one word. The first is "diffusion" and the second is "divergence." Diffusion covers the realities of our world today in terms of technology. Only twenty or thirty years ago we used to think about American know-how insulating us from competition. We were the greatest and the best. But when you look around the world today you cannot see that insulation. For any of our basic industries you can go to the Bechtels or the Rusts or the Kelloggs or any number of other large engineering firms and say, "I want a paper mill," or "I want a steel plant," and they will immediately lay the whole thing out with the latest technology. If you are prepared to find the money, you can have the plant anywhere in the

Government-Business Relations 35

world. We have diffused our technology pretty well around the world. As a result, we are up against a very difficult problem in insulating ourselves from competition. The second problem is divergence. We in the western democracies have engaged in a diverging set of goals for our standards of living. We have attempted to raise our standards, but around the world we see others who are satisfied with much lower standards of living. The best example is the fact that Koreans pay about two dollars an hour to their steelworkers and they are competing with their U.S. counterparts who get twenty-five dollars an hour. Some may consider that unfair competition, but it is very real competition and it is going to exist. Now, what do you do about it? You can close the door, but all you do then is divert your foreign trade from imported steel to imported automobiles, imported refrigerators, imported everything else. You close the door on that. What happens next? World trade eventually comes to a complete standstill. That, I submit, is not the answer. We are now clearly up against a problem of declining world trade. World trade has declined for the last two years, and I predict that it will continue to decline unless we address ourselves to this problem, and if we do not, we have enormous difficulties ahead of us. Another of our current problems is inflation. We think we have conquered inflation in this country. But I submit that the reduction in inflation has come, not because we have stopped the cost push side of it, but because we have benefited from the collapse in the price of commodities. A close examination of the inflation rates reveals that we still have a wage push. In fact, in England, in the last year, we have had an enormous struggle with the unions over just this point. Europe, and in particular Britain, has also suffered from inflation. If the first quarter of 1975 and the first quarter of 1980 are indexed to 100 in terms of the unit cost of labor in four countries, the following figures are revealed. In Britain, the unit cost jumped from 100 in 1975 to 179 in 1980, a 79 percent increase. In the United States, the cost jumped from 100 to 135; in Germany from 100 to 115; and in Japan, it went down from 100 to 99. These are the kinds of problems we are up against. Large numbers of industries are pricing themselves out of business, and that is clearly what happened to British Steel. We are engaged, therefore, in a struggle with our unions over how to solve the problem, apart from generating greater efficiency by reducing the number of people on the payroll. At one time, we had maybe three men for every job, and now we have two men for every job with the expectation that we will soon have one and one-half. But,

Viewpoints on Strategies for Growth 36

in the meantime, I have appealed to my workforce to understand that there will be no annual increase because we cannot afford it; it will only further price us out of business. Rather, I told the employees that they can earn more money if they improve quality and production, and now they are earning more money. This principle seems to be one we have forgotten too often. We in the western democracies must get back to the idea that we have to produce if we are going to survive. We must find ways to create wealth. We have become experts in the distribution of income. We must get back to the idea that we should be experts in how to create wealth. We must review the political philosophy of trying to create riskless societies. The human race has survived only because it is capable of taking risks. The political idea that people can live in a riskless society is misleading. We must also work toward global cooperation. One of the things that the astronauts gave us was a sense of proportion. Surely everyone listening was moved when one of the astronauts looked out of a window and reported that he could see this tiny little globe, the earth, and he described how small it looks in the depths of space. We have broken all the barriers in communications. We are in the process of breaking economic barriers, but we refuse to break political barriers. In fact, some of our political institutions have a vested interest in the individuality of nations. The time has come for us to recognize the fact that we live on this small globe and that we had better find ways together to optimize the use of the resources, be they human, natural, or financial. Above all, we must get rid of inflation. There is a lesson for us in the history of Spain. Spain ruled the world in the sixteenth century. When the Spanish found Latin America they took the gold and silver from there and made Spain the wealthiest country in the world. May I suggest that in the process they increased their money supply. They had their hands on seemingly endless supplies of gold and silver. Everyone felt so rich that production declined and immediately inflation took off. Within fifty years the country was destroyed. It was destroyed as a world power; it was destroyed as a financial power; it was destroyed as a leader in ethics and religion and culture. There was a great collapse of the society, and Spain has never recovered.

Government-Business Relations 37

* * * * * * * * * * * * * * * *

PART TWO POLICY AREAS

Labor Productivity a n d

^ V i i n i n V ^ i i r

Demographics

7. THE TRAINING COMPONENT OF GROWTH POLICIES Michael L. Wachter INTRODUCTION Historical studies find that improvements in the quality of the workforce through increased years of schooling, increased knowledge in general, and labor augmenting technological change are the most important contributors to productivity growth. In this context, it has been argued that the nation's supply-side policy is biased, lacking a well thought out "human capital" (as distinct from physical capital) dimension that can build upon the payoff to this type of investment. This paper attempts to put together some of the major strands that constitute United States policies today and to evaluate the payoffs from these or alternative policies. General discussion of skill enhancement policies involves two groups. The first group consists of disadvantaged individuals, disproportionately the young and the minorities. They are now the main recipients of employment and training programs. Most of these individuals are unemployed prior to being enrolled in training programs or hired into public service jobs, while others are out of the workforce entirely. Based on eligibility criteria, the disadvantaged are those with low skills and only partial labor market attachment. The second group consists of displaced workers who have lost jobs as a consequence of international trade or technology shifts. A major difference between disadvantaged and displaced workers is that the latter had previously been regularly employed, sometimes at high wages. A similarity between them is that they are both categorized as structurally unemployed. Research assistance for this study was provided by the General Electric Foundation and the National Institutes of Health. The author wishes to thank Sar Levitan and William L. Wascher for helpful suggestions and Nancy Zurich for research assistance.

Training Component of Growth Policies 41

To what extent can increased funding for employment and training programs increase the productivity and output of disadvantaged workers? Especially with respect to labor market programs, both output and productivity effects must be distinguished. These programs are designed to increase the number of hours employed or the hourly wage rates of program participants. Both yield an increase in earnings and national output, but only the increase in hourly wage rates results in an increase in economy-wide productivity. There is some evidence that training programs lead to increased employment for program participants over the immediate postprogram period. This may be in the form of more time spent in the labor force, a lower incidence of unemployment while in the labor force, or increased hours of work while employed. Less success has been achieved in increasing wage rates of program participants relative to a control group. Since they do not increase real wages, training programs will not tend to increase productivity. Efforts to help the disadvantaged workers have consisted of direct employment programs as well as training programs. The former consist of public service employment jobs and "work experience" jobs. (Work experience jobs provide a sheltered work environment, typically with a government agency, where the hard-core unemployed can be socialized in the rules of the work environment.) These employment programs have, with a few exceptions, been a failure. First, they have had less success than training programs in raising the earnings of program participants. Second, although the programs have attempted to provide countercyclical employment opportunities for unemployed workers, they have proved to be procyclical. The problems faced by displaced workers are very different from those of disadvantaged workers. Displaced workers have a long and stable employment history, and their skill levels are considerably above those of disadvantaged workers. Their difficulties are due to the fact that they have accumulated a certain amount of specific human capital which is no longer in demand and, for those in strongly unionized industries, receive a union wage premium. The result is that the displaced worker has an opportunity wage that is lower and at times considerably lower than the wages attained in the last job. In most cases, given the policy options that are available, much of the wage loss is permanent and cannot be undone. This suggests that more attention be given to collective bargaining solutions that avoid displacement in the first place. This phenomenon is apparent in a recession environment, as workers "give back" wages in return for improved job security. In order to formulate labor market policies for the 1980s, the underlying outlook for supply and demand conditions must be ana-

Policy Areas—Labor Productivity and Demographics 42

lyzed. Two issues are of particular importance: the demographic factors which have had a major impact on the labor supply over the past two decades and the potential effects of technological change on the demand for labor. Labor supply factors will be highly favorable over the next decade. The percentage of young workers in the labor market will be decreasing as the baby boom cohort enters its early career stage. The increasing labor force participation rate is likely, at least, to slow its ascent. Perhaps most important, however, is that the percentage rate of increase of the total labor force will decline sharply. This labor market environment, if it does develop, should make the task of dealing with disadvantaged and displaced workers more manageable. Specifically, the disadvantaged and displaced unemployed workers compete in the same labor markets as new labor market entrants. The fewer the number of these new entrants, the more favorable the job prospects of others. Moreover, the improving capital-labor ratio growth rate increases the potential for placement at higher wage rates. The new environment, however, will require a different mix of employment and training programs from that utilized during the 1970s. The outlook for the demand for labor in the short run will be affected by an economy operating below its potential output. Unemployment will thus remain above its equilibrium level in the short run. But will the equilibrium unemployment rate itself be increased as a consequence of the displaced worker phenomenon? It now appears that as the economy recovers, the number of unemployed, including the number of displaced workers, will decline—leaving no permanent scars on overall labor market indicators such as the equilibrium unemployment rate. A distinct argument from this cyclical scenario is that unfavorable secular shifts in labor demand will dominate the employment picture in the 1980s. This claim is based on the prediction of pervasive laborsaving technological change associated with the rapid diffusion of microelectronic technologies. These forecasts, however, are based on a misinterpretation that stems from focusing on partial rather than general equilibrium effects of changes in technology. Indeed, if the economy is to increase its output and productivity growth rates, a faster rate of technological change will be mandatory. In section 1 of this paper, the problems posed by disadvantaged workers are noted and the recent performance of employment and training programs is evaluated. Section 2 evaluates the potential policy remedies for dealing with displaced workers. Finally, the general labor supply outlook for the 1980s is described and the labor demand argument, based on rapid technological change, is critiqued.

Training Component of Growth Policies 43

THE DISADVANTAGED WORKER THE NATURE OF THE PROBLEM

The term disadvantaged worker is typically used as synonymous with the notion of the "hard-core" or structurally unemployed; that is, those individuals who are chronically unemployed and reside in low income families. Specifically, these individuals are not cyclically unemployed in that their labor market difficulties involve "employability" and not simply a lack of jobs. Consequently, an economic recovery will not resolve their problems.1 Since the disadvantaged worker classification is used, however, to define eligibility for certain government employment and training programs, it is unwise to define that term as being synonymous with the unemployed. Some low income individuals, who may at any particular time be temporarily out of the labor market but who may also have a history of frequent or prolonged bouts of unemployment, should also be included. The characteristics that define the disadvantaged worker group thus include low skills and education and family responsibilities or personal difficulties (including ill health) that prevent a full-time attachment to the labor market. That the term disadvantaged is defined by two criteria—that is, family income as well as current and past unemployment experience— rather than in terms of unemployment alone is due to the fact that the link between economic hardship and overall unemployment has been broken.2 In 1979, when the economy was last close to its equilibrium or full employment level, only one out of seven labor market participants who experienced unemployment during the year resided in a poor family. Over half of the unemployed resided in families with income above $15,000 or just below the median family income level.3 The growth in the percentage of families with two or more wage earners (in 1980 approximately 56 percent of all families had more than one wage earner) and government transfer programs account for the relatively high income status of the average unemployed worker. Where to draw the line in defining low family income is a subjective issue. As a consequence, there is no widely agreed upon count of the size of the disadvantaged population.4 This shift in the definition of hardship, toward a combined income and unemployment-based measure instead of exclusively an unemployment rate measure, has had the effect of shifting the demographic characteristics of those labeled disadvantaged. That two-criteria group contains many more minorities, Aid to Families with Dependent Children (AFDC) recipients, and families with one or zero wage earners. Obviously, the

Policy Areas—Labor Productivity and Demographics 44

average family income of the hardship group is considerably below that of the average unemployed family. THE 1970s RECORD OF EMPLOYMENT AND TRAINING PROGRAMS

Should the employment and training programs of the 1970s be resuscitated to deal with the disadvantaged worker problem in the 1980s? Before answering this question, it is first necessary to understand the goals of the programs and the mechanism through which these programs raise the earnings of the disadvantaged workers. In addition, it is also useful to understand why the programs became sufficiently unpopular in the last few years to encourage the administration and the Congress to reduce significantly their scope. During the late 1960s, the employment and training programs of the Labor Department were the centerpiece of the war on poverty. By the 1980s, their effectiveness was sufficiently in question that they received significantly reduced funding in the midst of the deepest recession in forty years. Two important negative features of the programs, as they were actually administered, account for the fall from grace. First, preferential funding was given to direct job creation in the public sector rather than to training programs geared to improving employability in the private sector. Second, these job or employment programs proved to be procyclical rather than countercyclical. Throughout the 1970s, there was budgetary competition between the two goals of increasing employment through direct job creation and, alternatively, of improving employability through manpower training. The specific programs of the Employment and Training Administration could be divided into employment and training efforts. The employment programs included public service employment and work experience. The former simply funded state and local governments in the direct hiring of individuals. The latter provided a sheltered work environment, typically in a government agency, for the most difficult to employ individuals. The training programs consisted primarily of classroom training and on-the-job training. Whereas classroom training was used for jobs that could be taught in the classroom, such as secretarial work, on-the-job training subsidized participating private sector employers for the extra cost incurred when they hired individuals from the eligible population. The reimbursement to employers typically equaled 50 percent of the participants' wages during the training period. The argument was made by some adherents of the employment programs that that approach dominated training programs, on a benefit-cost basis, in improving employability. Others argued simply that it was more important to reduce unemployment rates quickly.

Training Component of Growth Policies 45

Faced with a given budget constraint, the maximum number of individuals could be serviced if the funds were used largely to pay the salaries of enrollees; and training-related expenditures, for example, for training personnel or purchasing capital equipment, were minimized or avoided entirely. Moreover, whereas those enrolled in training programs were not counted as employed, those in public service jobs were counted. Direct job creation won the funding battle over the training programs. The direct job creation component (which includes the work experience programs and public service employment) of total outlays was approximately 20 percent in 1970 (see figure 7.1). Five years later, in 1975, direct job creation accounted for 38 percent of the outlay and that percentage continued to increase, reaching 57 percent in 1979.5 A problem with this drift in funding was that cost-benefit evaluation studies were recommending the reverse course of action. Those studies indicated that training dominated employment programs in terms of ability to improve the post-program earnings of participants. Public service employment (PSE) programs, moreover, had the side effect of skewing the employment structure toward government employment in a seemingly permanent manner, when the underlying objective was to moderate temporary job losses in the private sector during recessions.6

THE PERVERSE CYCLICAL TIMING OF PSE

The usefulness of any countercyclical expenditure program is ultimately related to its ability to fill in the peaks and troughs in business activity. The direct job creation programs have not been successful in satisfying this criterion. The procyclical expenditure pattern of direct job creation has been a consistent problem of all of the major jobs programs. This story is worth telling because of its relevance to the current jobs program. The Neighborhood Youth Corps (NYC) program was started in the early 1960s when the economy was in a slack period. During the boom years of the middle and late 1960s, the number of first-time enrollments grew from 137.9 thousand to 504.1 thousand. Enrollments did decline marginally between 1967 and 1969, but the economy was then experiencing substantial overheating. In that environment, funding for work experience should have been reduced to some minimal level. The decline in business activity during 1970 did coincide with an increase in NYC job creation. Funding for the program, however, continued to reach new highs during the strong business expansion from 1971 to 1973. By fiscal year 1974, with unemployment below its

Policy Areas—Labor Productivity and Demographics 46

FIGURE 7.1 Outlays for Training and Employment Activities, All Federal Agencies Fiscal Years 1964 to 1981 $ Billions

18

- -

Proposed Youth Initiative

15 Public Service Employment"

12

9 --

Work Experience OJT

6 -Institutional Training

3 -Vocational,

H 1 h -i N O N O N O N O n O NO NO NO ON O Nj M UN 1 O ON N ON 00ON aNO O »-> source: See n. 5.

1 1 1 NO NO NO Vlvjvj

"Rehabilitation, All Other

h H 1 1 1 NON£NONONONO V lJO^ N j vv jgvo jovNj O oO o O

1 V^ 00 i-»

Fiscal Years

Total public service employment activities.

equilibrium level, the number of NYC jobs had increased by 85 percent above the level reached in fiscal year 1970. The perverse cyclical orientation of NYC was shared by the Public Employment Program (PEP) of the early 1970s and the Comprehensive Employment and Training Act (CETA) program thereafter. The PEP program, authorized by the Emergency Employment Act of 1971, was explicitly designed to deal with countercyclical unemployment. But the PEP job creation effort did not begin until the recovery was under way, and it reached its peak in the summer of 1973 when the

Training Component of Growth Policies 47

unemployment rate was lower than the equilibrium rate of unemployment. With the economy exhibiting the classical signs of overheating, PEP jobs most likely had the effect of "crowding out" private sector jobs and contributing to the rising inflation rate. CETA followed a similar procyclical pattern. Ideally, for maximum countercyclical effect, CETA should have been increased in 1974-75 and then reduced in scale or omitted entirely in 1977-79. Between 1975 and 1979, the number of work experience and PSE participants jumped from 1.084 million to 1.854 million and expenditures rose from 2.7 billion to 8.2 billion. This increase in direct job creation activity occurred in the context of a strongly growing economy that approached the equilibrium unemployment rate by 1977-78. By 1979, with the unemployment rate again below its equilibrium level, almost 2 percent of the labor force was involved in these largely countercyclical efforts. Finally, the Reagan administration, in reducing the funding for the job creation programs as economic business activity slowed, continued the mistiming phenomenon. Although I believe the evidence did suggest merit in substantial and permanent reductions in the scope of the jobs programs, they could have been maintained until the recovery of 1983. EVALUATING TRAINING PROGRAMS

Whereas public service employment programs have strong arguments against them, the same is not true for the training effort. These latter programs do seem to be able to increase the employability of program participants and to have somewhat less of a procyclical funding problem. They also have features which suggest that they may be applicable to the displaced workers as well as to the disadvantaged workers. To the extent that the specific policy goal being pursued is to increase output or productivity, the benefits of training in that policy context can be evaluated in terms of the ability of the programs to increase the wages, employment, and hence earnings of program recipients above what they could have earned in the absence of the program. Figure 7.2 provides a simple diagram to illustrate the nature of the evaluation process. The typical individual who is selected for a training or employment program has suffered a recent decrease in earnings because of a decrease in wage rates or, more likely, a reduction in hours of employment. The latter may be caused by a bout of unemployment or a period of nonlabor market activity. Preprogram permanent income is shown by the line segment oa. The negative transitory factor is depicted by ab, which is drawn below oa. Hence, the fact

Policy Areas—Labor Productivity and Demographics 48

FIGURE 7.2 Pre- to Post-Program Earnings Earnings

« - Pre-Program

Post-Program - >

that "immediate" preprogram earnings are typically low or even zero is due to the negative transitory component. While enrolled in a training program or employed in a public service job, the program participants' economic welfare is obviously improved. In terms of figure 7.2, line segment be is greater than ab. In fact, for many individuals be will be greater than oa. The test for program efficacy, however, must ignore the economic improvement while enrolled or employed in the program. Rather, it should be based on a comparison of earnings after program participation is terminated (that is, line segment cd) with the earnings of a control group that had similar preprogram earning experience of oa.7 An improvement in earnings of program participants above ab is not sufficient; rather, it is assumed that that decline would likely be temporary even without program assistance. The notion that, for most individuals, the preprogram earnings loss (ab) is transitory is suggested by the behavior of the control group. Many of them also show a period of declining earnings, but the decline proved transitory even without their being enrolled in the program. This justifies requiring that cd may be greater than oa and not simply ab. There have been a number of excellent studies evaluating the suc-

Training Component of Growth Policies 49

cess of employment and training programs. Although conclusions differ across studies, it is possible to list a number of consensus findings. 8 Most studies show that earnings increased for participants over earnings of a control group of comparable individuals. The largest gains were generated by training programs, including on-the-job and classroom training as well as the Job Corps. Public service employment and work experience, the direct job creation programs, were less successful than the training programs.9 An important component of the earnings gain of program participants has been due to increased employment or hours of work rather than increased wage rates. That is, the labor supply is increased through increased labor force participation or extra hours of work by those already employed. In addition, a lower incidence of unemployment would also raise hours worked. Typical of the increased earnings, 75 to 95 percent of the gain can be attributed to increased employment or hours, with the remainder attributed to wage rate gains. It is worthwhile to isolate the effects of training programs on adult participants (those 24-plus years of age) because of their potential relevance to policy approaches of the displaced worker problem. For this specific age group, training programs had positive benefits for women but not for men. (The specific point estimates of the benefits for males were positive but not statistically significant in terms of the zero effect null hypothesis.) Of the earnings gains for women, 80 percent were due to increases in time spent working with the remainder attributed to increases in wage rates.10 For public service employment and work experience programs, benefit-cost ratios typically are less favorable than for training programs. Moreover, the gains that are recorded are more open to controversy or, at least, less relevant to today's environment. Specifically, the gains are largely attributable to participants' shifting from supported to unsupported public service jobs. In the current environment, which stresses growth in private sector employment, PSE programs are particularly handicapped. Since training programs do seem to be successful in increasing earnings, do they fit into a policy framework geared to increasing output and productivity? That the success of the programs is tied to their ability to increase hours of work rather than wages is pivotal in answering this question. With respect to productivity goals, training programs appear to be unsuccessful. Since productivity is calculated by dividing output by hours, productivity only increases if output rises more than hours. The evaluation of training programs, however, indicates that they increase output (measured as the increased income) of program participants only by increasing hours. Wages paid per hour and thus

Policy Areas—Labor Productivity and Demographics 50

productivity are stationary. With respect to output goals, however, the assessment is more favorable. Increased earnings count toward this realization of higher output whether generated by increased hours worked or by wages per hour. These relatively large employment and low gains of program participants are compatible with the notion that the labor supply curve of disadvantaged workers is very elastic in the relevant range. Much of the increase in hours of work can be attributed to increases in labor force participation rates. Many of the workers eligible for training programs have a casual attachment to the labor market; that is, they move frequently between labor market and non-labor market status. The programs appear to increase the percentage of time that these workers are in the labor market. In addition, decreases in the incidence of unemployment, as well as increases in hours of work once on a job, may be explained by an increase in the supply of work. In a traditional cost-benefit analysis, increases in earnings due to increases in the supply of labor are not benefits to be credited to the program on a one-for-one basis. The reason is that the participants are giving up leisure, and on the margin, this leisure has a value approximately equal to the wage on the extra hour of work. In the context of an economic growth program, however, these labor supply increases can be interpreted as partial offsets to the labor supply disincentive effects created by welfare and tax programs. (See the Hausman paper in this volume.) THE DISPLACED WORKER DEFINING THE PROBLEM

Much of the current debate over unemployment policy involves the displaced rather than the disadvantaged worker. There is a wide variance in how the displaced worker phenomenon is defined. Some appear to use the term interchangeably with individuals who have lost their jobs during the current downturn. For analytical purposes this categorization is not useful since it overlaps with traditional measures of cyclical unemployment. The various types of unemployment need to be differentiated in order to clarify the mechanism that causes the unemployment as well as the appropriate menu of policy options. The term displaced worker is used in this paper as a category for those workers who will not be reemployed in their previous job in the next cyclical upturn and who are not unemployed because of a lack of skill or work attachment (the disadvantaged workers). In addition, however, the term is also meant to include only those for whom a change in jobs will prove costly; that is, those who have made an investment in seniority and job-specific training.

Training Component of Growth Policies 51

Since there is no way of knowing whether any given worker will be rehired in the next upturn, the number of displaced workers can only be measured by adopting some proxy variables that approximate the definitional characteristics. For purposes of this paper, the displaced worker is defined as one who held previous employment in a declining industry with some length of job tenure.11 The declining industry is defined here as one in which employment levels decrease from peak to peak as the result of either reduced output levels or reduced manhour requirements at any given level of output. The structural as distinct from cyclical employment decline has been attributed largely to long-term trends in international trade competition and the adoption of labor-saving technologies, in particular those based on microelectronics. The length-of-job-tenure criterion is adopted to distinguish between those who have settled into what had promised to be their lifetime or career jobs and those who did not have jobs with much tenure at the time they were discharged. The latter group has made less of an investment in training specific to their previous jobs and are younger on average. As a consequence they can typically change jobs at lower cost to themselves. The Congressional Budget Office has compiled statistics showing the number of displaced workers, as of January 1983, based on a number of definitions of the term. Based on 1982 data, they found that 1.29 million of the unemployed were from declining industries and that 280,000 of those workers also had ten or more years of job tenure. See table 7.1. A declining industry is defined as an industry that had declining employment levels from 1978 to 1980.12 The industries that fit that characteristic and contributed the most to the displaced worker population were lumber, automotive, primary metals, textiles, wearing apparel, and certain retailing industries. The personal characteristics of the displaced worker population are quite different from those of low income families. (See table 7.2. This table, as indicated in accompanying note a, uses a definition of displaced workers somewhat different from that adopted above.) A greater percentage of the displaced workers have a high school diploma or better (66.2 percent), and a smaller percentage are from the minority population than is true for the low income family. The major differences, however, involve the considerably higher economic status of displaced workers in the year prior to being displaced. One-quarter of them came from families with income of at least $15,000; one-half were covered by employer pension plans; and more than one-half had one or more other family members employed.

Policy Areas—Labor Productivity and Demographics 52

TABLE 7.1 Estimated Numbers of Displaced Workers in January 1983 under Alternative Eligibility Standards and Economic Assumptions (in thousands) Eligibility Criteria Single criterion Declining industry Ten years or more of job tenure More than 45 years of age Multiple criteria Declining industry and ten years or more of job tenure 45 or more years of age

Numbers of Workers *

1,290 870 1,160

280 280

SOURCE: Congressional Budget Office estimates based on tabulations from the March 1982 Current Population Survey. 'Assumes that the number of dislocated workers in each category decreases proportionately with the projected change in the aggregate number of unemployed workers between the first quarter of 1982 and the first quarter of 1983, a reduction of nearly 5 percent. THE ECONOMIC NATURE OF THE PROBLEM

To evaluate potential policy measures to deal with the displaced worker problem, the relevant underlying labor market mechanism must be understood. From the vantage point of the workers, the jobs that are lost are those in which the workers have invested in specific training, acquired the benefits of seniority or who now receive a wage premium because of unionization. Starting a new job compromises those gains. In addition, whereas seniority is a benefit to workers on established jobs, that age factor is a liability when searching for a new job. A worker, prior to being displaced, can be viewed as having a potential flow of wage income (see age-earnings profile in figure 7.3). The age-earnings profile slopes upward since workers tend to receive higher wages as they age (curve AAl). This can be attributed to a return on specific training or a seniority system in which length of job tenure is itself rewarded. If the jobs are unionized and the union succeeds in raising wages, the age-earnings profile can be depicted as BB\ If workers are displaced, they can, after some time, find a job. In this new job, the workers can be assumed to lose the benefits of unionization, job seniority, and any investments in specific training. The "opportunity" wage or the wage on the new job is shown by the

Training Component of Growth Policies 53

TABLE 7.2 Characteristics of Displaced versus Disadvantaged Workers (by Percentage) Characteristic High school diploma or better Minority Female Pension plan coverage in at least one job held during past year Family income $15,000+ in last year Family with one or more additional workers

Displaced Worker"

Disadvantaged Worker*1

66.2 30.6 35.0

55.9 42.7 37.2

50.3

13.3

24.5

0.2

55.8

29.2

SOURCE: Marc Bendick, Jr., and Judith Radlinski Devine, "Workers Dislocated by Economic Change: Do They Need Federal Employment and Training Assistance?" Seventh Annual Report of the National Commission for Employment Policy (1981), pp. 175226. NOTE: Data are for March 1980. "Workers from industries in which employment change was negative between 1978 and 1980 and who were unemployed for more than eight weeks. Job tenure and age were not defining characteristics. Disadvantaged workers are those from low income households. Low income households are defined as those households whose total family income from all sources in the year 1979 was less than 1.5 times the Bureau of the Census poverty threshold for a family of that size arid location.

curve OO 1 . This curve depicts the beginning wage on the new job for displaced workers of different ages. It is shown to decline with age, at least after a certain point in the life cycle. The decline reflects a number of factors ranging from institutional customs or hiring practices to declining skill with age. The older workers, precisely because of their age, find it more difficult and less profitable to invest in new specific training. The difference between workers' rising age-earnings profiles (BB1) and the declining opportunity wages (OO1) yields the annual wage loss to the displaced workers. That annual loss increases significantly with age. The lifetime earnings loss as distinct from the annual earnings loss would be the area between the two curves beginning at the time of displacement. Clearly, the oldest workers, although they have

Policy Areas—Labor Productivity and Demographics 54

FIGURE 7.3 Loss of Earnings of Displaced Workers

Earnings

B' A'

O

B

A •

Age

(AA1) Average Earnings Profile for the blue-collar worker who retains his job, that is, is not displaced. (BB1) Average Earnings Profile for the union member who retains his job, that is, is not displaced. (OO1) Opportunity Wage for the displaced workers, that is, the wage that they can obtain on a new job in a competitive labor market. AA'-OO 1 is the annual earnings loss to a nonunion displaced worker. BB'-OO 1 is the annual earnings loss to a displaced union worker.

the largest annual loss, will not have the largest lifetime earnings loss. That distinction is more likely to befall displaced workers who are in their late forties or early fifties. There is no unique age at which the loss would be a maximum; rather, it would vary with the nature of the industry and occupation and the quantity of specific training. It is this potential, permanent lifetime income loss which is worst for older workers who are too young for early retirement that is at the heart of the displaced worker problem. Newly displaced workers are likely to begin the job search looking for jobs that can use their specific training skills and that pay a wage rate comparable to the wage paid on the lost job. Consequently, even

Training Component of Growth Policies 55

in an expanding economy, they are likely to face a lengthy bout of unemployment until their reservation wage—that is, the wage at which they will accept a new job—falls to their opportunity wage. The higher the wage on the lost job, the longer the period of unemployment. For some workers, the earnings replaced by unemployment insurance may be close to the earnings available on the alternative jobs. Empirical studies based on plant closings in the early 1970s support the conclusion that workers permanently displaced, unlike those on temporary layoffs, may suffer substantial losses in earnings for prolonged periods of time. The size of the earnings loss, however, depends to a great extent on the existence of a large union wage differential in the previous job. Earnings losses over 25 percent can be found for automobile and steel workers. For those in apparel and textiles, the losses are more likely to be under 10 percent. Although I have defined displacement in terms of declining industry employment and length of job tenure, a regional dimension can also be introduced. The declining industry base is largely in the industrial north central and northeastern states. Since some towns and cities in these regions have a heavy concentration of employment in declining industries, alternative employment opportunities are limited. As a consequence, recovery from job displacement may require geographical mobility. The human capital framework analyzes migration as a type of investment decision where discounted benefits and costs are equilibrated. The older the worker, the fewer the number of post-migration years in which to garner the benefits of the geographic move and the greater the fixed investment in the original community in terms of social and psychological relationships. The fact that other family members may still be employed adds another cost dimension to geographical mobility. Fixed investment in specific training, union wage premium, and housing all become obsolete and, like the plants in which they worked, must be simply written off. The policy issue for the truly displaced worker is not how to regain those lost fixed assets but rather how best to make new investments at a time when remaining worklife expectancy is short. RELATIVE WAGES AND DISPLACEMENT

Although an analysis of the causes of the ongoing structural change is beyond the scope of this paper, one aspect of the topic is of central concern. In the discussion above, it was argued that the cost of displacement is a function of the difference between individuals' wage rates on their last job and their opportunity wages. To the extent that

Policy Areas—Labor Productivity and Demographics 56

individuals' wage rates represent a union wage premium, the opportunity wages on new jobs in different firms will be lower by that amount. Not only do wage rates play a pivotal role in defining the problem of displacement, however, but also they are crucial as a causal element in explaining the extent to which displacement is likely to take place. Specifically, any job with an increasing wage premium, that is, a wage above the market clearing wage, has a higher risk of displacement than a similarly situated job that pays the equilibrium wage. One might normally expect that industries facing stiffer competition would act to restrict wage gains. Quite remarkably, the reverse happened. In four of the five manufacturing industries identified as declining industries, wages increased faster than in the total nonagricultural economy. See table 7.3.13 Indeed, over the decade of the 1970s, average hourly earnings in motor vehicles grew 1.4 percent per year faster than in the overall economy. In steel, wages grew almost 3 percent faster per year than in the rest of the economy. There is no evidence to suggest that these rising relative wages reflect change in the skill composition of the workforce in those industries. The magnitude of the displacement effect resulting from relative wage gains depends upon the employment elasticity with respect to wages. Increased relative wages generate both a negative industry output effect as well as a substitution of capital for labor. In a closed economy or a protected domestic market, product demand is likely to be inelastic, and hence, labor demand is likely to be inelastic with respect to wages. In an international market, the elasticity of demand for the United States produced product will be high, and consequently, employment will also be responsive. TABLE 7.3 Wage Increases in Declining Industries Growth Rate in Average Hourly Earnings (by percentage)

All Industries Basic Steel Motor Vehicles Lumber Apparel Textiles

1970 to 1975

1975 to 1981

7.00 10.78 8.82 7.55 7.43 6.99

8.15 10.47 9.22 8.62 6.46 8.30

Training Component of Growth Policies 57

Relative wage levels are only one part of the story. The moderate wage increases in the apparel industry have not prevented continuing market losses. Moreover, the rising value of the dollar has had a larger quantitative effect on the American wage level problem than domestic relative wage changes. As stressed in the introductory chapter to this volume, real wages in the United States have underperformed those of its major trading partners. The point concerning relative wages is raised here to indicate that the policies pursued by the private sector parties are important determinants of the scope and nature of the displacement problem. Workers in industries with increasing relative wages not based on changes in the skill composition of the workforce face an increased probability of being displaced. POLICIES FOR DISPLACED WORKERS

The current approach to the problems posed by displaced workers is to use "special protection programs" to provide transfer payments to displaced workers that are more generous than those received by other unemployed workers. That policy approach has been criticized because, by providing supplementary benefits, it discourages workers from finding new jobs. It also does not provide the training that could better equip displaced workers for new jobs. The special protection programs applicable to displaced workers are diverse. The most well known is Trade Adjustment Assistance (TAA). It is targeted toward workers in industries that are designated as adversely affected by imports. Transfer payments (70 percent of previous weekly wages up to the national average weekly manufacturing wage), training, and relocation benefits are available. To date, only the transfer payments have been widely use. 14 The novel conceptual feature of TAA is that it is designed to compensate affected workers not only for their earnings losses (which are covered by unemployment insurance, UI) but also for their loss of job seniority and other job related rights that result from government initiated actions, including free trade. This approach, however, has three serious flaws. First, at the time that workers are dismissed, the workers, the policymakers, even the firms do not know which workers might eventually be recalled and which are, in fact, permanently displaced. Second, Trade Adjustment Assistance does not distinguish among workers with respect to their tenure on the job. As a consequence, relatively junior workers who have not made large investments in specific training or seniority are being compensated for a loss that they have not actually incurred.

Policy Areas—Labor Productivity and Demographics 58

Third, the distinction between unemployment caused by government policy, generally interpreted, and other types of unemployment is difficult to make. Although some types of unemployment may be a very specific result of some specific government policy, most if not all unemployment can be viewed as being affected by general government policies. Thus the Trade Adjustment Assistance approach constructs artificial distinctions among unemployed workers and pays supplementary benefits to certain groups that have no greater claim on those resources than any other unemployed workers. Since the above problems are to some extent inherent in the concept of special protection, restructuring existing programs can only make a bad situation somewhat better. The alternative is simply to fold the transfer payment provisions onto the UI system. In that way, all unemployed workers would have their benefits calculated according to the same formula. Providing training, as distinct from transfers, for displaced workers does not have the above limitations. If the workers are interested in being retrained, then there is a presumption that they are indeed displaced and not simply on temporary layoff. Indeed, the notion of retraining for displaced workers is currently popular. One policy recommendation is to make existing training programs available to them. For programs targeted toward disadvantaged workers, many of the displaced workers would not be currently eligible because their past wages and family income would be too high. To what extent, however, can existing programs that were designed for disadvantaged workers deal with the unique problems posed by the displaced workers? As noted in the preceding section, current training programs largely have their effect by increasing the hours of work for workers with marginal labor market attachment. The displaced workers, however, have an established work history marked by strong job attachment and the proven ability to learn (at least certain types of) job skills. Their problem is neither too few hours of work nor marginal skills; rather, it is that their previous jobs paid high wages relative to the opportunity wages that they face on alternative employment. On this basis there is reason for skepticism about the potential success of extending coverage of existing training programs. The most promising approach would be to use on-the-job training, vouchers, or employment tax credits targeted toward displaced workers. In this fashion, the government could compensate private sector employers directly for "extra" training costs associated with specially targeted workers (i.e., those eligible for the program). If a voucher, employment tax credit, or on-the-job training program were to be implemented, what value should be attached to the

Training Component of Growth Policies 59

vouchers provided to displaced workers? In other words, what are the damages suffered by these workers that should be viewed as compensable? This is the fundamental question concerning the displaced worker issue. For example, suppose that the displaced workers had enjoyed a wage premium resulting from collective bargaining agreements. Making the workers whole could be interpreted as providing them with a voucher or employment tax credit of sufficient value so that they could eventually earn (as a return on their skills) in their new jobs the wage premium paid on their lost jobs. There is, of course, the question whether any combination of vouchers or on-the-job training could be successful enough to compensate the workers fully. Even if it could be accomplished, there is still the question whether it should be attempted. Suppose, for example, that the union wage on the lost job did, in fact, represent a wage above that dictated by competitive labor market forces. The displaced unionized workers were receiving a higher wage, based on a collective bargaining agreement with the past employer, than similarly skilled workers in nonunion firms. Although the government might want to assist the displaced workers in finding jobs at the competitive wage earned by most other workers, funding extra training to support the wage premium itself would be more difficult to justify. Some researchers have argued that the union wage premium is actually a compensating differential for the fact that the unionized jobs are in those sectors where employment is particularly sensitive to cyclical layoffs or employment uncertainty in general. In this sense, the observed high wage is not precisely a wage premium; rather, it is a compensating wage differential for the higher risks of unemployment. If this were true, the employment loss from the high variance employment industry would reflect the realization of a relatively high probability event (compared, for example, to being displaced from a job in the finance sector). The placement of a displaced worker in a new job—in a lower employment variance industry—could be made at the competitive, nonunion wage since the compensating risk differential would no longer be required. A separate but even more intractable issue is posed by the notion that the government should consider some mechanism for compensating displaced workers for their lost investment in job-specific training. For example, if the government were to treat human and physical capital symmetrically, the loss of a human capital investment could yield an income tax write-off for its owner. The difficulty is that that type of training is inherently unquantifiable. Attempting even a rough estimate of its monetary value would be too speculative to serve as a guide for policymakers.

Policy Areas—Labor Productivity and Demographics 60

To summarize, one can argue that the displaced worker's loss of a wage premium should be noncompensable from a societal perspective. What government policy could still accomplish is the reduction in the transition costs associated with finding a new job. That is, the government would attempt to restore jobs at the competitive or prevailing labor market wage for workers with similar, broadly defined skill levels. Whereas replacing lost wage rates would be very difficult, finding new employment for displaced workers in an expanding economy would be a simple task. Since this would only require retooling and placement, on-the-job training could facilitate that retraining process. The current on-the-job training program should be restructured to be better adapted to older workers with established work histories.15 Given the above argument, private sector initiatives may be the only route to deal with the income loss posed by displacement. Specifically, the parties to the collective bargaining agreement in declining industries may need to address the displacement problem. This is particularly relevant to the extent it is determined that society can and will compensate displaced workers only for their lost jobs and not for the lost wage premiums on those jobs. In this instance, job insecurity—that is, the protection of job-specific investments and wage premiums—is more fully an employer-employee problem that requires a private sector solution. Extra attention must be given to avoiding the job loss in the first place. Where workers are unionized, they can bargain collectively with employers for job protection. Since this is already done extensively in most industries and crafts, the issue is what weight to assign to those concerns in relation to other union objectives. This paper is not the place to investigate the collective bargaining topics that bear on the problem. It is worth noting, however, that there is considerable latitude for improving job security, if traded off against other concerns. This is particularly true with unions that are organized along company or industry lines. LABOR SUPPLY FRAMEWORK The likely course of the disadvantaged and displaced worker problem over the remainder of the 1980s will reflect changes in the underlying labor supply and demand picture. Since these workers may be viewed as structurally unemployed, the size of the problem will be strongly affected by changes in actual and equilibrium unemployment rates. This section deals with the labor supply framework, while the labor demand potential is evaluated in the next section. The changing demographic profile of the population and labor

Training Component of Growth Policies 61

force will dominate labor supply developments over the intermediate run and will be a strongly positive factor with respect to relative unemployment and excess demand conditions in low wage labor markets over the next decade. This should make the problems posed by disadvantaged and displaced workers more manageable. Moreover, with the exception of one important disadvantaged group, the number of disadvantaged workers should decline. The percentage of the population composed of teenagers between 16 and 19 years old has already been declining for several years. Whereas that group was 10.8 percent of the population in 1975, they were 9.9 percent in 1980, and will be only 8.0 percent in 1985. The 20to 24-year-old age group peaked in size in 1979. Their percentage of the population will decline from 12.6 percent in 1980, to 11.6 percent in 1985, and to 9.7 percent in 1990. Early career workers, age 25 to 34, will be the most rapidly increasing group in the population through the mid-1980s. By 1990, there will be 3 million more of them than in 1982. Thereafter, the 35- to 39year-olds will be the most rapidly increasing age group. Late career workers 55 to 64 years of age will be a decreasing percentage of the total. Even 45- to 54-year-olds will be a slightly declining percentage of the total. Related to the favorable compositional shifts in the population will be the decline in the rate of overall labor force growth. Labor force growth rates are closely tied to the size of the 16- to 24-year-old population cohort. Whereas the labor force grew at slightly over 2.2 percent per year between 1970 and 1982, it will grow at only about 1.5 percent between 1983 and 1990. This drop in the rate of growth of the labor force means that 6.85 million fewer workers will be entering the labor market than would have if the old labor force growth rate were in effect. These labor force shifts are exceedingly important in understanding the likely direction of the labor market in the 1980s. The population base for two potential problem groups will be decreasing. The young workers are disproportionately represented in the disadvantaged worker group, and the older workers are most seriously at risk from job loss due to displacement. If there are fewer workers in the problem groups, then the overall quantitative size of the problem is lessened. This is especially true for younger workers and the problems associated with that age group. In addition, both the compositional change and the decrease in the growth rate of the labor force will result in a shift in the pattern of (age and skill related) excess demand conditions in favor of youth and related unskilled labor markets. This change in relative excess de-

Policy Areas—Labor Productivity and Demographics 62

mand conditions will contribute to an increase in the relative wages of young workers and the low skilled workers that they compete with. As the secular pattern in these labor markets changes from excess supply to excess demand, the secular trend over the past two decades that has penalized the earnings of these workers would be reversed. For example, whereas males age 20 to 24 earned $.73 for every $1.00 earned by males age 45 to 54 in 1955, they earned only $.58 on the $1.00 by 1975.16 An increase in the relative wages in those youth and unskilled jobs will also be associated with a decrease in equilibrium unemployment rates. The close relationship between the equilibrium unemployment rate and the demographic composition of the labor force has been described elsewhere and will not be reiterated here. How much unemployment (in terms of the duration of each spell) is caused by these demographic and employment shifts will depend upon the "cost-of-being unemployed." That concept is equal to the foregone wages from not working minus the transfer payments available when not working. Since foregone earnings are difficult to measure when cyclical unemployment is high (it is not clear at what wage any job would be available), the term is primarily of use in describing unemployment duration when the economy is close to its equilibrium rate.17 Defined in this fashion, the cost-of-being-unemployed was considerably lower by the end of the 1970s than at the beginning of the 1960s. This was a result of the increase in eligibility and relative replacement rate of programs such as unemployment insurance, AFDC, and food stamps. With those programs increasing faster than market wages, the difference between the market wage and the transfer payment available when not working decreased.18 Over the next decade the equilibrium unemployment rate should decline. The demographic labor supply effects, tilting the labor force heavily toward job-stable older workers and away from youth workers, and the slower increase in the rate of growth of the labor force should be strongly positive factors. A decrease in the number of new and young unskilled workers should increase the relative wage of these workers, increasing the cost-of-being unemployed and thus decreasing the equilibrium rate of unemployment. Similarly, decreases in transfer programs should operate to decrease the equilibrium rate. Given this decrease in the equilibrium rate of unemployment and the associated relative improvement in excess demand conditions in youth and unskilled labor markets, it will be that much easier to integrate those workers who are displaced or disadvantaged. In other words, not only will there be few workers in those age groups that

Training Component of Growth Policies 63

have a high incidence of structural unemployment, but also the economy will be better able to deal with the disadvantaged and displaced populations that remain. There are, however, two important negatives in this optimistic demographic, labor supply story. First, the percentage of new entrants into the labor market will have a growing percentage of minority workers during the 1980s. Since minorities have a higher incidence of structural unemployment than white males, this should offset some of the gains in the equilibrium unemployment rate mentioned above. Second, a quantitatively sizable group in the disadvantaged worker population consists of single parent, female-headed households. Although these household units are only 15 percent of all families, they are 48 percent of poverty families; that is, one out of two poverty families is headed by a single female. (The single parent, male-headed household is a negligible component of the poverty population and is proportionately the same as its representation in the overall population.)19 The "representative" female-headed household in poverty has a female head slightly over the age of 30 with dependent children. Although there is a popular belief that most of these households have young heads, in fact, only 17 percent had female heads age 15 to 24. 20 This statistic is central to an analysis of the contribution of the demographic cycle to poverty and related labor market problems. For the next decade, the aging of the baby boom will actually increase the relative number and thus the importance of those family units that have a high incidence of poverty because they have single parent female heads. As discussed below, however, government training programs have achieved some success in dealing with this specific disadvantaged worker groups.21

LABOR DEMAND FRAMEWORK THE CYCLICAL DEMAND OUTLOOK

This paper is concerned primarily with intermediate rather than shortrun fluctuations in the labor market. Typically this would mean that changes in the demand for labor that are related to the business cycle could be ignored. In the current economic environment, with the unemployment rate still recovering from the deepest recession since the 1930s, some attention must be given to the cyclical factor. Since the prevailing forecasts are for a slow return to full employment (to approximately at 6.0 to 6.5 percent equilibrium unemployment rate), labor markets will be exhibiting economic slack for several

Policy Areas—Labor Productivity and Demographics 64

years. To what extent should labor market policies be geared to solving these cylical problems? As I have argued above, labor market policies, particularly as they were used during the 1970s, are poorly equipped to deal with cyclical problems. The major failure of labor market policy during the 1970s was the adoption of employment policies that proved to be procyclical rather than countercyclical. Since the negative record of these policies is consistent in this regard, there is reason to believe that the problem is endemic to these policies. THE STRUCTURAL DEMAND OUTLOOK

Some researchers have argued that the number of displaced workers will grow dramatically over the remainder of this decade. For example, recent studies argue that the introduction of microelectronic (high tech) technology could cause a job loss of 3 million during the 1980s and up to 7 million by the year 2000.22 The latter figure would mean a loss of one-third of the manufacturing jobs currently in existence. In analyzing these projections, it is necessary to evaluate the potential for successful predictions with respect to the demand for labor. Projections in this area are inherently more difficult than predictions of the labor supply. There are no hard, predetermined factors that compare with the population figures on the supply side of the market. Presumably one can always project existing trends, and this is largely the technique adopted by the Bureau of Labor Statistics. But a major shift in the process and speed of technological change would require a concomitant break in trend growth rates of employment data by industry. The projections of the magnitude of the job loss with respect to microelectronic technology innovations illustrate the speculative nature of the problem. Many of the underlying studies are engineering studies that essentially count the number of jobs that could be taken over by machines as part of the new technology. Cost effectiveness is omitted, but this is the crucial component. Industry does not and should not regularly operate with the "best technology." Rather, the appropriate technology, and in this sense the best technology, is that which will maximize profits given existing factor prices. Often this will not be the new or high tech technology.23 The major criticism of the "high tech" disemployment argument is that it is based on a partial rather than a general equilibrium view of the economy. Since this criticism is discussed elsewhere, I only review the major conclusions here. 24 The direct effect of technological change is that fewer inputs than had previously been needed are needed now to produce a given output quantity. The resources or

Training Component of Growth Policies 65

inputs previously employed in producing the old quantity of output can be utilized to produce additional goods and services. The result is that technological change generates a positive income effect. It is this feature of technological change that has led to its being recognized as the premier generator of increased standards of living. If as feared, today's technological change turned out to be laborsaving, only labor's share of national income need decrease. That is, total income would still increase and thus real wages could also increase. There is no presumption that unemployment would increase. Moreover, the adoption of labor-saving technological change in some sectors of the economy does not insure that the aggregate result would be a decrease in labor's share. There are numerous factors that could neutralize or even reverse industry-specific effects. For example, if the affected sectors were labor-intensive or if they purchased intermediate products from labor-intensive sectors, the economy-wide result might be to increase labor's share and real wages. Historically there is little reason to fear the labor-saving scenario. Broad classes of technological change, once the output effect is considered, have been neutral, tilting neither toward labor nor toward capital in their net effect. Indeed, over the past fifteen years, labor's share of national income has actually increased. This may be the result, however, of a number of factors besides technological change. To the extent that the current type of technological change does not mark a sharp break with the recent past, then the data for the past fifteen years should allay concerns that the underlying process of technological change is labor saving. What of the workers whose specific jobs are lost? Although overall the economy may gain and real wages increase, some inevitably lose. I would argue that the current overall count of displaced workers is unlikely to be higher in the future than it is today; that is, the number of newly displaced workers should be less than the number reabsorbed into employment. First, displaced workers stay unemployed longer than the average unemployed worker, but eventually do find new jobs. Second, marginal or high cost plants and equipment tend to be phased out during downturns in business activity. The capital stock that survives the budgetary knife when case flow is at its trough is less likely to be closed once the recovery begins and cash flow improves. Although some jobs will vanish in the coming decade, strong economic growth, if it occurs, will cause the displaced to be reabsorbed. The problem facing these workers will not be a lack of jobs but rather the need to accept a lower wage job. Looking backward over time, one can find demand projections for

Policy Areas—Labor Productivity and Demographics 66

nearly every decade that suggest wholesale unemployment of less skilled workers. Periods of high unemployment, however, are almost always the result of business-cycle downturns. Periods of rapid technological growth tend to be correlated with periods of rapid economic growth. NOTES

1. The structurally unemployed are usually included with the frictionally unemployed as the components of the full employment or equilibrium unemployment rate. 2. Sar A. Levitan and Robert Taggart, Employment and Earnings Inadequacy: A New Social Indicator (Baltimore: Johns Hopkins University Press, 1974). 3. Robert Taggart, "The Hardship Consequences of Labor Market Problems," Center for Social Policy Studies, George Washington University, mimeo, 7 June 1982. Not only are most of the unemployed not poor, but also most of the poor are not unemployed. Approximately 61 percent of the poor did not work at all in 1979, and few of those who did not work indicated that inability to find a job was the reason for not working. Of all poverty individuals, only 7.4 percent worked less than 50 weeks because they were unable to find work, and only 2.6 percent did not work at all because they were unable to find work. 4. Several definitions have been suggested. These include, for example, drawing the line at the poverty level or setting it at 70 percent of the lowbudget level as defined by the Bureau of Labor Statistics. The size of the disadvantaged population need not, for example, include a larger number of individuals than those included in the unemployment numbers. The unemployed with family income above that low income cutoff are not included in the count. On the other hand, individuals who are out of the labor force and hence not unemployed may be included in the count if they reside in low income families. 5. Janet W. Johnston, "An Overview of Federal Employment and Training Programs," National Commission for Employment Policy, Sixth Annual Report (December 1980), pp. 49-140. 6. This was the broadly based conclusion of the National Council on Employment Policy. See their policy statement, CETA's Results and Their Implications, National Council on Employment Policy (September 1981). For a favorable account of the work experience effort, see Summary and Findings of the National Supported Work Demonstration (Cambridge, Mass.: Ballinger Publishing Company, 1980). See also Judy Gueron, "The Supported-Work Experiment," in Employing the Unemployed, ed. Eli Ginzberg (New York: Basic Books, 1980), pp. 73-93. 7. Since data for period oa are not available for program participants, the usual tack is to analyze the wages of similarly situated individuals (that is, same race, sex, age, educational attainment, marital status, etc.). Hence, the individual's cd earnings capacity is compared with those of similarly situated individuals in period oa.

Training Component of Growth Policies 67

8. CETA's Results and Their Implications, National Council on Employment Policy (September 1981). 9. Michael E. Borus, "Assessing the Impact of Training Programs," in Employing the Unemployed, ed. Eli Ginzberg (New York: Basic Books, 1980), pp. 25-40; and Robert Taggart, A Fisherman's Guide: An Assessment of Training and Remediation Strategies (Kalamazoo, Mich.: W. E. Upjohn Institute for Employment Research, 1981). For a negative assessment of training programs, see Nicholas M. Kiefer, "The Economic Benefits from Four Government Training Programs," in Evaluating Manpower Training Programs, Research in Labor Economics, ed. Farrell E. Bloch, Supplement 1 (Greenwich, Conn.: JAI Press, 1979), pp. 159-86. 10. U.S., Congressional Budget Office and National Commission for Employment Policy, CETA Training Programs: Do They Work for Adults? (Washington, D.C.: U.S. Government Printing Office, July 1982). 11. The term can also be defined as involving declining occupations rather than declining industries. 12. U.S., Congressional Budget Office, Dislocated Workers: Issues and Federal Options (Washington, D.C.: U.S. Government Printing Office, July 1982); and unpublished data provided by the Congressional Budget Office. 13. For a more detailed discussion of this issue, see Michael L. Wachter and William L. Wascher, "Labor Market Policies in Response to Structural Changes in Labor Demand" (Proceedings of a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyo., August 1983), forthcoming 1984. 14. For an excellent study of special protection programs, see Philip L. Martin, Labor Displacement and Public Policy (Lexington, Mass.: D. C. Heath, 1983). 15. New initiatives with respect to employment tax credits or vouchers would not be suited to the problem if it were decided that displaced workers should not be given special programs to compensate them for job losses. Rather, they would need to make use of programs generally available to all unemployed workers regardless of the presumed cause of their unemployment. In addition, attention would need to be given to the problems posed by the higher fringe benefit costs that are frequently associated with older workers. This topic is beyond the scope of this paper. 16. U.S., Bureau of the Census, Current Population Reports, Series P-60, various issues. 17. Michael L. Wachter, "The Changing Cyclical Responsiveness of Wage Inflation over the Postwar Period," Brookings Papers on Economic Activity 1 (1976): 115-59; and "Economic Challenges Posed by Demographic Changes," in Work Decisions in the 1980s, ed. Nicholas S. Perna (Boston: Auburn House, 1982), pp. 35-75. 18. Whether these programmatic changes in social welfare policies were desirable is primarily a normative question. Although the political climate has turned somewhat against liberalizing transfer programs, the liberalization that took place during the 1960s and 1970s was a conscious policy decision. Unfortunately, the changes in social programs were not viewed as having had much effect on unemployment. Current empirical research (see, for example,

Policy Areas—Labor Productivity and Demographics

68

chapter 8) strongly supports the existence of a quantitatively important relationship between the duration of unemployment and the income available from unemployment insurance. 19. U.S., Bureau of the Census, Current Population Reports, Series P-60, no. 133, Characteristics of the Population Below the Poverty Line: 1980 (1982). 20. Younger females with dependent children but without spouses are more likely to escape poverty income levels by living with their parents. In addition, because of their age, they are unlikely to have completed their childbearing. Consequently, their worst economic problems do not arise until they are in their late 20s or early 30s. 21. In her discussion of these issues, Isabel V. Sawhill had a similar treatment of the supply but a more negative asessment of the demand outlook than I expressed here. See "Human Resources Policies for the 1980s," mimeo, 1983. 22. "The Impacts of Robotics on the Workforce and Workplace," Carnegie Mellon University, manuscript, 14 June 1981; see also Robert Ayers and Steven Miller, "Robotics, CAM, and Industrial Productivity," National Productivity Review 1 (Winter 1981-82): 42-60. 23. Some argue that the new technology will be adopted much more rapidly in the current context because of the threat of international competition. According to this scenario, the casual factor in job displacement is international competition and not new capital innovations. Indeed, viewed in this context, the new technology will save jobs in industries that would otherwise be lost as old plants were closed and not replaced. Argued on these grounds, it can be more easily seen that the process of labor displacement is selflimiting and may, in fact, not occur at all in terms of the overall change in the number of jobs. Comparative advantage and growing international trade mean that new jobs will be created as others are lost. 24. See n. 13.

Training Component of Growth Policies

69

8.

TAX POLICY AND UNEMPLOYMENT INSURANCE EFFECTS ON LABOR POLICY Jerry A. Hausman

The taxation of labor income has undergone significant policy changes in the past two years. The three most important changes have been (1) the 25% reduction in tax rates, (2) the tax credit for working spouses, and (3) the indexing of tax brackets beginning in 1985. Moreover, proposals for even more radical tax changes are currently under discussion. A flat tax of constant marginal rates has been proposed and congressional hearings conducted on the subject. 1 The tax rate in such proposals is about 15-20% depending on the level of initial exemption contained in the tax. Alternative proposals have been made to keep the current overall structure but to reduce drastically the number of tax brackets and to lower the marginal rates.2 When it is realized that as recently as 1969 the maximum tax rate on earned income was 90%, the enacted and proposed changes are even more remarkable. To the extent that tax policy affects labor supply, such changes are important for economic growth since output will expand along with increases in factor inputs. This paper addresses the question of what effects the enacted and proposed tax changes may have on labor supply. Changes in the tax law that affect labor supply are among the most important factors that determine economic growth. The studies of Solow and Dennison on the determinants of economic growth have emphasized the role that labor input has on the growth process. If changes in the tax law lead to changes in labor supply, output can expand from the increase in the largest factor in value added as a result of the shift in the labor

Policy Areas—Labor Productivity and Demographics 70

supply function. This direct effect has been emphasized in much recent policy debate, especially among supply-side policy advocates. Changes in the tax law may have an important effect on the economic cost of the tax system. The economic cost of taxation does not arise from the decrease in labor supply alone. In fact, taxation may lead to increases in labor supply, as I will explain later. Nevertheless, the economic cost of taxation might still be large even if labor supply were to increase in the presence of taxation. The economic cost of taxation arises because of the alterations in individual behavior that accompany taxation. The imposition of taxes leads to a distortion in prices which has an adverse effect on consumer welfare. Economists measure the economic cost of taxation through a concept known as deadweight loss (or excess burden). The deadweight loss of a tax is the amount of money that must be given to an individual to make him as well off as he would be in the absence of taxation, even if the tax revenues are spent efficiently. The economic cost of a tax rises approximately with the square of the tax rate. Thus, the proposed tax changes which would lower marginal tax rates could have an immense impact on the deadweight loss, or economic cost, of the tax system. Besides their effect on labor supply, the proposed tax changes may have important efficiency gains to recommend them. The conflicting goal of income redistribution, which is largely accomplished by the income tax system, may be significantly altered by the proposed changes. It is difficult to quantify what the right amount of redistribution is. However, an important component of the decision is to know what the cost of the redistribution is. By measuring the deadweight loss of the current and proposed tax systems, we can compare them in an important way. The elimination of tax preferences which most of the tax reform proposals call for will have only a small effect on the poorest segments of the U.S. population. The growth of output under the proposed tax changes may allow for continued redistribution through government expenditures without unacceptable economic costs. It is increasingly clear that the U.S. electorate has become less generous in its redistributive goals as the growth process has stagnated. The concerns up to this point have been explicitly long run in nature. However, with the current unemployment in excess of 10%, differences in "desired" labor supply and actual opportunities must be recognized. The other major feature of U.S. policy that I consider, therefore, is unemployment insurance. U.S. policy toward the unemployed has changed in an important way with reduction in Trade Assistance Act (TAA) payments and increased taxation of unemployment benefits. The basic industries that have been most affected in

Effects on Labor Policy 71

the current recession seem unlikely to return to their former levels of employment. Also, it seems unlikely that many of the permanently laid-off workers will be able to find other jobs at equivalent levels of payRecent economic research has demonstrated that unemployment insurance (UI) payments can have important incentive effects on the period of time that workers remain unemployed. But these economic effects must be weighed against the insurance aspects of UI. I will consider these aspects of the problem and argue that a different type of UI plan may be called for, specifically, instead of a constant stream of benefits that continue as long as the worker is unemployed, a twopart scheme of an initial payment followed by lower scheduled payments that decline over time. In the next section I will discuss the current U.S. tax system and recent and proposed changes. In the second section I will discuss possible effects on labor supply of tax changes, and in the third the economic cost of taxation. In the last section I will turn to the design of the UI system and what effect changes on the payment schedules might have. TAXATION OF LABOR SUPPLY The effect of taxes on labor supply introduces questions in economic theory, econometrics, and public finance. Since the greatest share of federal tax revenue, approximately 50% in 1980, is raised by the individual income tax, we are certainly interested in its effects on economic activity. The Federal income tax is based on the notion of ability to pay; and its progressive structure has received wide acceptance. The income tax has not been thought to induce large economic distortions, and so it has been generally accepted as probably the best way to raise revenue where an unequal distribution of income exists (e.g., Pechman 1976). The other major tax on labor income is the payroll tax. We finance social security by FICA, which is a proportional tax with an upper limit. As both the tax rate and limit have grown rapidly in recent years, FICA taxes have become the subject of much controversy. In 1980 FICA taxes represented 28% of total Federal tax revenue. It is interesting to note that during the period 1960-80, while the marginal income tax rate, that is, the tax rate on the last dollar earned, of the median taxpayer remained constant, the FICA tax rate more than doubled. At the same time the earnings limit rose about 220% in constant dollars. See table 8.1. Over the same 20-year period the corporate income tax has decreased from 24% to 13% of Federal tax revenues. Likewise, excise taxes have decreased from 13% to 5%.

Policy Areas—Labor Productivity and Demographics 72

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Thus, taxes on labor supply currently amount to about 75% of Federal taxes raised.3 Their potential effects on labor supply and economic welfare are important because of the large and increasing reliance on direct taxation. Recent econometric research has attempted to estimate the effect of income taxation on labor supply.4 Both theoretical and econometric problems arise with income taxation. Most of consumer demand theory deals with the instance of a constant price for a commodity. Because income taxation is progressive, the after-tax wage received at the margin by a worker is not independent of the amount of labor he supplies. For example, a worker might receive a gross wage that is 1.5 times his normal wage, but after income taxes and his FICA tax are included, his tax bracket might well be 26%. Depending on his projected income for the year, his marginal tax bracket might well rise to 32%. Therefore, before he decides whether to work overtime, he must take into consideration the fact that the more he works the less he receives in after-tax wages per hour of work at the margin. 5 The dependence of the marginal, after-tax, wage on hours worked leads to a nonlinear budget set in the sense that the price, that is, the after-tax wage, depends on the quantity supplied. The nonlinear budget set is the main complication introduced into econometric models by taxes. Recent studies have been made on the effect of taxation on labor supply not only in the U.S. but also in Great Britain and Sweden. 6 These studies have concluded that taxation has a significant influence on labor supply and that reduced labor supply is the result of the current tax systems. Economic theory indicates that two counterbalancing effects arise from taxes, one effect increases labor supply when taxes are levied, and the other decreases labor supply. The circumstances in which taxes can increase labor supply can be demonstrated by an indifference curve (see figure 8.1). In figure 8.1 we consider the effect of a wage change from w to w'. The initial wage is w where labor supply, hours of work per year, is on the horizontal axis and total income is in the vertical axis. Initial hours of work H* are determined by the tangency of the indifference curve U with the budget constraint which is determined by nonlabor income y and the wage w. The effect of a tax is to lower the net wage to w', and after-tax hours H' are determined by the tangency of the indifference curve U' with the new budget line. This change could occur if the government levied a wage tax and exempted nonlabor income, for example, income from savings. Note in the diagram that after-tax hours of work H' exceed pre-tax hours H* even though the after-tax wage is less. Ordinary economic behavior leads to the outcome in figure 8.1. We merely have the coun-

Policy Areas—Labor Productivity and Demographics 74

FIGURE 8.1 Impact of Income Tax on Labor Supply Y

teracting influences of the income and substitution effects which have opposite signs under normal assumptions. The income effect along with the assumption that leisure is a normal good implies that labor supply increases when nonlabor income decreases holding the wage constant. Since one effect of an income tax is to decrease after-tax income, we see that the income effect alone would lead to increased labor supply. In figure 8.1, the movement from point A to point B arises from the income effect. The movement along the lower indifference curve from point B to point C, then, represents the (compensated) substitution effect. It holds utility constant but lowers the wage from id to w'. Economic theory states that the substitution effect will decrease labor supply when the net wage falls. Thus, even in the most simple case of a wage tax, the income and substitution effects are of opposite sign. Econometric estimates are necessary to measure the total response and magnitudes of the two separate effects. 7 With a progressive income tax the situation is considerably more complicated because of the multiplicity of net wage rates which are created by the approximately 12 tax brackets in the IRS tax code. However, the same general principles hold in the more complicated, progressive tax situation.

Effects on Labor Policy 75

Marginal tax rates for the period 1950-84, according to current legislation, are summarized in table 8.2.8 These rates are for single taxpayers with no exemptions or deductions accounted for. Consumer Price Index (CPI) and median family income are also included so that valid comparisons across different years can be made. First, note that the tax system between 1950 and 1980 was only imperfectly indexed for inflation. In 1950 the median income of $3,300 faced a marginal tax rate of 22%, but multiplied by the change in the CPI (2.42), this income faced a marginal rate of 26% in 1980. Similarly, $10,000 of earned income in 1950 had a marginal tax rate of 38% in 1950, but adjusted for inflation, this marginal tax rate increased to 50% in 1980. Similar increases in marginal tax rates occurred over the periods 196080 and 1970-80. This imperfect indexation corresponds to greater progressivity, which may have been the intent of Congress over the period. However, note that under the tax reform of 1981, marginal rates will drop substantially by 1984 as a result of the 25% tax reduction, with the exact amount depending on inflation over the 1982-84 period. Much of the "bracket creep" of the past decade will be eliminated. Under current legislation, the tax system will then be indexed after 1984. Another interesting finding that emerges from the figures in table 8.2 is the significantly higher marginal tax rates faced by the median earner over the period. Besides the effect of inflation and imperfect indexation, real wage growth also led to higher marginal taxes. Finally, note the remarkable decline in maximum taxes or earned income that followed the Tax Reform Act of 1969. To determine the effect of these tax changes we now consider the actual marginal rates faced by given segments of the population. Marginal tax rates calculated by Steverle and Hartzmark (1981) from a sample of returns are presented in table 8.3. The tax rates correspond to total income rather than just labor income, which was considered in table 8.2. There was a significant rise in the progressivity of the income tax in the 1960-80 period (see table 8.3). Note that in 1961 for those households that paid tax, the marginal rate was between .18 and .26 up through the 95th percentile. In fact 59% of all taxpayers who had a nonzero marginal rate, had a rate of 18%. While the marginal rate for the median return increased by 10% between 1961 and 1979, the difference in rates on the interquartile range increased by 33%. This considerable increase in the progressivity of the marginal tax rates will be significantly decreased by the tax legislation changes of 1981. An examination of tax rates from 1950 to 1980 leads to the following conclusions. First, although Congress passed repeated "tax cuts" during the period to offset bracket creep brought about by inflation,

Policy Areas—Labor Productivity and Demographics 76

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Effects on Labor Policy 77

TABLE 8.3 Marginal Rates of Taxation on Personal Income Percentile

Marginal Rates

of Returns

1961

1969

1974

1979

1

.00

.00

.00

.00

5

.00

.00

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10

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25

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.15

.15

.14

50

.18

.23

.20

.20

75

.22

.25

.22

.24

90

.22

.28

.28

.32

95

.26

.32

.32

.38

99

.38

.47

.47

.50

SOURCE: Steverle and Hartzmark (1981). NOTE: 1969 includes an approximation for surtax charged in 1969.

the tax system was only imperfectly indexed for inflation: the marginal tax rate faced by the median income earner increased by about 20% over the period. Second, there was a marked decrease in the maximum tax rate on earned income from 90% to 50%. Third, increasingly large percentages of both Federal and state budgets have been raised from income taxation because of increases in the Social Security payroll tax and state income taxes. Therefore, the potential economic effects of income taxation have become more important over the 195080 period because of the increasing reliance on direct taxation of labor income.

LABOR SUPPLY EFFECTS OF THE INCOME TAX Studies of the effect of taxes on labor supply have given the most attention to the effect on two groups: prime age males and wives, defined as married women with husbands present. Prime age males are usually taken to be from 25 to either 55 or 60 years old. Labor force participation among this group is nearly 100%, especially when disabled individuals are not considered. Unemployment is typically low among this group in a nonrecession year. Most studies therefore do not account specifically for unemployment or constraints on labor market activity.9 A needed advance is an integrated model of family labor supply with taxes to take account of wives' labor market activity and its possible effect on husbands' labor market behavior.10

Policy Areas—Labor Productivity and Demographics 78

The best interpretation of the labor supply results estimated on cross-section data for a sample of individuals in a given year is an equilibrium model where actual hours differ from desired hours for unexpected stochastic reasons. The prime age male labor force is not uniformly at work for 40 hours per week and 2,000 hours per year. On the contrary, significant variation exists in both the normal number of hours worked per week and weeks worked per year. Hours per week of work, conditional on being employed, typically have a mean of about 42 hours with a standard deviation on 10-15 hours in typical cross-section data.11 Men presumably choose jobs that have the number of hours that most closely correspond to their desired hours, taking account of overtime and possible layoffs. However, for a significant proportion of the prime age male population, changes of employers is fairly rare (see Hall 1982). How much of the year-to-year variation in labor supply for this group arises from fluctuations in their market wage is problematical. Therefore, the models of labor supply and empirical results presented here are probably less relevant for short-term labor response to business-cycle conditions. Five studies of the prime age male labor supply are relevant here: Wales and Woodland (1979), Ashworth and Ulph (1981), Hausman, ("Labor Supply," 1981), Blomquist (1982), and Hausman (1982).12 All five studies take into account the effect of taxes. A comparison of their results shows that uncompensated labor supply elasticity is much closer to zero than is typically found in labor supply studies that ignore taxes (see table 8.4). Another difference is that the income elasticities vary from - . 0 4 to - . 1 7 and thus imply that leisure is a normal good in contrast to many studies that ignore taxes and find the opposite sign. Given the effect of progressive taxation on after-tax income, the clear implication is that taxes will affect the labor supply decision. The combination ot these two results leads to the last result, which is perhaps the most satisfying. All five studies imply a positive compensated wage elasticity so that the compensated labor supply curve is upward sloping. These results are in marked contrast to models that ignore taxation and very often estimate a compensated elasticity of the wrong sign. This finding is difficult, if not impossible, to justify even when more general models of labor supply are considered. Since an upward sloping compensated labor supply curve is the only implication of economic theory for simple models of labor supply, it is satisfying to find that the results become acceptable to the theory when the effect of taxes is taken into account. We cannot say a priori whether the effect of taxes is to increase or decrease labor supply. Most models for prime age males that ignore taxes estimate a backward bending labor supply curve.13 Therefore, according to these models, the reduction in tax rates that has recently

Effects on Labor Policy 79

TABLE 8.4 Prime Age Male Labor Supply: Results of Five Studies Authors

Data

Model

Wales-Woodland Ashworth-Ulph

PSID UK

CES Generalized CES Linear Linear Linear

Hausman" Blomquist* Hausman3

PSID Sweden PSID

Wage Elasticity

Income Elasticity

.09" -.13

-.11» -.05

.00 .08 .03

-.17 -.04 -.14

'Specification permits variation in preferences. Mean results are given. 'Results are approximate since means of data were not given.

occurred in the U.S. and U.K. will lead to a reduction in hours of work. A contrary view has been put forward by supply-side advocates in the U.S. who have argued that a reduction in tax rates will lead to such a large increase in labor supply that government revenue would actually increase. Two studies by Hausman ("Labor Supply," and "Exact Consumers' Surplus," 1981) demonstrated using 1975 data for the U.S. that compared to a no-tax situation, desired labor supply was 8.2% lower because of the U.S. tax system, including FICA taxes and state income taxes. In table 8.5 the results are given by wage quintiles from the PSID sample. The figures in the second row indicate the change from the no-tax situation. The effect of the progressiveness of the tax system is that high-wage individuals reduce their labor supply more from the no-tax situation than do low-wage individuals. The higher marginal tax rates have a greater effect on after-tax income and cause a greater reduction in desired labor supply. This pattern of labor supTABLE 8.5 The Effect of Taxes on Prime Age Male Labor Supply in the U.S. Market Wage

$3.15

$4.72

$5.87

$7.06

$10.01

Percentage Change in Labor Supply from Current Situation NoTaxes 10% Tax Cut 30% Tax Cut

+4.5 +0.4 +1.3

+6.5 +0.5 +1.6

+8.5 +0.9 +2.7

+10.1 +1.7 +3.1

Policy Areas—Labor Productivity and Demographics 80

+12.8 +1.5 +4.6

ply has, of course, an adverse effect on tax revenues. The figures in the second and third rows of table 8.5 indicate the expected change in labor supply for tax cuts of 10% and 30%. Note that desired labor supply increases with a tax reduction. We find the expected pattern that the effect on high wage individuals is greatest since the linear labor supply model used has an increasing elasticity with virtual income. The effect of a 30% tax cut is roughly three times as large as that of a 10% cut, but the ratios are not exact. The finding that a reduction in tax rates would lead to increased labor supply has been an important contention of supply-side economic policy. However, its most fervent advocates have claimed more. Their claim has been that tax rates are at a sufficiently high level in the U.S. that a tax cut could well be self-financing.14 That is, a reduction in marginal tax rates could lead to higher tax revenues. While this result from the Laffer curve is certainly a theoretical possibility, labor supply models do not find nearly high enough elasticities to make it any more than a remote possibility. Three studies by Hausman (1981) of the Kemp-Roth type of tax proposals, which call for across-the-board tax cuts of a constant percentage amount, considered two levels of tax cuts, 10% and 30%, and focused on the question of what effect these tax cuts would have on tax revenues. The results are partial equilibrium because possible changes in market wages induced by the changes in labor supply that are due to the tax cuts are not accounted for. The main effect here arises from the change in labor supply. But increased labor supply also moves some individuals into higher tax brackets. Both effects need to be accounted for. For the 10% tax reduction, mean hours of labor supply for husbands rose 22.5 hours or 1.1%. Tax revenues fell by 7.4% (Hausman, "Income Tax Policy," 1981). Even given the fact that our model is partial equilibrium, rudimentary calculations demonstrate that general equilibrium effects which would take account of possible changes in wages are very unlikely to be large enough to prevent tax revenues from decreasing significantly in the short run as the results show. For the 30% tax cut, labor supply increases by 2.7% while tax revenue falls by 22.6%. Thus Kemp-Roth tax cuts have large effects in terms of decreased government revenue. Fullerton (1982) considered self-financing tax cuts within the context of a general equilibrium model, although his treatment of taxation was not as complete as Hausman's. His results indicate that the labor supply elasticities would have to be well outside the range of previous estimates before the tax cut would be self-financing. The tax cuts enacted in the 1981 tax legislation play a large role in the current and projected U.S. budget deficits. Indexation of the income tax that is scheduled to begin in 1985 will also have an important

Effects on Labor Policy 81

effect on the size of the deficits. The effect of the budget deficits of the size currently projected on U.S. growth prospects is difficult to determine both because of the size of the deficits and because of uncertainty over future monetary policy. While decreased taxes lead to increased desired labor supply, the predicted growth in the U.S. economy may not occur unless economic policy is followed which leads to increases in investment, employment, and consumer demand. The demand side of the economy must be considered as well as the supply-side effects. To the extent that the income tax cuts create an increased budget deficit which retards U.S. economic growth, the predicted effects of the supply-side policies will not occur. An examination of two types of radical tax reform, a progressive linear income tax with all current deductions, such as interest, removed, first with no initial exemption and second with a $4,000 initial exemption, suggests that such tax reform would cause increases in desired labor supply. A progressive linear income tax that allows for no initial exemption has a constant marginal tax rate, and its implementation would broaden the tax base considerably. For this situation, using 1975 data, we can calculate that a tax rate of 14.6% would be required to raise the same amount of tax revenue as does the current U.S. tax system. Desired labor supply for the prime age males rises about 8.1%. For a progressive tax with an exemption level of $4,000 (1975 dollars), the required tax rate rises to 20%. Desired labor supply increases by about 7.7%. Therefore, a decrease in marginal tax rates does lead to an increase in desire labor supply of significant amounts although much of the progressivity of the tax system is lost with such a proposed tax reform.15 The two fundamental characteristics of the income tax, the amount of revenue that it raises and the redistribution that occurs through increasing marginal tax rates, have been altered substantially by recent tax legislation. While the 1981 Economic Recovery Tax Act (ERTA) will have the largest effect, marginal tax rates have been decreased significantly since the 1969 Tax Reform Act. Econometric results indicate that increased labor supply which will result in more economic growth is the likely result of such tax changes. But since economic growth is a crude measure at best of economic welfare, many economists might argue that the changes have not been favorable. To decide this issue, close attention must be given to government expenditure as well as taxation. It is difficult to determine the effect of marginal government expenditure since the appropriation decisions of Congress are net the outcome of a careful planning process. And since the correct amount of progressivity, or vertical equity, involves ethical judgments, evaluations of the recent changes are even more difficult. However, economists do have a measure for the economic costs of taxation, dead-

Policy Areas—Labor Productivity and Demographics 82

weight loss. The next section examines this measure for the current U.S. tax system and for proposed changes.

WELFARE COSTS OF TAXATION The effect of taxation is most easily grasped through its effect on labor supply and hence on economic growth. We have previously discussed why offsetting income and substitution effects make the question of the effect of taxes on labor supply difficult to answer. To an economist, the effect of taxes on labor supply is the most important part of the overall effect, but it omits an additional component, the effect of taxes on economic welfare. This extra component is the deadweight loss, or excess burden, of the tax.16 Regardless of how efficiently tax revenues are spent, there is a deadweight loss of the tax. Suppose that the government levies a tax to raise revenue and spends the revenue in an efficient and nondistortionary manner. That is, the government spends the money in a pattern desired by consumers or, even better, returns the revenues by means of a nondistortionary grant (lump-sum subsidy) to consumers. The cost of the tax at first glance might seem to be zero. But the cost is not zero because the tax rates have caused individuals to change the amount they would work in their original (no-tax) situation by altering their net, after-tax, wage. This distortion in relative prices leads to the deadweight loss of the tax. Economic theory demonstrates that the amount of deadweight loss rises in proportion to the square of the tax rate so that higher taxes have an increasingly larger effect on individual welfare. Therefore, recent as well as proposed changes in the tax law can have important effects on the economic cost of income taxation. It is incorrect to measure the economic cost of a tax by its total effects on labor supply. As we see in figure 8.1, the wage tax increased labor supply, and so for the effect on labor supply the tax might be deemed favorable. Yet the individual has been made worse off by the tax since his after-tax indifference curve lies below his before-tax indifference curve. He works more hours at a lower after-tax wage than in the no-tax situation and his welfare has decreased. Furthermore, even if the government returned the amount of tax revenue raised, which is given by the line segment CD, in the form of the consumption good, the individual has still been made worse off by the tax. Thus, in our simple example, the "size of the pie" has increased because the tax has brought forth more labor supply. But still the individual's utility decreases because of the tax through the disutility of increased labor supply. Therefore an appropriate welfare measure,

Effects on Labor Policy 83

rather than labor supply alone, is needed to measure the effect of taxation. The first component of a welfare measure is the effect of the tax on individual utility. Here the measure long used by economists has been some form of consumers' surplus. Consumers' surplus is the amount of money each individual would need to be given, after imposition of the tax, to be made as well off as he was in the no-tax situation, if he receives no benefit from the government expenditure of the taxes. Measurement of consumers' surplus is often calculated by the size of a trapezoid under the individual's demand curve, or here it would be the labor supply curve. But Hausman (see n. 18) has demonstrated that for labor supply this method can be very inaccurate. Instead the theoretically correct notion of either the compensating variation or equivalent variation must be used. These measures, set forth by Sir John Hicks, are probably best defined in terms of the expenditure function. The expenditure function determines the minimum amount of money an individual needs in order to attain a given level of utility at given levels of wages and prices. Its form is determined by either the direct utility function U(H,Y) where H is hours of work and Y is income or the labor supply function. In our example of the wage tax in figure 8.1 the compensating variation equals the vertical distance between the points y and y', which is the amount required to make the individual as well off as in the no-tax situation. That is, the welfare loss to the individual, measured in dollars of the consumption good, equals the minimum amount of nonlabor income needed to keep the individual at his original utility level U minus his nonlabor income in the no-tax situation, y. Since utility is kept at the before-tax level U, the compensating variation arises solely from the substitution effect. The income effect is eliminated because the individual is kept on his initial indifference curve. In the more complicated situation of progressive taxes, the only difference is that a more complicated measure of income determined by the system is used rather than actual nonlabor income. We need one more ingredient to complete the measure of the welfare loss from taxation. The government has raised tax revenue, and we need to measure the contribution to individual welfare that arises from the government's spending the tax revenue. The assumption commonly used is that the government returns the tax revenue to the individual through an income transfer. Here it would correspond to increasing the individual's nonlabor income by the amount of tax revenue raised. Then the total economic cost of the tax is given by the deadweight loss (or excess burden) which equals consumers' surplus minus tax revenue raised.17 Much of public finance theory is concerned with the problem of

Policy Areas—Labor Productivity and Demographics 84

raising a given amount of tax revenue while minimizing the economic cost as measured by the deadweight loss.18 But in considerations of tax policy, redistribution must be accounted for or otherwise we certainly would have no need for a progressive income tax. If the government were to levy a lump sum or poll tax, the effects as measured by both labor supply and by deadweight loss would be favorable in comparison to other tax systems that raise the same revenue. The labor supply effect is favorable since the before-tax and after-tax wages are identical. Therefore, only the income effect but no substitution effect is present. With only an income effect present, labor supply will increase so long as leisure is a normal good. Furthermore, no distortion in relative prices occurs and so no deadweight loss occurs. The result of the lump-sum tax is to increase labor supply while not creating any deadweight loss. For economic efficiency, it is an ideal tax. But it is doubtful such a tax would ever be acceptable politically since the redistributive aspect of the current income tax has been lost. In fact, the lump-sum tax is extremely regressive. Therefore, a trade-off exists between the degree of progressivity that society wants in the income tax and the economic cost measured by the deadweight loss. Thus neither deadweight loss nor labor supply are sufficient measures alone in an evaluation of the income tax. Deadweight loss gives the economic cost of the tax, but the "benefit" of the tax which is based on its redistributive aspect must also be accounted for. Unfortunately, because of the difficulty of reaching agreement on the correct degree of redistribution, consideration of income tax policy changes is a difficult subject. The recent tax changes have had measurable effects on economic welfare. Hausman ("Labor Supply," 1981) estimated that deadweight loss as a proportion of the revenue raised is about 28%. The deadweight loss calculation indicates that the income tax is a relatively high-cost means of raising tax revenues since a quarter of every dollar of tax revenue raised is deadweight loss. The large amount of redistributive expenditure by the Federal government is being done at a high economic cost. The marginal cost of raising the tax revenue is even higher because of the relationship between the square of the tax rates and deadweight loss. In the last section we noted that overall labor supply rose 1.1% for the 10% tax cut, and it rose by 2.7% for the 30% tax cut. To evaluate the effects of the recent tax changes on economic welfare we may divide the population into quintiles by market wage (in 1975 dollars). See table 8.6. Under the column DWL/Tax Revenue, we give the ratio of deadweight loss to tax revenue raised under the pre-1981 tax system and with the tax reductions. This amount gives the true economic cost to the consumers of tax revenue raised by the government. For

Effects on Labor Policy 85

TABLE 8.6 Effects of a 30% Tax Cut Market Wage (1975 dollars) 3.15 4.72 5.87 7.06 10.01

DWL/Tax Revenue After Before

(%)

(%)

9.4 14.4 19.0 23.7 39.5

6.8 10.9 14.5 17.9 29.5

DWL/Net Income Before After

(%)

(%)

.8 2.0 3.1 4.5 9.9

.4 1.1 1.8 2.5 5.3

Change in Labor Supply

(%)

+ + + + +

1.3 1.6 2.7 3.1 4.6

NOTE: DWL = dead weight loss.

instance, for a market wage of $5.87, the figure 19% means that the average economic cost of $1 of government tax revenue is $1.19. Therefore, the benefit from the expenditure must exceed its cost by 19% to make him as well off as in the no-tax situation. The same convention is used in the column for DWL/Net Income. The deadweight loss/tax revenue ratio can be seen to increase rapidly with the market wage. This rapid increase arises from the progressivity of the tax system. Also, deadweight loss rises as a proportion of net income. Since the tax cut is the same in percentage terms, the largest decreases in deadweight loss occur among the higher wage earners. Thus, those who are well-off have benefited most by the tax change in terms of their economic welfare. When the further consideration that government revenue will fall by about 22% is taken into account, the distributional effect is even larger under the assumption that the change in government expenditure patterns will be regressive in large part. Similar results are found for wives (see Hausman, "Labor Supply," 1981). While tax cuts like those that have been enacted will have supply-side effects and will increase economic growth, their effect on income redistribution and government expenditure should be kept in mind. An equal progressive linear income tax, or flat tax, can have a favorable effect on both labor supply and economic efficiency. To show this we can calculate, for various exemption levels, the constant marginal tax rate for husbands that would raise the same amount of tax revenue as the 1975 tax system did. See table 8.7. Note first that the required tax rate begins at 14.6% with an exemption level of zero and rises to 20.7% with an exemption of $4000. Each tax measure produces

Policy Areas—Labor Productivity and Demographics 86

TABLE 8.7 The Effect of an Equal Yield Linear Income Tax with Exemption for Husbands Exemption Level

Tax Rate"

0 14.6% $1000 15.4 2000 16.9 20.7 4000 Pre-19811RS Code

Change Change in DWL/Tax in DWL Revenue Hours -825.75 -798.82 -765.31 -659.18 —

.071 .083 .098 .145 .287

+ 170.0 + 169.3 +167.6 + 163.0 —

Average Tax Rate at: $4000

$8000

$16000

$24000

14.6% 11.6 08.5

14.6% 13.5 12.7 10.4 14.7

14.6% 14.4 14.8 15.5 17.3

14.6% 14.8 15.5 17.2 18.8

00.0 11.9

NOTE: DWL = dead weight loss "Constant marginal tax rate above exemption level.

a substantial gain in economic welfare. Since tax revenues remain the same, the change in deadweight loss is responsible for the welfare gain. Note that even with the highest exemption level of $4000 the deadweight loss falls by 49% from the current system (i.e., from .287 to .145). The labor supply, as indicated by the change in DWL, also increases substantially from the current system. Lastly, we look at the question of distribution. By considering the average tax rate for various exemption levels, we see that either the $2000 or $4000 exemption is superior to the current tax system since the average (as well as the marginal) tax rate is lower at every tax bracket. The results are sensitive to the various deductions and credits an individual taxpayer declares but yield the conclusion that approximately all taxpayers are made better off by this type of linear income tax system in terms of their labor supply. Lower income groups can gain from a lowering of the top marginal tax rates. But part of this gain arises from the elimination of tax preference items. Most economists seem to favor this significant broadening of the tax base, and the popular image is the elimination of tax shelters and other notorious tax avoidance measures. But a tax preference item less easy to eliminate is the mortgage deduction. Therefore, while the linear income tax has very favorable effects on both labor supply and economic efficiency, its redistributive aspect will create substantial opposition. Both growth and economic welfare measures must be tempered by the perceived fairness of the income tax that arises through its redistributive effects. In the last two sections we have considered the labor supply effects and the welfare effects of income taxation. Since decisions about the correct amount of income redistribution involve ethical judgments, no definitive judgment can be given on the "optimal" income tax. But

Effects on Labor Policy 87

tentative policy recommendations can be made. First, empirical evidence has demonstrated that taxes affect the labor supply of men and have an even larger effect on the labor supply of women. Appropriate economic policies can increase labor supply and economic growth. The approach of the current administration has been an across-theboard cut in taxes. While "supply-side" effects will result from this tax, it has led to a large increase in the size of the structural (full employment) budget deficit. This increased budget deficit will have adverse economic effects. And cuts in government expenditures also have a cost in economic welfare, even if they are difficult to measure. My first policy recommendation would be to move to a more broadly based tax system by eliminating most tax preference items. The dramatic effects on tax rates of such a reform are given in table 8.2. Most economists accept the policy of reducing the number of tax preference items. Besides having favorable effects on tax rates, such policy would liberate thousands of lawyers from tax avoidance drudgeries. My second policy recommendation would be to move to a system of lower marginal tax rates, even if it would cause a reduction in the progressivity of the tax system. This reform would be made easier by the acceptance of the first reform of a more broadly based tax since tax revenue need not fall. Both labor supply and economic welfare would increase given our calculations in the last two sections. Advocates of a flat tax would like to take this reform to its limit by having only a single tax rate. The idea does have some attractive features. Yet current political realities seem to rule out its adoption in the near future. Rather, a reform that would greatly reduce the number of tax brackets, to perhaps two or three, and lower marginal rates would probably have a greater chance of success. It would broaden the tax base and probably have no adverse effects on the budget deficit.

UNEMPLOYMENT INSURANCE We have discussed both the labor supply and economic welfare effects of income taxation. There is, however, another important component of government policy toward labor supply: unemployment insurance (UI). The discussion of the effects of the income tax on labor supply and economic growth emphasizes long-run effects on labor supply. Given the unprecedented levels of unemployment and the likely possibility that many employees of basic industries on permanent layoff will not be recalled, the effects of unemployment insurance may be very important. Unemployment insurance typically replaces 50-70% of the worker's net, after-tax wage. It can extend from 26 to 52 weeks. The benefits are terminated upon reemployment. Government policy has

Policy Areas—Labor Productivity and Demographics 88

changed toward UI in two ways in the past two years: (1) Taxation of UI benefits has increased. Receipts on family income above $18,000 are now subject to taxation. (2) The generosity of payments under the Trade Assistance Act (TAA) has decreased markedly. The replacement percentage of net wages for unemployed workers in basic industries has decreased from levels of up to 90% in some instances. TAA now extends the period of benefits but no longer increases the payments. We will examine the effects of UI on labor supply and consider possible changes in the UI benefit schedule that might increase economic efficiency.19 We will concentrate on the effect of UI on the duration of unemployment. The incentive effect of UI may well be to prolong spells of unemployment and thus to cause decreases in labor supply. Other possible effects of UI are layoff policies that are based on imperfect experience rating, worker preferences for seasonal and temporary employment, and increases in labor supply that are due to increased future benefits.20 Econometric studies have consistently found a positive relationship between the size of UI benefits and duration of unemployment. The concept of "replacement rate" is often used to denote what fraction of after-tax earnings are replaced by UI when the worker loses his job. Typical estimates find that an increase in UI benefits of 10%, say from a replacement rate of 40% to one of 50%, lead to an increase in the expected duration of a spell of unemployment of from one to two weeks. The effect of higher benefits and extended duration on wages in the next job must be considered also. Econometric evidence here indicates a significant effect on wages for prime-age males, ages 25-55, through higher benefits; for other groups the evidence is less precise. Overall, the estimates of the effect of UI on unemployment duration are more precise than are the estimates of the effect of UI on wages in the job taken after unemployment ends. At a level of unemployment of 10.5%, using the higher estimates of the effect of UI on duration, we find a decrease in hours worked of about 1.1%. Note that the analogous reduction in labor supply from the income tax is about 8%. Therefore, the effect is considerably smaller but still important. As with the income tax, the effect compared to the no-UI situation is not of primary interest. The effect of UI on unemployment duration can be very important in specific industries. Current unemployment rates in the motor vehicles industry and primary metals industry are approximately 25%. Wages in these industries are significantly higher than in other manufacturing industries. If these industries are in the process of longterm contraction because of increased international competition, it is likely that a large proportion of the laid-off workers will not be re-

Effects on Labor Policy 89

called. But workers may find it very difficult to find alternative jobs at their previous wage levels. It is not unlikely that job offers they receive will not be significantly greater than the amount of UI they receive after taxes are accounted for. UI has the positive effect of leading to longer periods of search and higher wages in subsequent jobs. But if long-term structural changes are occurring, redesigned UI plans that create the correct incentives for the unemployed worker would be preferred to the current system. Complete theoretical models of the effect of UI are difficult to construct. 21 The combination of uncertainty and the intertemporal aspects of the problem lead to difficulties in the analysis. That is, because unemployed workers are searching for jobs, the uncertainty of what jobs are available is important. Intertemporal aspects involve the tradeoff between lost wages during unemployment and possible higher wages for the next job if more search is undertaken. Nevertheless, we will consider some possible changes in the form of UI benefits with the proviso that subsequent theoretical analysis might lead to different conclusions. Our stylized characterization is that individuals have high returns to search in the initial period of unemployment as they gather information on the labor market. However, we assume that these returns to search decrease with time. The problem with the current UI plan of constant payments over a given period of time is that the UI benefits make search less costly but at the same time they subsidize leisure. To separate out the income and substitution effect, we will consider possible UI schemes that consist of an initial payment followed by either a constant or possibly a declining benefit stream over time. An extreme example would be to assume that individuals are risk neutral. Then the socially optimal form of UI benifits would consist of an initial payment only. The incentive to find a job is thereby optimized because the substitution effect has been eliminated. The initial payment has an income effect, and so workers can afford to search, but they will make the decision whether to take an offered job without the distortion created by continued UI benefits if they were to remain unemployed. When workers are not risk neutral and the duration of unemployment is uncertain, the disadvantage of this scheme of initial payment only is that the insurance aspect of UI has been reduced. That is, unlucky workers who remain unemployed for long periods of time will exhaust their initial benefit and may be forced to take an inferior job in comparison to the luckier searchers. Therefore, some weekly payments should probably remain. But a combination of an initial payment and weekly benefits may be an improvement over the current system. To demonstrate the possible effect on unemployment of such an

Policy Areas—Labor Productivity and Demographics 90

altered system I have used a model by Shavell and Weiss (1979).22 The model accounts for both uncertainty and intertemporal aspects. The two unknown coefficients of the model are estimated from 1982 unemployment data assuming a replacement rate of .60 and a duration elasticity of .2. The plan we consider consists of an initial payment followed by weekly benefits that are terminated when a new job is accepted. The benefits do not terminate after a given number of weeks if a new job is not taken. We use the budget constraint under the current plan where we assume unemployment benefits stop after 39 weeks. Therefore, the revised plans have the same expected cost as the current UI system. As a normalization, the weekly wage is set to $200. The results are given in table 8.8. For instance, if the replacement rate is decreased to .30, the initial payment is $918. Unemployment duration decreases by 14.6% and causes an increase in overall labor supply of about .2% from the current situation. A more extreme change to lower the replacement rate to .10 together with an initial payment of $1454 leads to a change in unemployment duration of 21.4%. The change in the form of UI benefits increases labor supply by decreasing the current distortion in UI benefits with an initial payment plan. On average the worker is made better off, both because of the nontermination of benefits and the improved incentive effect of the revised plans. Yet the cost to the UI system remains the same while the overall cost of unemployment to society decreases. 23 TABLE 8.8 Initial Payment and Weekly Benefit Plan

Initial Payment $

0 320 624 918 1196 1454 1574

Average Duration of Unemployment Replacement Rate (weeks) .60 .50 .40 .30 .20 .10 .05

14.0 13.6 13.2 12.7 12.1 11.3 10.6

Pr > 26 weeks .15 .14 .13 .12 .11 .09 .08

NOTE: While the model is meant only to be illustrative, it is interesting to note that it fits the distribution of 1982 unemployment quite well. The Economic Report of the President 1983, 36:36, gives the percentage distribution for four categories of weeks unemployed. The average absolute prediction error for the model for each category is approximately 2%. A weekly average of $200 is used to normalize the initial payment amount.

Effects on Labor Policy 91

The other possible change would be to replace the current system of providing constant benefits which have a specific termination date with a nonlinear schedule by which the level of benefits would decline over time. Here the analysis becomes even more difficult. But plausible reasons can be given for adopting a declining benefit path over time especially if my characterization of returns to search over time is reasonable. This change from a specific termination date might be quite important since recent empirical evidence indicates that the end of benefits dramatically raises the probability of job acceptance. An initial payment followed by decreasing benefits would then decrease the adverse incentive created by the current system, provide insurance for the unlucky long-term unemployed, and decrease the duration of unemployment. An alternative way to compare these proposed changes with the current system is to consider the initial payment scheme alone. It would resemble an insurance payment when an accident, in this instance unemployment, occurs. The government might, for example, pay the insurance amount in 26 equal installments, perhaps partly for paternalistic reasons. However, the payments continue even if the individual finds a new job. Therefore, no distortion exists because the individual makes the best choice between a new job and continued search. The current system, in comparison, imposes a 100% tax on the government payments when the individual takes a job. His choice is distorted by this tax since he will need a better offer to find it worthwhile to return to work. A combination of the initial payment and weekly benefits which stop with a return to work reduces the current distortion. Some distortion remains, but more insurance is provided than the pure initial payment plan. The declining payment scheme increases the insurance aspect over the current system but attempts to encourage individuals with unrealistic expectations or high preferences for leisure to return to work. The alternative plans all reduce the current 100% tax level and so increase labor supply. These results arise from special models and need to be further studied. Also, the financing of UI would need to be carefully considered, especially the issue of experience rating. With imperfect experience rating, there is an incentive for firms to lay off workers for short periods. Figures for the number of layoffs would not be sufficient to set experience rating levels; the average duration of unemployment would be needed too. Also, the imposition of a waiting period before UI can be collected, such as now exists, would alleviate the shortlayoff problem. Still, the initial payment scheme with a constant or declining benefit payment schedule does seem attractive in certain instances. Take an example of a permanently laid-off auto worker or steel worker. If he does not have long seniority, it is unlikely that he

Policy Areas—Labor Productivity and Demographics 92

will be recalled even when the economy recovers. But it is unlikely that he will find a job that will have wages significantly higher than the 50-70% of his previous net wages that he receives from UI. An initial payment coupled with a lower replacement rate than he currently receives would probably lead to a better outcome than the current system. We might even want to design a UI system in which the individual can choose between the current schedule and the altered schedule. The parameters of the altered UI schedule could be set according to budget considerations; but with a shortened duration of unemployment, labor supply and economic growth would increase. High levels of unemployment seem likely to continue even when the economic recovery begins. Changes in the UI payment schedules could well lead to increases in economic welfare for the unemployed as well as to increased output, which would accompany the increased labor supply. CONCLUSION We have proposed government policies that can increase labor supply. Increased labor supply can have important effects on economic growth. But these suggested policies can have their desired effect only if labor demand expands accordingly. Private sector investment is needed to provide additional capital, which is the other major component of the growth process. Increased productivity which results in higher wages is also important since in this situation jobs become more attractive and tax revenues increase, and that increase in turn lessens the current problem of large government deficits. Recent and proposed tax cuts have played a large role in the increased size of this deficit. As our results indicate, these tax cuts will lead to increased labor supply but at the cost of decreased government revenue. If other sources of revenue or decreases in government expenditure do not accompany these tax cuts, the likely result is a prolonged period of high deficits. These deficits may adversely affect the growth process which the increased labor supply is designed to cause. Government fiscal policy must consider the effects on government revenue of the tax cuts to insure a period of prolonged economic growth. NOTES

1. See R. Hall and A. Rabushka (1983) for an extensive discussion of a flat tax proposal. I will not discuss the other major feature of many tax reform proposals, the consumption tax. The major effects of the consumption tax are on savings behavior, although it can have an effect on labor supply. 2. A Democratic proposal, the Bradley-Gephardt Bill, would decrease the top marginal tax rate to 28%.

Effects on Labor Policy 93

3. Not all income tax revenue is a tax on labor supply because of the taxation of capital income which was about 12% of adjusted gross income in 1980. Also, a portion of the incidence of FICA taxes falls on the employer, although the amount is likely to be small. 4. See Burtless and Hausman (1978), Hausman (1979), Wales and Woodland (1979), Hausman (1980), and Hausman, "Labor Supply" (1981). 5. At the point that he reaches the FICA contribution limit his after-tax wage will actually rise. The current limit is about $32,000. Further complications in an econometric model are introduced by the earnings limit. 6. See Atkinson and Stern (1980), and the papers in Brown (1981) for the U.K. and Blomquist (1982) for Sweden. 7. The possibility that taxes could increase labor supply is not merely a theoretical curiosity. Much earlier econometric research that did not incorporate taxes into the model reached the conclusion that taxes increased labor supply. 8. The tax rates are taken from Tax Foundation (1981). 9. Hausman, "Labor Supply" (1981) does account for zero hours considerations. Ham (1981) considers constraints on further work at the given wage. 10. Ashworth and Ulph (1981) estimate household models of labor supply. See also Hausman and Rudd (1983). 11. This variation is calculated after the self-employed and farmers have been eliminated from the sample. 12. We do not use the earlier result of Hall (1973), and Brown, Levin, and Ulph (1976) because of difficulties of interpretation and econometric technique. 13. Some models find a backward banding curve only for medium and high wage males. 14. See Canto and Laffer (1981), and Evans (1981) for models that find this result. 15. Democratic proposals such as the Bradley-Gephardt Bill (see n. 2) would also have significant labor supply effects. 16. See Chipman and Moore (1980), three studies by Hausman (1981), and Auerbach (1982) for recent developments in the theory and measurement of deadweight loss. 17. The technical definition of the compensating variation is CV(iv,w',U) = e(w',U) - e(w,U) where e is the expenditure function. The deadweight loss is given by the formulae, DWL(w,w',U) = CV(w,w',U) - T(w,w', U) = e(w',U) - e(w,U) - T(w,w',U). 18. See Atkinson and Stiglitz (1980), chaps. 12-14, and Auerbach (1982) for recent expositions. Mirrlees (1971) wrote the seminal paper on optimal income tax theory. 19. For a survey of the effects of UI, see Danziger et al. (1981). The earlier literature is reviewed in Welch (1977) and accompanying papers. 20. See Feldstein (1978) and Topel (1983) on temporary layoffs and dura-

Policy A r e a s — L a b o r Productivity a n d D e m o g r a p h i c s

94

tion of unemployment. Hammermesh (1979) discusses the effect of qualifying for future benefits. 21. See Mortensen (1977), Baily (1978), Flemming (1978), and Shavell and Weiss (1979) for recent theoretical analyses of UI. The following analysis uses a search model of unemployment behavior which is typically used in the theoretical literature. Whether this model provides a reasonable description of individuals' behavior is open to serious questions given recent empirical work. 22. The specific form of the model we use is given in equations (A17)(A22) of Shavell and Weiss (1979). However, the paper is in error in its derivation of the key equations (A21) and (A22). In fact, the direction of the duration effect for a change in benefits goes in the opposite direction that it should. 23. We have not considered externality aspects of search as in Diamond (1982).

BIBLIOGRAPHY

Ashworth, J. A., and D. T. Ulph. "Estimating Labour Supply with Piecewise Linear Budget Constraints." In Taxation and Labor Supply, ed. C. Brown. London, 1981. Atkinson, A., and N. Stern. "On Labour Supply and Commodity Demand." journal of Public Economics 14 (1980). Atkinson, A., and J. Stiglitz. Lectures on Public Finance. New York, 1980. Auerbach, A. "Measurement of Excess Burden and Optimal Taxation." Mimeo. 1982. Baily, M. "Some Aspects of Optimal Unemployment Insurance." Journal of Public Economics 10 (1978). Blomquist, S. "The Effect of Income Taxation on Male Labor Supply." Mimeo. Sweden, 1982. Brown, C. Taxation and Labor Supply. London, 1981. Brown, C. V., E. Levin, and D. Ulph. "Estimates of Labor Hours Supplied by Married Male Workers in Great Britain." Scottish Journal of Political Economy 23 (1976). Burtless, G., and J. Hausman. "The Effect of Taxes on Labor Supply: Evaluating the Gary NIT Experiment." Journal of Political Economy 86 (1978). Canto, V., and A. Laffer. "Tax Rates, Employment, and Market Production." In The Supply-Side Effects of Economic Policy, ed. L. Meyer. St. Louis, 1981. Chipman, J., and J. Moore. "Compensating Variation, Consumers Surplus, and Welfare." American Economic Review 70 (1980). Danziger, S., et al. "How Income Transfer Programs Affect Work, Savings, and the Income Distribution." Journal of Economic Literature 19 (1981). Diamond, P. "Search in a Model of Unemployment." Mimeo. 1982. Evans, M. "An Econometric Model Incorporating the Supply-Side Effects of Economic Policy." In The Supply-Side Effects of Economic Policy, ed. L. Meyer. St. Louis, 1981. Feldstein, M. "The Effect of UI on Temporary Layoff Unemployment." American Economic Review 68 (1978).

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Flemming, J. "Aspects of Optimal Unemployment Insurance." Journal of Public Economics 10 (1978). Fullerton, D. " O n the Possibility of an Inverse Relationship Between Tax Rates and Government Revenue." Journal of Public Economics 19 (1982). Hall, R. "Wages, Incomes, and Hours of Work in the U.S. Labor Force." In Income Maintenance and Labor Supply, ed. G. Cain and H. Watts. Chicago: Markham Press, 1973. . "The Importance of Lifetime Jobs in the U.S. Economy." American Economic Review 72 (1982). Hall, R „ and A. Rabushka. Low Tax, Simple Tax, Flat Tax. New York, 1983. Ham, J. "Estimation of a Labour Supply Model with Censoring Due to Unemployment and Underemployment." Review of Economic Studies 49 (1982). Hammermesh, D. "Entitlement Effects, Unemployment Insurance and Employment Decisions." Economic Inquiry 17 (1979). Hausman, J. "The Econometrics of Labor Supply on Convex Budget Sets." Economic Letters 3 (1979). . "The Effect of Wages, Taxes, and Fixed Costs on Women's Labor Force Participation." Journal of Public Economics 14 (1980). . "Labor Supply." In How Taxes Affect Economic Activity, ed. H. Aaron and J. Pechman. Washington, Brookings Institution, 1981. . "Exact Consumers' Surplus and Deadweight Loss." American Economic Review 71 (1981). . "Income Tax Policy and Labor Supply." In The Supply-Side Effects of Economic Policy, ed. L. Meyer. St. Louis, 1981. . "The Econometrics of Non-Linear Budget Sets." Mimeo. 1982. Hausman, J., and P. Rudd. "Taxes and Family Labor Supply." Mimeo. 1983. Mirrlees, J. " A n Exploration in the Theory of Optimal Income Taxation." Review of Economic Studies 38 (1971). Mortensen, D. "Unemployment Insurance and Labor Supply Decisions." Industrial Labor Relations Review 30 (1977). Pechman, J. Federal Tax Policy. 3d ed. Washington, 1976. Seater, J. "Marginal Federal Personal and Corporate Income Tax Rates in the U.S. 1909-1975." Journal of Monetary Economics 10 (1982). Shavell, S., and D. Weiss. "The Optimal Payment of UI Benefits over T i m e . " Journal of Political Economy 8 (1979). Steverle, E., and M. Hartzmark. "Individual Income Taxation, 1947-79." National Tax Journal 34 (1981). Topel. American Economic Review 1983. Wales, T., and A. Woodland. "Labor Supply and Progressive Taxes." Review of Economic Studies 46 (1979). Welch, F. "What Have We Learned from Empirical Studies of Unemployment Insurance?" Industrial Labor Relations Review 30 (1977).

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DISCUSSANTS Isabel V. Sawhill In the last two decades we have seen changing fads in the marketplace for ideas, particularly economic ideas. In the 1960s interest centered on Keynesian ideas and the efficacy of demand management policies. Then, when that appeared to be not working, people became enamored of Monetarism. Next came supply-side theory, which was first espoused by Republicans but is now being advocated in a different form by "Atari Democrats," that is, by supply-side Democrats. This group diagnoses the problem that we are going to face over the next 10 or 20 years as a growing mismatch between the skills of the workforce and the needs of a high technology economy. Most of them are reasonably optimistic about the benefits of technology. They believe it will create many jobs in the aggregate but that, in the process, there will be serious structural dislocations. The recommended solution is a major investment in education, training, and retraining. I think this is a basic idea that has a great deal of merit, but I also think it is in danger of being oversold. This is a danger, because if it is oversold, it will lose its credibility just as Keynesians and Monetarists and supply-side Republicans have lost some of their credibility by having oversold their remedies for our problems. We need to ask first if the thesis is true that there is going to be a growing mismatch, that is, a growing structural unemployment problem. A look back at the past 25 years reveals that there probably has been some increase in structural unemployment. If the level of structural and frictional unemployment was 4 or 4.5 percent in the midfifties, it is probably somewhere in the neighborhood of 6 percent now; and as Michael Wachter points out in chapter 7, it looks as if it will probably decline over the next 10 years because the baby boom generation has matured and also because what he calls "the cost of unemployment" is going up. The cost of unemployment is going up because the availability and generosity of various income maintenance programs has been reduced recently, particularly relative to wage levels.

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One hears that we have lost in excess of 2 million jobs in manufacturing over the past four years and that we are never going to see them again. It is true that we have lost 2.2 million jobs in the last four years in the manufacturing sector, but I do not think it is at all true that those jobs are not going to ever be there again. I recently completed an analysis of employment in manufacturing and found that virtually all of the recent decline in employment could have been predicted with a cyclical variable. It is not necessary to invoke a structural thesis to explain what has occurred. There has been no shift in the secular trend. Employment in manufacturing is down because the economy is down. During normal times employment in manufacturing and in most, although not all, of the individual smokestack industries is still growing, except during recessions. It is true that it is growing slowly and is not keeping pace with the growth of employment in some other sectors of the economy, such as the service sector. That explains why we find that a declining share of all jobs is held by manufacturing workers. But it is not true that, in an absolute sense, these jobs are no longer there; they are. Now, what about the so-called dislocated worker? My own view, after looking at all of the evidence, is that this group is really very small. The number that has already been cited in preceding chapters of less than 250,000 is probably a good estimate. This does not mean that it is not an important problem, both socially and politically. There is real distress out there in small communities where there have been plant shutdowns. Moreover, we are talking about older blue-collar workers with middle class incomes and stable community ties. Typically, this group has a lot of political clout. I do not want to dismiss the problem. I just want to point out that the numbers are small and that therefore it should not be difficult to manage the problem by bringing either private or public resources to bear on it. What about the future? How do we know that 10 or 20 years from now it will not be a worse problem as international competition heats up and technological change continues? Here I have to speak with less confidence because nobody can predict the future. But let us examine the Bureau of Labor Statistics projections which, while imperfect, are the best thing we have. They say there are going to be about 20 million new jobs over the next decade. Over half of these new jobs will be relatively low skill: in sales, service, clerical, operative, and laborer categories. If we look at the fastest growing jobs, the so-called high-tech jobs such as computer operator, systems analyst, office machine servicer,

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although they are growing very rapidly, they are growing from such a small base that they will contribute little to total job growth over the next 10 or 20 years. In sum, occupations that are growing most rapidly are doing so from a very small base, and occupations that are still growing slowly are doing so from a very large base. Thus, we are not suddenly going to need a large number of workers trained to take on these high tech jobs. Some industries and some regions will decline, while others will prosper. That growth and decline is going to occur gradually, and most of the needed adjustments will occur through the normal turnover of the labor force. Industries and occupations rarely decline at a rate that exceeds a couple of percentage points a year, whereas normal turnover or natural attrition tends to occur at a rate of 20 to 30 percent a year in the average occupation or industry. Therefore, in the absence of cyclical decline, and assuming we do something about plant shutdown and hard-hit communities, the problem should be quite manageable. The second part of the "Atari Democrats" agenda is more education and training. I think we do need more education and training but not necessarily for the reasons that have been suggested. There are tremendous educational deficiencies that need to be remedied. The problem is not quantity but quality: it is not so much that our young people do not complete enough education but that they do not learn enough. As a matter of fact, the evidence is very strong that, in purely economic terms, we have an oversupply of college graduates. For the last decade, college graduates have been bumped down the occupational ladder and the projections for the eighties is that the problem will become worse. But nevertheless I do not feel that we are producing an overeducated workforce, because the more college educated or highly educated people there are entering the labor force, the fewer people there will be who are willing to take manual jobs or low skill jobs. That will drive up relative wage rates in those jobs. That, in turn, is going to encourage employers to automate those jobs and that automation, I think, will be the source of productivity growth. You do not therefore need education so much because technology requires it. You need education to force the economy to go through the transition to a more automated, high tech economic base. The final point I would like to make is that we do not know how to improve the quality of education. It is not just a matter of adding additional resources; we have tried that. Expenditures per pupil have gone up for the last 20 years. Teacher-student ratios have gone up.

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Teachers' salaries have kept pace. That has not been the answer. But that does not mean we should not try harder and that we do not need a national commitment. Education, as has been pointed out by others, does contribute to productivity and has many other noneconomic benefits as well.

Bernard E. Anderson It might be useful to reflect on the current employment situation as a backdrop for considering the difficult choices that must be made in promoting economic growth and increasing productivity. The recent recession has created an extraordinary problem of unemployment reflected in an aggregate rate of unemployment of over 10 percent; a youth unemployment rate greater than 20 percent; an unemployment rate among minority group youth approaching 50 percent, and an unemployment rate among displaced workers of about 15 percent. In approaching the issue of productivity and demographic changes in the labor market, one must consider both equity and efficiency. Moreover, although many of the problems may be resolved through the usual forces of the marketplace, it is very likely that a rather substantial involvement of the public sector will be required to achieve the twin goals of efficiency and equity. In addressing the current unemployment problem, one must give serious attention to two very difficult groups among the disadvantaged. One is disadvantaged minority group youth with very high rates of unemployment. Some observers have suggested that demographic change is likely to reduce the rate of growth in the number of young people in the labor force, thereby lowering their unemployment rate. While that might be so for the labor force as a whole, it is not likely among minority youth whose numbers as a proportion of the total youth population are expected to increase over the next five and perhaps ten years. The second group with special difficulties is the single parent female headed household. This is the group in which poverty is now heavily concentrated. When the phrase "feminization of poverty" is used, it means the poverty of this population group. The most likely and effective solution to the poverty problem for this group is increased participation in the labor market, not higher income transfers. But the difficulty is the hard choices this nation must make between targeting the limited resources on these two groups, that is, disadvantaged minority group youth and female heads of household,

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as compared with displaced workers, in an effort to deal with the very high residual of unemployment left over from the recent recession. In this connection, the numbers are not very encouraging. The consensus forecast for real GNP growth over the next 18 months or so is about 4 percent. If, as expected, the labor force grows by about 1.5 percent, and productivity increases by about 2.5 percent, a real growth of output of 4 percent means unemployment will remain essentially unchanged. In fact, the Administration's forecast, the most favorable one, does not project a return to an aggregate unemployment rate of less than 6 percent before 1988. In comparison, the rate of unemployment in 1979 was 5.8 percent. Thus, based on the macroeconomic expectations alone, the outlook is not favorable to the kind of job expansion typical of recoveries from most past recessions. The 1981-82 recession produced the most serious increase in unemployment the nation has experienced since World War II. The expected competition between the various groups that have to be served creates very difficult problems that will not be easy to resolve but must be addressed in the interest of promoting opportunities for all Americans willing and able to work, to participate in the labor market, and to make a productive contribution to society. Among the very difficult complications are the basic educational deficiencies limiting the occupational skills training potential of disadvantaged youth and other hard to employ groups. Another problem, especially important to female single parents, is the limited availability and cost of child care that many families need. The recent experience with employment and training programs suggests that job creation is a very important component of efforts to deal with the structural employment problem of these groups. There might be implementation difficulties with countercyclical public service employment, and indeed, some economists have difficulties with the notion that the government, itself, should participate in job creation for the economy as a whole. But it is unrealistic to think the very serious problem of structural unemployment in certain sectors of the labor force can be addressed without some form of targeted public job creation. For example, about 80 percent of all the jobs held by minority group youth between 1977 and 1979 were publically created jobs. They were not private sector jobs created through market forces. Second, one of the major programs in existence during the late 1970s, mandated by the Congress, was the Entitlement Program. Under this program, there was a direct link between schooling and employment in which disadvantaged youth were guaranteed a part-time job after school during the academic year and a full-time job during the summer if they remain in school or return to school. Only 20

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percent of the 78,000 jobs, all of which paid wage rates totally subsidized by the Federal government, were in the private sector. This suggests that while it is useful to think about ways of expanding opportunities in the private sector, it is not clear that private industry is willing or able to be the principal source of employment for disadvantaged youth with serious employability limitations. A public job creation program probably will be an essential part of any serious effort to deal with the employment problems of disadvantaged groups. Further, the structural transformation now taking place in the economy is going to result in a high level of unemployment concentrated in certain regions, such as the northeastern and north central regions. This means targeted measures also will be necessary to address regional unemployment problems, if both equity and efficiency objectives are important. Because the amount of public resources available for employment and training programs are expected to be very limited during the immediate future an additional strategy seems advisable. Specifically, rather than develop large-scale programs in Washington that are replicated throughout the country, there should be more experimentation with different approaches for dealing with problems of disadvantaged youth, minority female single parents, and other welfare recipients. Experimentation and demonstration projects can test the ideas before they are replicated; in that way, the expenditure of Federal and state funds can be made more productively. There are two major examples of where this strategy has worked. One is the program that was supported by the Federal government and by private foundations, the Supported Work Project, which over a five-year period tried to discover whether a specially designed program to help the very disadvantaged members of the population would be successful for different groups such as high school dropouts, welfare recipients, ex-offenders, and ex-addicts. The program was thoroughly evaluated and after a five-year period the results showed that among those who participated, only welfare recipients were major beneficiaries of the program. Another example is a program called Jobs for America's Graduates supported initially three years ago by the Rockefeller Foundation and later jointly with the Department of Labor. It is a school-to-work transition program which depends very heavily upon a cooperative relationship between the school system and the private sector in local communities. A nonprofit labor market intermediary is created and works directly in high schools to increase the job finding and retention skills of high school seniors who are not enrolled in vocational education programs or programs for the college bound. These are the

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high school students who very often drop out, or graduate with no knowledge about the labor market and no prospects for employment; most very quickly become unemployed. About 65 percent of more than 1,000 high school graduates who participated in the program during the 1981-82 academic year had jobs within the first three months after leaving school. This record was achieved during the depths of the very serious recession in 1982. The point is that there are some lessons that can be drawn from recent experience to show how the joint problems of equity and efficiency can be addressed in approaching the unemployment problem. It will not be easy; hard choices must be made. But it is necessary to remember the importance of public expenditures in addressing such problems. They cannot be addressed simply by cutting budgets all around and reducing substantially the amount of funds available for education, employability development, and targeted job creation. Robert W. Lundeen I have contended all during my business career that the American worker, properly informed, led, and motivated is as productive as, if not more productive than, workers elsewhere in the world. And I have been to a lot of different countries. My contention presupposes, of course, that you not only have good workers but you also have good management. Those two things run together. We have come to a point now, however, where we have to think seriously about the educational foundations we are providing for those workers. And that is what I would like to concentrate on, particularly grades K through 12.1 am not worried so much about higher education, at the university level, at least not in this discussion. I strongly believe the economic well-being of a nation is derived from the ability of its workforce to create and to use knowledge and technology. All the employees, from the entry-level workers to the top managers, constitute a workforce, and all participate in activities affecting the economic growth of the country. This economic growth has traditionally required a workforce possessing basic educational skills, simplistically defined as the ability to comprehend a simple written passage, the ability to compute with whole numbers, and the mastery of elementary writing mechanics. Decades of technological growth have changed the way Americans create new products and services. Today it is the norm for a new clerical employee to work with a word processor, and certainly the newest operator in any of our chemical plants will routinely use a

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computer to obtain maximum efficiency and cost control from a process. Many, but not all, of our existing and emerging industries depend on cutting-edge technologies that call for highly advanced technological skills. In the future, economic growth will require an expansion of these basic educational skills. Indeed, in portions of the workforce, there will be ever more demanding requirements for reasoning and conceptualizing skills, communications skills, and scientific, mathematical, and computer literacy. Unfortunately, the current testing and assessment data of American youth indicate a growing gap between their abilities and those very skills. In fact, many of our students are poorly prepared even for the minimal requirements of the workplace, let alone these highly advanced skills. Contributing to this lack of adequate preparation are some serious deficiencies which have been elaborated on by a number of educators and other people: out-of-date school curricula and facilities; a substantial public indifference to the quality and status of our teachers; teachers who leave the profession because it does not pay enough money; and qualified teachers who are hamstrung by a rigid educational hierarchy, by the bureaucracy of teachers' unions, and by bloated state bureaucratic educational establishments. I get a lot of this data from teachers themselves, so it is not my perception alone. Fewer qualified individuals are entering the teaching profession today, and absenteeism among students is high. I was appalled to learn in recent work I have done that about 25 percent of the nation's youth drop out before graduating from high school. The number of high school students is expected to decline through the eighties, but the number of workers required for technical occupations is expected to increase. This suggests that a large proportion of today's students will require a well-grounded knowledge of technology for participation in their world of work. So to insure the economic well-being of the nation, it is essential that we strengthen education and training, particularly at the elementary and secondary levels. These are the crucial years in the development of all individuals, and for most Americans, they represent the sum of their formal education. Finding ways to improve the quality of education is, admittedly, a formidable task. I have two points to make about this task. First, I feel that there is very definitely a role here for the private sector. Second, we can learn something about education from other countries, Japan in particular. We at Dow Chemical, for example, have been working in cooperation with the Committee for Economic Development on a two-year study, and I have been working also with the Education Commission for the States on the problem. Dow, like many other companies, gets

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involved in the communities where we have factories, workers, and professional people. In small communities where there are big, advanced-technology industries, there is usually a fairly high standard of education, because the people who work in those industries are sensitive to the need for quality schools. The parents help their children with homework. They volunteer their skills in the schools, and they help or show their interest in many other ways. There is much we can learn by contrasting our system of education with that of Japan. Japanese education to a large extent reflects their culture and the homogeneity of the society. The Japanese have built into their system a lot of discipline. The whole school system reflects one philosophy: To be a good Japanese, you must be able to perform. A second major characteristic of Japanese education is an awesome competitive system, something that, politically, we could never institute in this country. Children in Japan must be interviewed and endorsed by the faculty before they can be admitted to the best kindergarten. That begins the competitive process. Throughout their years of schooling, the Japanese must take rigid competitive examinations. Those who do not attain the minimum grade required are dropped. Society there accepts this system; we do not in this country. Ray Marshall The Economic Policy Council of the United Nations Association Panel on Productivity is getting ready, after more than a year of study, to make a final report. I have worked with the Council, and I have been asked to reflect on our findings. Economists have been unable to measure with much precision the reasons for the slowdown in productivity growth in the United States since 1965 and more especially since 1973. We have neither analytical techniques nor measurements powerful enough to isolate the causes of a slowdown. It is possible to get insight into why there is some slowdown in the United States, however, by studying those countries that have had relatively rapid productivity growth during this period and have managed their economic affairs reasonably well. The first important conclusion is that what happens in the firm where productivity actually takes place cannot be isolated from the country's overall economic policy. Those countries that have had the highest productivity growth and continuing growth also have had fairly well coordinated macroeconomic policies and ordinarily have had industrial policies that maintain a stable environment within which

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productivity can take place. They especially have had fairly stable growth, low unemployment, and low rates of inflation. The Japanese have had the fastest rate of growth of any country, and a good argument can be made for the conclusion that their public management systems have been mainly responsible for their high productivity growth. That is contrary to a lot of the thinking about the so-called Japanese management system which is heavily concentrated in particular industries but indistinguishable from one industry to the next. A second important conclusion is that most countries that have had relatively rapid productivity growth have had consensus mechanisms of various kinds at various levels and particularly for the formulation of macroeconomic policy. Many of them developed these consensus mechanisms after a period of unproductive conflict. Japan in the 1950s and Germany in the 1960s both recognized that if they continued to fight internally their gross national products were going to decline and they would have great difficulties maintaining their living standards and competing in international markets. So they developed these consensus mechanisms. Consensus mechanisms have helped especially to get agreement on comprehensive and consistent overall national economic objectives and on the implementation of alternative policies to achieve those objectives. Consensus mechanisms have also helped to improve economic regulations. For example, the Japanese spend more money relative to GNP on environmental protection than we do, but they spend a lot less on lawyers and a lot more on technicians and engineers. As one Japanese put it: "If we have a problem, we hire engineers and work it out. If you have a problem, you hire lawyers and fight it out." Like most other countries with relatively successful economic policies and performance, Japan has a much more cooperative approach to the regulatory process. Another extremely important outcome of consensus mechanisms for public and private decision making is better information. The third conclusion I have drawn from the Economic Policy Council study is the importance of having capital available on competitive terms. Most of these countries, especially Japan, have kept interest rates very low and have made capital available through the banking system for production. That policy has avoided what Reginald Jones calls the tyranny of Wall Street. The Japanese rely much less on shortterm equity financing for capital needs and therefore are able to pay much more attention to long-run capital formation and technological change.

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Fourth, incentive systems are very important at all levels, incentives that encourage real investment in plant and equipment and also incentives within the system to improve worker motivation and productivity. Fifth, the Japanese have developed supportive international trade policies that cannot be characterized as free trade, though Japan, like the U.S., has a lot to gain from fairly liberal and open trade. The Japanese policy has been to use a combination of competitive markets and cooperation in order to protect their industry until it is ready to compete in international markets. These countries with successful growth also have developed adjustment policies. As Malcolm Lovell points out elsewhere in this volume, a basic problem underlying our employment and training system is the funding cycle. And if we could deal with that funding cycle through an employment and training fund, we could go a long way toward improving the management of that whole system. But, as he also points out, adjustment policies are important because they try to provide an equitable sharing of the benefits and costs from economic change, and that reduces resistance to change. Sixth, education and training is important but not just in the school system. Education in most of those countries with high productivity growth continues on the job; that is partly what the so-called quality control circles are. Japanese workers come to the job with fairly high levels of education, which facilitates continuing education. In Japan, 90 percent of the eligible population graduates from high school, and each high school graduate has had six years of math and science through calculus and six years of English. And then they continue the training on the job. A very small percentage of Americans who are high school graduates have any math beyond one year of algebra. In Texas, last year, for example, only slightly over 7 percent of the high school graduates had more than the one year of algebra required of all graduates. Seventh, Japan and other countries also have more cooperative industrial relations systems, which were established after a period of conflict and the recognition that they need to develop more cooperative systems. Many people believe the Japanese system is rooted in Japanese culture. It is not. Their industrial relations system was based on class warfare. During the 1950s they had waves of strikes and then decided they had better get together or the system was going down. Next, research, development, and innovation are very important, as are management systems. We have concluded that there is nothing unique about the Japanese management system. After all, we Americans taught the Japanese a good bit of that system and good managers

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tend to do the same things everywhere. Since average productivity is higher in the United States than it is in Japan or any other country, our management systems have been pretty good, especially those that have always been involved in international competition. It is instructive, however, to consider some of the ingredients of the Japanese system. One is job security, which is very important in maintaining good worker motivation and morale. Another is incentives. The Japanese and others use incentives and bonuses to develop wage flexibility. Because it is easier not to pay a bonus than it is to cut wages, they gain considerable flexibility. Other ingredients in the Japanese system are worker participation in the production process, implementation of the latest technology, and attention to product quality. Many of the companies working with our panel were surprised to learn how important quality is to productivity. There are differences in the quality control systems in Japan— some tend to be more preventive—but quality tends to be extremely important in determining market share, morale, the ability of the workforce to work together. The final elements I will mention are flexible and adaptable systems, and the significant integration of production processes to create unity. Instead of there being a separate engineering department, for example, engineering is brought to the work floor. Those seem to us to be the essential ingredients of the most productive work system. Malcolm R. Lovell I would like to discuss the displaced worker because of the importance of this problem in achieving competitiveness. There is general agreement throughout the country that the U.S. should use its influence to maintain a relatively open world trading system. If we succeed in this effort, we will have to make sure that we remain competitive so that we take full advantage of the expanding wealth inherent in a growing world economy. This means rapid development and implementation of new technology, wise use of capital resources, and a willingness to purchase products made abroad even if it means a temporary loss of American jobs. How we manage our human resources in this process is tremendously important. If we expect individuals adversely affected by technological change or by competitive forces to bear the full burden of transition to new employment, then we can expect the political tide to turn against our opening our markets to other nations, and we can

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expect a reversion to protectionist policies which, over the long term, will mean fewer jobs and less wealth. So, by being a vigorous competitor we can expect the job mix to change, as well as the nature of work within companies and industries. We know, for example, that the percentage of workers in manufacturing is going to decline dramatically throughout the rest of this century. Peter Drucker has estimated that it will move from its present 22 percent to less than 5 percent by the year 2000. More conservative estimates suggest a move to 14 percent. Although the actual number of jobs in manufacturing may not change dramatically over the next several decades, those jobs will be less significant to the total economy. There are those that argue that if the economy is strong, then individuals displaced by either technological change or other economic forces can move rapidly and with minimum inconvenience into other work. I do not subscribe to this philosophy. The exact numbers of people that will be affected each year by displacement cannot accurately be predicted at the present time. The wide range of estimates dramatizes the inexactness of the computations. Some say 100,000 a year, and others 2 million; both extremes probably represent gross exaggerations. I would assume a conservative number, between 500,000 and 1 million, which, although it is a small percentage of the workforce, represents an important enough group to require public policy attention. Many of the individuals displaced would be able to move quickly and comfortably into other employment. This is particularly true for individuals whose skill levels and pay rates are in tune with other industries and who live in areas where the job market is fairly amiable to the job seeker. It would not apply to workers who held highly paid jobs with minimal skills or to individuals who were laid off in areas of high unemployment or to those somewhat older workers inexperienced in the art of job search and more rigorously tied to specific physical areas and styles of life that make job change more difficult. One has to recognize, too, that more than ever before workers in America are in competition with workers throughout the world. Management skills, technology, and capital all can be exported, and routinized production jobs, even in so-called sophisticated industries, can be taught to Brazilians, Indonesians, Koreans, and Malaysians with the same ease that inexperienced American workers displaced from the farm were absorbed into America's burgeoning manufacturing economy. It is generally recognized that at the same time the manufacturing segment of our society is becoming less important the so-called ser-

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vice industries are expanding, both in real terms and as a percentage of the workforce. It is true as well that currently many service jobs do not pay rates comparable to many of those in the manufacturing sector requiring comparable educational background. Since the manufacturing population in real terms will probably not decrease, the vast majority of workers in the manufacturing area will not be required to shift into service jobs. New entrants in the labor force, however, will have fewer options open to them in the area of manufacturing than heretofore has been true. The important consideration, in my judgment, is not that we retrain all displaced workers from manufacturing for lower paid service functions requiring different skills, but that we provide options for these individuals so that they may choose to continue in similar work, if that is their want and the work is available, or to move into dramatically different occupations requiring acquisition of different manual and cognative skills. I think that the responsibility to deal with the displaced worker lies both with private industry and with public policy. Private companies will have to give greater consideration to using redundant people in other operations or to helping them prepare to be competitive in other industries. The Ford United Automobile Workers 1982 contract moves significantly in that direction. At the same time, public policy has to provide a greater array of options than currently exist with our unemployment compensation system, the remnants of the Trade Adjustment Act, our faltering Employment Service, and Title 3 of the Job Partnership Training Act. I recommend four principles that should be considered in contemplating public policy options to aid the displaced worker. First, we must define the term displaced worker. I would define it as an individual who has been at least four years in covered employment and who is certified by the employer as unlikely to return to that company within six months. Second, we should accept the concept that any program to deal with this individual should link income support with various services to be made available, such as job search assistance and training and education. Third, we should have a financing arrangement which is independent of the unemployment insurance system but which is, like that system, user-financed. Such an arrangement might consist of a small payroll tax borne equally by employers and employees, paid into a trust fund. And finally, a displaced worker should be allowed to choose whether to participate in this system or to rely on existing income support programs and conduct the job search independent of government effort.

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SUMMARY REPORT Robert C. Holland Discussion at the panel on labor productivity and demographics affirmed that the labor area is indeed plagued with many deterrents to economic growth—not so much one-time obstacles as ongoing inhibitors to as full employment and as substantial a rate of economic growth as the potential of our labor force would permit. Some of these deterrents were judged to be amenable to assistance from better government policy programs. Others could be helped by better private policies and programs. Many of them also would require better attitudes and effort on the part of the individual members of the labor force. Panelists contemplated three functional avenues for potential improvement in the contribution of labor to overall economic growth. One avenue is through getting more people to work. The most important policy prescription for achieving this would be better designed macroeconomic policies in the United States. This objective could also be helped by more and better education and pre-job training programs, as Michael Wachter's paper amply demonstrates. A second avenue is getting people to work more. This purpose could be partly served by the provision of more and better education and job training. It could also be encouraged by lightening the disincentives to work that exist in various parts of the tax system and by making appropriate changes in some of the support programs for unemployed or partly employed individuals in order to build into those programs more incentive for individuals to work. Jerry Hausman's paper carefully evaluates what has recently been done and what more might be done in these areas. The third functional avenue is getting people to produce more per hour. This traditional way of improving labor productivity could be best served by the provision of better training programs and development of suitable job experience. It can also be helped a great deal by the development of better management-labor interaction in most phases of employment.

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Cyclical problems of labor utilization are serious, but we are presently faced with much more than a cyclical problem of labor force utilization. There are longer-run and secular problems embedded in our labor force that involve deep-seated social values and economic relationships. These will take time to change for the better, and they call for carefully designed and carefully tailored programs to try to improve them. Members of the panel and the audience probed for relevant facts and experience that could help in recognizing and targeting remedial programs. Looking around the world, panelist Ray Marshall flagged ten characteristics that he sees typically displayed in countries that have achieved rapid productivity growth in recent years. Looking within the U.S., panel members pointed out sharply differing needs among the various demographic groups that make up the unemployed labor force. Concerns focused particularly on two groups of would-be workers who seem to have the most significant needs for assistance; namely, displaced workers and disadvantaged workers. The panel seemed to regard displaced workers as the less problemladen of these two groups. The contemplated number of displaced workers was expected to be relatively small at any one time, perhaps averaging 250,000 or somewhat more. This group was perceived to have disproportionately large political power, however, and therefore a disproportionately large ability to trigger governmental programs, both supportive and protectionist, in response to a loss of employment. Among the programs that could be helpful to this group in an efficient way might be a rescaled unemployment insurance program. The idea here was to pay out a larger portion of the total benefit relatively early during the period of job loss and dislocation, perhaps in one lump sum or voucher at a relatively early stage. Amounts paid in the later phases of the duration of unemployment payments would be made correspondingly smaller, thus providing progressively greater incentive for the worker to seek and accept new employment. As panelist Malcolm Lovell recommended, this kind of program modification should also be accompanied by tailored retraining and relocation assistance available to displaced workers at their option, beginning at a fairly early stage in their unemployment. These supportive arrangements would probably be most efficiently utilized if they were linked to a requirement for job search efforts on the part of the recipient. Panel member Isabel Sawhill injected some words of caution against exaggerating the impact of technological advance in rendering worker skills obsolete. Such changes could spread gradually enough through the economy to allow time for the requisite adjustments in jobs, skills, and education if the proper steps were taken.

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The second group given attention—disadvantaged workers—is expected to number in the millions, many times larger than the anticipated number of displaced workers. As panelist Bernard Anderson emphasized, programs aimed at assisting disadvantaged workers are desirable not only because of the productivity gains from bringing them into the group of employed workers but also because of the equity involved in assisting these less fortunate members of society. Panel members seemed to agree with him that, given the limited resources likely to be brought to bear on the needs of this group, it would be most equitable to focus a disproportionately large share of such resources on the two most disadvantaged subgroups within this total. One such disadvantaged subgroup is minority youth. The programs judged to be most helpful to this group were those that would improve the quality and availability of education received by such young people in primary and secondary schools. Members of this group also can benefit from generalized job training, particularly when it can be linked to actual jobs in some practical fashion. The second most disadvantaged subgroup consists of singleparent families headed by a young female parent. This group, rapidly growing as a share of the population, involves a variety of social concerns. Programs likely to be most helpful here are those that would provide training and appropriate levels of education for these parents. The availability of day care facilities and suitable job search assistance could also be very helpful in many cases. At several points the discussion probed the possibilities for private sector participation in the kinds of remedial programs outlined above. Panel member Robert Lundeen pointed to numerous examples of corporate assistance in local programs of job training and educational improvement. He felt that businesses could be successfully called upon to extend this kind of help to their communities. But he also felt that all parts of society needed to support strengthened education and training, particularly at the elementary and secondary levels, since these are the crucial years in the development of all individuals. The panel recognized that there is unfortunately a residual core of the most disadvantaged and dysfunctional individuals who are not likely to become usefully employed by any combination of the programs outlined above. For this core group, the only decent and sensible recourse is to provide some last-resort public employment programs and welfare payments. (Some members of the panel saw the role for such public-service employment as larger-scale than did other panelists.) But these last-resort assistance programs should be designed and scaled so as not to attract people away from engaging in useful gainful employment if and as they are able. In these as in other

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labor assistance programs, it will be important to give weight to considerations of equity as well as efficiency in designing the details of the program. In total, the policy changes recommended by the members of the panel are a challenging assemblage. Much time and effort will undoubtedly be required before major progress can be achieved in these directions. But Michael Wachter reminded us that, for the next decade at least, the demographics of the U.S. labor force should make that task more manageable than in the years just past.

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Motivation and New Technologies ik & 9. THE NEED FOR NEW PRIVATE AND PUBLIC POLICIES Franklin A. Lindsay Jerome S. Rubin

Richard L. Cohen

OVERVIEW There is widespread agreement today that major American industries have lost ground competitively in world markets. There is also a growing consensus that advanced technology is one key to regaining our competitive vitality. The inference that managers frequently draw from these facts, however, is only a part of the answer to sustained economic growth. Research carried out by the Public Agenda Foundation suggests that managers see the new technologies mainly as a means of solving the problem of high labor costs.1 The argument is: in the 1970s we employed too many people at uncompetitive wage and benefit rates; in the 1980s we must use the labor-saving potential of the new technologies to lower labor costs and enhance productivity, and we must do this as rapidly as possible. This argument is not wrong per se. The problem with it is the strategy that often evolves from it. To the extent that the introduction of the new technologies ignores human factors—the skills, cooperation, and dedication of employees—it is likely, in the new workplace of the 1980s, to prove self-defeating. In the discussion that follows, we draw upon a series of case histories to bring out a number of principles that companies have found to be effective in dealing with the human factors associated with the introduction of the new technologies. These principles are: • Avoid surprises. • Share the knowledge of the economic and competitive realities of the company with employees.

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• Involve employees directly in the introduction of the new technologies. • Invest adequately in employee training and retraining. • Provide employees the incentive of sharing in the productivity benefits resulting from the new technologies. • Explore new forms of employee job security. These principles are not mechanical recipes for success in all companies under all circumstances. Nor are they simple to implement. But, when carried out with skill, persistence, and sensitivity, they lead to high levels of productivity based on melding new technologies with a significant improvement in employee skills and dedication. New technology is producing a fundamental transformation in the American and world economies. It is moving us from the industrial age as we have known it for many decades into a radically different economic system based on knowledge and information skills. This transformation raises a host of important policy issues, including: the need to revitalize our educational system, so that over the long run we will have an adequate supply of the human talent that the new technologies require; the need to invest adequately in the basic research and development on which technological innovation is so heavily dependent; the need to reexamine antitrust, tax, and trade policies in the context of the new realities of a world economy increasingly based on advanced technology. These and other issues, while far from resolved, are receiving increasing attention in the public debate. Our sense is that the issue on which we will focus here—how to meld advanced technology with a high degree of human skill and commitment—is of comparable importance but less well understood. We begin by reviewing briefly why managers find the new technologies so compelling, and why we need to be cautious about viewing them as a near-term cure-all for our economic ills. We then explore some important ways in which the new technologies lead to a new role for jobholders and new ways of managing. Finally, in what is the heart of our discussion, we examine in detail each of the principles outlined above.

THE NEW TECHNOLOGIES The new technologies include a wide and growing range of new, computer-based products and production processes. They also include more recent developments such as biotechnology that, over the long run, may have an impact on our society and economy every bit as profound as that of integrated circuits and the computer. The new

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technologies, far more than industrial processes as we have known them, will form the central core of advanced economies of the future. It is hardly a secret that the United States has lost ground competitively over the past decade. Along with the greatly increased cost of oil and, more recently, an overpriced dollar, one of the major problems has been the comparative decline in the U.S. economy's rate of productivity growth. In 1983, the U.S. economy was still the most productive in the world. Yet, over the decade of the 1970s, its lead over other advanced industrial nations narrowed considerably. Between 1973 and 1980, productivity increased at an average annual rate of 3.5% in Japan, 3.1% in West Germany, 2.7% in France, 0.4% in the United Kingdom. During this same period, productivity did not grow at all in the United States. Slowed productivity growth has affected some U.S. industries and economic sectors more seriously than others. The adequacy of our current measures of productivity also leaves much to be desired. Skewed exchange rates among national currencies have contributed, as well, to the ability of some countries, notably Japan, to penetrate foreign markets. Still, with appropriate qualifications, slowed productivity growth is widely—and correctly—seen as a principal source of declining U.S. competitiveness. The new technologies derive much of their current appeal from their potential contribution to restoring competitive rates of productivity growth. A few examples suffice to make the point. A new, semi-automated textile mill covers 8,500 square meters and employs 95 people; it replaced three mills that covered 45,000 square meters and employed 435 people. An insurance company has installed an electronic policy-issuing system that cuts the time required to issue a policy from three weeks to three minutes. According to one study, after the General Motors plant in Lordstown, Ohio, introduced robot welding-machines, it boosted production by 20% while reducing the workforce by 10%. Whereas it once took 75 hours to assemble an electromechanical telex machine, the new electronic machines can be assembled in 18 hours. 2 None of this even begins to touch on still-nascent developments like biotechnology that may further revolutionize production processes and lead to barely imagined new products and industries. Most observers are convinced that we have only just begun to see the changes that will be wrought by computer-based and other new

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technologies. The application of the new technologies to economic activity is in its earliest stages; the real revolution in the workplace and the economy is yet to be felt. But advanced technology is propelling us toward an economy as different from the industrial age as the industrial age was from the age of agriculture. Few individual firms, few businesses or industrial sectors, few national economies will be able to compete successfully in the context of a world economy without making effective use of the new technologies. Sales, profits, jobs, national prosperity will all be dependent on the successful application of these technologies. Yet, if we focus on their promise, there is considerable danger of our viewing the new technologies too simplistically. With characteristic American enthusiasm, we run the risk of placing too much hope in them as a "quick-fix" solution to our economic problems. We may fail to appreciate the kinds of private and public policy changes that will have to be made if the new technologies are to be used effectively, the investment in time and resources that these changes will require.

A CAUTIONARY NOTE It is difficult today to pick up a newspaper or magazine without encountering some discussion of the miracles of the new technologies. In 1983, hundreds of bills relating in one way or another to advanced technologies were introduced into the U.S. Congress; committee hearings on the subject began to flourish. In cities and states throughout the country, the cultivation of hightechnology industries has seized the imagination of countless officials. "It's a great bandwagon business," says one local official. "There are 4,500 economic-development agencies in this country, and it's fair to say that every one of them is after high tech." 3 President Reagan has added his voice to the chorus of enthusiasm. "As surely as America's pioneer spirit made us the industrial giant of the 20th century," he said in his 1983 State of the Union Address, "the same pioneer spirit today is opening up another vast frontier of opportunity—the frontier of high technology." The spread and intensity of such hope no doubt has been stimulated by the depths of our recent recession. With unemployment at a post-World War II high, various of our traditional core industries tottering, and communities throughout the land economically devastated, enthusiasm for technologies that seem to hold out so much promise for economic revitalization is hardly surprising. Yet, for a variety of reasons, new technology will not anytime soon be a cure-all for the economic illnesses of most industries in most

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communities. We must not expect too much from them too soon, or fail to appreciate the kinds of sustained commitments that will be required for their successful use. To illustrate, it would be a serious mistake for us to look to the new technologies over the next decade or so as the solution to our unemployment problem. The number of jobs required simply is not likely to be there. As Stanford University researchers Henry Levin and Russell Rumberger, working from Bureau of Labor Statistics projections, have pointed out: Slower-growing occupations with a large employment base are expected to contribute far more jobs to the economy than high technology occupations. Of the 20 occupations expected to generate the most jobs in the economy during this period, not one is related to high technology.4

The number of janitors and sextons is estimated to increase by 672,000 between 1978 and 1990, the number of nurse's aides and orderlies by 594,000, the number of sales clerks by 591,000, and the number of cashiers by 545,000. In the same period, the number of computer systems analysts is expected to increase by 199,000, the number of computer operators by 148,000—each less than a third of the number of new janitors and sextons. New technology is certain to alter the way many traditional jobs are done. High-technology-related occupations will also have the highest rate of growth. The number of new jobs they generate, however, will be relatively small. Revised Bureau of Labor Statistics estimates project that such occupations will account for only 7 percent of all new jobs created between 1980 and 1990.5 There is also a danger of placing too much hope in the new technologies as a source of economic revitalization at the local level. Building a base of advanced-technology industries is a complex process made up of several stages and typically years in the making. Boston's "Route 128" and Palo Alto's "Silicon Valley" simply cannot be recreated overnight. Only those few communities possessing major university and corporate research centers are likely to provide the scientific cores around which high-technology firms are spawned. The major opportunities for other communities will be to provide skilled worker pools when these high-technology firms reach the "break-out" phase. The employee requirements in this second stage will be primarily for people with good high school, community college, and four-year engineering school training. Communities with this type of labor force will stand the best chance of attracting the IBMs, the Hewlett-Packards, the Digital Equipment Corporations, and their future offspring when they are searching for new locations.

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The caution appropriate to those looking for the new technologies to stimulate employment and community growth applies equally to individual firms. The efficient exploitation of these technologies does not come quickly or easily. One major company, for example, withdrew a computer-aided design system that had been in operation for only a few months because it was unable to reconcile the system with established production procedures.6 More than one robot has stood unused in the factory corner for want of understanding how best to make it function in a given production process. The problems are not with the technology per se but with how it is applied. Successful application often requires substantial attitudinal, organizational, and procedural changes not quickly or easily effected. As one observer has put it: "The journey to the promised land may not take 40 years, but it's apt to remain painfully slow." 7 Finally, with the growing enthusiasm about the new technologies, there has been considerable debate and confusion about whether we should or should not let these technologies supplant certain of our traditional core industries, such as steel. We say confusion because the fact is often overlooked that the new technologies have a two-part impact on our economy. On the one hand, they are generating an array of new businesses, companies, jobs, occupations, and products. On the other hand, they are a means by which existing industries can be modernized, old products produced in new ways. All industries do not need to be preserved at all costs. Scarce resources should not be used to prop up industries that have little chance of competing in the technology-based economy of the future. At the same time, it is a mistake to write off industries simply because they have been around for a long time and may now be in trouble. Some of these industries contribute significantly to our national security. Many, through the application of the new technologies, can be made economically competitive again. General Electric, for example, decided to modernize its locomotive works in Erie, Pennsylvania, because it continued to see a profitable market, and because it could use new production technologies to compete effectively in this market. Perhaps our best model of the introduction of advanced technology in a traditional industry is the history of farming in this country over the past one hundred years or so. Through the progressive application of advanced technologies, we have increased our agricultural productivity many times over, while simultaneously freeing all but a small percentage of our workforce from the land. We are today, by all accounts, the most productive agricultural nation in the world. Agriculture is also one of our greatest competitive strengths internationally. Technological advances, in short, did not lead us to abandon

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agriculture in favor of manufacturing. They enabled us to do both well. A NEW ROLE FOR PEOPLE With these cautionary notes in mind, we turn now to some of the issues raised by the new technologies, and their implications for private-sector managers. One of the most notable consequences of the new technologies is to heighten the importance of the individual human jobholder. At first glance, this may seem paradoxical. For one of the primary motivations for the adoption of new technologies is the desire to lower labor costs. The goal is to produce more and better products, more cheaply, with fewer workers. Yet, the evidence to date indicates that the new technologies typically have the effect of making those workers who remain on the job more and not less important to the overall production process. The education, skills, and commitment of people also become the keys to continued innovation. The "old" technologies, symbolized by assembly lines and fixed automation, generally lessened the importance of the individual jobholder. At the heart of the system was the notion that work tasks should be divided and subdivided until any one jobholder had only a relatively small piece of the action and responsibility.8 In many instances, the new technologies move us in the other direction. They have the effect of making jobs more whole and less fractionated, of giving individual jobholders a greater span of control over the larger production process. In a survey of workplace issues conducted by the Public Agenda Foundation in the fall of 1982, close to three-quarters (73%) of those who had experienced technological changes in their jobs said that the changes had made their work more interesting, and over half (55%) said that the changes had given them greater independence in their work.9 The point has also been illustrated in case studies conducted by the Public Agenda.10 For example, at a southern-based printing plant that had recently undergone a major transition to new technologies, a youthful, former photo-stripper was doing page make-ups on a computer. The introduction of new technologies had taken a good deal of the previous tedium out of his work. It had also significantly enlarged his span of control and responsibility in the preprinting process. In another case examined by the Public Agenda—this one involving a major move into office automation—jobholders once restricted to highly conventional secretarial chores were performing more as administrative assistants, again with enlarged responsibilities and impact on the work being done. Some observers have expressed concern that the new technologies

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will result, on balance, in a significant "de-skilling" of the workforce, that they will transform once highly skilled craftspeople into little more than computer monitors." Doubtless, some jobs will require less skill. Some skills are also certain to disappear, as skills have consistently throughout history. The important point, however, is that the new technologies essentially expand rather than limit what jobholders can accomplish. It is up to managers to recognize and tap that potential. What is true of jobholders in the production context is even more true of those on whom we will depend to keep us competitive in technological breakthroughs and applications. New discoveries, and the translation of these discoveries to commercially viable products, processes, and services, are dependent on the knowledge, talents, and innovative bent of people. The size and quality of our pool of well-educated, creative, and highly committed people will largely determine our ability to stay in the race of increasingly rapid technological innovation. To a large degree, the majority of American private-sector managers are still operating on the basis of attitudes, outlooks, and practices born of a different era of production and inappropriate to a newtechnologies-based economy. Some of the changes in outlook and practices that need to be undertaken will be discussed more specifically below. But the first and most critical step, the step on which success on all other fronts hinges, is to see clearly the enlarged role, importance, and potential contribution of the human jobholder. NEW WAYS OF MANAGING Beyond enhancing the role of individual jobholders, the new technologies call upon us to develop substantially new ways of thinking about work, organizations, and managerial practices. This is particularly true in several areas that are fundamental to our ability to make best use of the benefits offered by the new technologies. In the first instance, managerial thinking and policies need to give more emphasis than has been typical to investments that have a medium- or long-term, rather than an immediate, payoff. Making the transition to the new technologies—for an individual firm, for an economic sector, for our economy as a whole—is neither quick nor inexpensive. Often, the payoffs will come only years later. They require staying power, a sustained commitment to what promise to be, on balance, larger benefits down the road. It will not be easy to lengthen the return-on-investment horizons of executives and investors who continue to be concerned with the

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possible resurgence of inflation and who operate in an environment of high interest rates. Our stake in maintaining a more stable monetary environment, and in stimulating longer-term investment outlooks, is substantial. Either we invest more now in longer-term payoffs, or we resign ourselves to a continued steady decline in our ability to compete. If there is reason for optimism, it is that increasing numbers of firms seem to be taking the longer view of their own vitality. The Emerson Electric Company, for example, long noted for its focus on current profit performance, in 1982 boosted substantially its research spending and the number of new products in development. It did so in the midst of one of the steepest recessions of the postWorld War II period. The General Electric Company is investing over $300 million to automate its locomotive production plant in Erie, Pennsylvania. Control Data Corporation has invested millions of dollars in its Plato learning system, with no near-term prospects for profits. The major American automakers have invested some $50 billion in retooling for the 1980s. On another front, American corporate executives need to begin placing a greater emphasis on an entrepreneurial, as distinguished from an administrative, approach to managing employees and product development. The new technologies put a premium on rapid innovation, on a company's ability to come up with new products and processes, to apply new technologies effectively, before they are left behind by others. One of the most critical tasks is to shorten the elapsed time between basic research and the application of innovations to commercially viable products and processes. This requires more initiative, more creative thought, less job segmentation, and more teamwork throughout organizations, including front-line supervisors and production workers, who are a vital link in the chain. Whatever our handicaps in competing in the world economy, our bent toward individual initiative must count as one of our foremost advantages. Nowhere has this been better illustrated in recent years than in the large number of new ventures and spin-off firms that have been a driving force of our technological innovation. From the Apple Computers to the Genentechs, the small entrepreneur has contributed enormously to the development and useful application of the latest technologies. So too have those few large corporations—the IBMs and the Hewlett-Packards—that have found ways to stimulate and reward individual initiative. The challenge to both public and private policies is to provide an environment that stimulates rather than smothers this kind of creativity and initiative, not only for new ventures, but within large, more established organizations as well. Finally, labor—in particular organized labor—will of necessity play

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an important role in the development of new approaches to dealing with work. In order to make the kinds of changes suggested above, to expand the scope for individual jobholder initiative, labor will have to be willing to work with management in relaxing many of the job strictures built into our current industrial-relations system. In many instances, these do more to retard than to stimulate the kinds of broad thinking and responsibility that the new technologies demand. One case examined by the Public Agenda offers a particularly good illustration of the point. The company concerned has three production facilities. Two are nonunion plants located in small-tomoderate-sized southern cities. One is a union plant located in a major city in the traditional industrial heartland of the country. Some time ago, management of the company decided that, in order to remain competitive, it had to introduce advanced, computer-based technology into a portion of its production process. In launching this modernization, it began with one of the nonunion plants, and it did so for a very clear reason: the workforce in this plant was simply more flexible; it was more willing to make the kinds of adjustments in job classifications and work rules that the new technologies would require in order to be used effectively.12 In this instance, at least, corporate management appeared particularly sensitive to the interests and concerns of its workers. It notified them well ahead of time about what was planned. It explained the reasons behind the introduction of the new technology. It involved the workers themselves in planning the introduction of this technology. It pledged that no worker in the plant would lose his or her job as a result of the introduction of the technology. It invested heavily in retraining its workers for the new systems and jobs that the technology would entail. Notably, the company was prepared to take the same approach in its union plant—except that it could not secure from the unions the flexibility it thought necessary. Management, for example, was prepared to retrain for a new job in the plant any worker whose present job was abolished as a result of the new technology. The unions involved, however, insisted that such a worker would have to go to the bottom of the seniority list for the new job, regardless of how long he or she had been working in the plant, or even a member of the same union. As a result of these and similar strictures, management could not justify making the investment in modernizing the union plant— with all the implications this holds for the long-term viability of the plant. The issue is not always union versus nonunion. Individual corporate cultures, the history of labor-management relations within a par-

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ticular company, geographical location, the age mix of a particular workforce—these and other factors also have an important bearing. Nor should the burden of change be placed exclusively on the shoulders of the unions. At a time of exceptionally high rates of unemployment, and perhaps the most fundamental change in the nature of work in many decades, management will have to be particularly sensitive to the legitimate interests and concerns of workers— their uncertainties, their fears, their anxieties. Not to do so will risk reviving the kind of bitterly hostile labor-management relations, and general social and political disruption, that characterized the 1930s. It will also risk retarding what management is seeking to accomplish— the smoothest, most effective possible introduction of productivityenhancing technologies. For the most part, management and labor are still operating according to rules that were developed in the context of an industrial system that is rapidly being made archaic by the new technologies. The rules were born of and perhaps appropriate to that old system. The challenge now is to recognize where they are no longer appropriate—in the context of the new technologies—and to change, modify, update them accordingly.

INTRODUCING NEW TECHNOLOGIES One of the most difficult and important challenges for private-sector managers is to find ways of bringing new technologies into the workplace while eliciting the support, commitment, and cooperation of the employees who must work with these technologies. The difficulty stems in part from the traditional American management attitude toward employees. Historically, the core premise of this attitude has been that employees are and should be treated as one of several key "factors of production," little different than land, capital, plant, and equipment. When there is more work to be done, more employees can justifiably be hired. When sales and profits sag, and less production is required, the requisite number of employees can justifiably be released. Far less than in Japan have American managers felt an obligation to maintain employees' jobs beyond purely economic, and largely near-term, justification. Far less than in the European countries have American managers been forced to assume such an obligation by government-imposed laws and regulations. This attitude on the part of management has a mirror-image in the attitudes of employees. Typically, American employees feel little hesi-

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tancy about switching jobs and companies when a better offer comes along. The difficulty posed by this traditional American attitude has been compounded by the economic turmoil of recent years, and by the promise held out by the new technologies. The basic conclusion reached by many if not most American executives in recent years can be sketched as follows: Over the past decade, American companies have not been as competitive as they could have been. To a large extent, the problem lies with high labor costs. Through the 1970s, American companies simply employed too many people at wage and benefit rates that proved uncompetitive in a world economy. The new technologies provide such companies with an opportunity to change that. The foremost task for American managers is to lower labor costs and enhance productivity by installing these technologies as rapidly as possible. The danger of following this line of reasoning alone is that it can lead to self-defeating policies and strategies on the human-resources front. As we have indicated, the new technologies tend to enhance the role and importance of those employees who remain on the job. Their responsibilities, their span of control, the amount of discretion they have over the quantity and the quality of their work, their ability to have an impact on the overall production process, their opportunity to contribute to greater innovation and enhanced competitiveness— all tend to be increased by the new technologies. Whatever the longterm visions of the "human-less factory," the fact remains that for as long as it makes sense to plan into the future, millions of people will be needed to work productively with the new technologies. Far more than under the current industrial system, the premium will be on an enhanced—not diminished—importance for the education, skills, and commitment of employees. The transition to the new technologies also has the potential to be enormously disruptive—for individual workers and their families, for communities, for particular companies and business and industrial sectors, for the American economy, society, and political system in general. Many people are likely to be called on to make wrenching changes in their lives—to learn new skills, to find new jobs and occupations, to uproot their families and transplant them elsewhere. To date, as we shall discuss below, there is little antitechnology sentiment per se among the American population or workforce. To date, there are relatively few restrictions on how the private sector

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goes about introducing the new technologies. The extent to which this continues to be true, however, will be determined in major part by the success with which the private sector handles this task. It is expecting too much to believe that the private sector's current broad scope for action will not be narrowed in the event that the new technologies are associated with widespread human suffering leading to significant social disruption. All of this points toward what we consider to be among the most important issues having to do with the new technologies. Put simply: There are different ways of introducing the new technologies into the workplace. Some ways are likely to be better than others, for both economic and human reasons. The decisions on how technologies are to be introduced rest, at present, largely with private-sector managers. The challenge for these managers is to find ways of melding advanced technologies with a high level of human skills and commitment to the job. At present, the American people are strongly inclined to look upon technology favorably. They see a clear connection between technological advances and an improved quality of life. In a 1978 survey by the Roper Organization, for example, six out of ten people (60%) said that life is better today than 50 years ago because of advanced technology; a mere 16% felt that life is worse. The public's perception of the impact of computers is even more positive. In a 1983 Roper survey, two-thirds of the respondents (66%) said they think computers have "made things better," while only 15% said they think computers have "made things worse." In another Roper survey, conducted in 1979, fewer than one in ten people (9%) identified "too much technology" as a major cause of the country's problems, ranking it last on a list of twelve such possible causes. 13 Americans, moreover, appear to have a fairly clear sense of the contributions of technology to the country. In a 1979 survey by Temple University's Institute for Survey Research, almost nine out of ten Americans (87%) agreed with the statement: "Technological knowhow is largely responsible for our standard of living in the United States." In the same survey, technological know-how was ranked first among eight factors determining "the degree of influence the United States has in the world." In a 1977 survey by Louis Harris and Associates, more than nine out of ten Americans (92%) agreed that scientific research and technological development "are necessary to keep the country prosperous" and nearly seven out of ten (69%) agreed that they "are the main factors in increasing productivity." Americans also tend to be hopeful about the continued positive role of technology. In a 1980 survey conducted by Louis Harris, close

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to six out of ten Americans (58%) felt that the benefits to society resulting from continued technological and scientific innovation will outweigh the related risks to society over the next 20 years; only a quarter (25%) felt the risks will outweigh the benefits. Similarly, threequarters (75%) of those interviewed in a 1978 Gallup survey said they would welcome "more emphasis on technological improvements" in coming years. Reflecting the views of the population in general, workers begin with a basically favorable view of advanced technology. In a 1982 survey of jobholders carried out by the Public Agenda, nearly seven out of ten of the respondents (69%) believed that the introduction of new technology will make jobs "more interesting and challenging," while only about a quarter (26%) thought it will make jobs "more routine, boring and dehumanizing." Among the 45% whose jobs had already been affected in some way by new technology: three-quarters said it has made their work "more interesting" (76%), rather than "more monotonous" (22%); two-thirds said it has made their work "easier" (65%), rather than "more difficult" (36%); over half said it has made their work "more independent" (54%), rather than "more dependent on others" (37%); just over a third said their jobs have become "more of a mental and psychological burden" (35%); one in six said their jobs have become "more lonely" (17%); and one in seven said their jobs have "changed for the worse" (14%). Similar results emerged from a Time/Yankelovich, Skelly, and White survey also conducted in 1982. In this survey, nearly three-quarters of the respondents (73%) said they think computers will likely "do the more boring tasks freeing people to do the creative things" and twothirds (67%) said they think computers will "help produce more so we can live better." A more targeted survey, focusing on the reactions of secretaries to office automation, also reinforced the Public Agenda's findings. Among 2,000 secretaries surveyed in October and November 1982 by C. A. Pesko Associates, under commission from the Business Equipment Division of Minolta Corporation: 91% said that office automation "will allow secretaries to produce a higher volume of work";

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90% said it "will allow secretaries to be more efficient"; 87% said it "has had a positive effect on the secretarial profession"; 86% said it "has increased secretarial productivity"; 73% said it "has made secretarial jobs more fulfilling"; 72% said it "will provide more time for secretaries to spend at more challenging and more responsible activities."14 In sum, there is substantial evidence to indicate that the American people at large, and American jobholders specifically, are inclined to look upon advanced technology positively, and to see the benefits it has to offer. Why, then, is there cause for concern on this front? Why is it an important issue for American private-sector managers? At present, the positive signs, however strong, are clouded by jobholder fears, uncertainties, and anxieties. At the heart of the uncertainty is concern about the impact of the new technologies on the availability, nature, and rewards of people's jobs. The Public Agenda findings, for example, show people about evenly split on their views of how technology affects job creation: about a quarter believe that technology creates more jobs than it eliminates (26%); another quarter believe it eliminates more jobs than it creates (27%); just over a third believe it creates about the same number of jobs it eliminates (37%). Similar doubts have emerged from other surveys. In a 1977 survey by Louis Harris, 44% of the respondents agreed that scientific research and technological development "are the only way we can create enough jobs for people who need them." But almost as many (39%) agreed that scientific research and technological development "eventually lead to the loss of jobs." In a 1980 Roper survey, nearly four of ten Americans (38%) agreed that "computers have made our institutions less sensitive to human problems by replacing people with machines." The same number agreed that "too many people have lost their jobs because they have been replaced by computers." In the 1982 Time/Yankelovich survey, a majority of the respondents (52%) thought that computers will "throw a lot of people out of work." Reflecting the concern about the future availability of jobs, four out of ten of those interviewed in the Public Agenda survey would "make sure that no jobs are lost before introducing new technology." Another 15% would introduce new technology "only if a majority of

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the company's workers agree." Only a third would introduce new technologies "as soon as possible, even if some jobs are lost." Specific segments of the American workforce are even more skeptical and concerned than these overall findings suggest. For example, while 39% of white-collar jobholders would introduce new technology as rapidly as possible "even if some jobs are lost," only 26% of bluecollar workers would do so. On the same issue, college graduates are more than twice as supportive as those with a high school education or less (49% vs. 23%); the same is true for those earning $25,000 a year or more compared to those earning $15,000 or less (45% vs. 20%). What emerges, then, is a portrait of an ambivalent American workforce. Jobholders begin with a favorable disposition toward the new technologies. They perceive a variety of benefits from these technologies. But they are also concerned that the technologies might adversely affect their jobs, incomes, security, and status. As the new technologies spread and affect more jobs, jobholder ambivalence is likely to be clarified, to move on balance in either a more positive or more negative direction. Despite all the press attention devoted recently to the new technologies, the Public Agenda findings show that fully half of all American jobholders have yet to be affected by these technologies. Only 21% have been affected in any major way. The same findings show that people's concern about the new technologies has not yet assumed a prominence comparable to ther concern about other economic issues, such as inflation, unemployment, and high interest rates. In the Public Agenda survey, technology-related issues were ranked near the bottom among fifteen economic problems deemed of serious importance today. In short, the real impacts of the new technologies are still to be felt, firm public attitudes about them still to be formed. The issue is whether, as the new technologies are progressively introduced into the workplace, they confirm the hopes or the fears of American jobholders. For the most part, this will be determined by the ways in which these technologies are introduced. Based on analysis of case histories by the Public Agenda and others, we can identify a number of key principles for stimulating support for the new technologies among employees who will remain on the job in one capacity or another. AVOID SURPRISES.

Jobholders should have as much advance warning as possible about the introduction of the new technologies, and the anticipated impacts of these technologies on jobs, work, and the workplace. Nothing

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stimulates uncertainty like the unknown. This is doubly true with the new technologies. As we have seen, these technologies have yet to affect the vast majority of American jobholders in any substantial way. First-hand familiarity with them is still at a minimum. With all of the recent press, advertising, and other attention, moreover, there is a good deal of mystery that surrounds the new technologies. In an alltoo-human fashion, people are prone to wonder: How do these new machines work? Will I be able to adapt to them? How will they change the way I do my job? How will they alter the way I relate to my fellow workers? Will they wipe out my job? If so, will there be other work for me to do here that I want to do and am capable of doing? In view of the latent, and often active, concerns among jobholders about the new technologies—their uncertainty about what these technologies will mean in terms of the future existence and nature of their own jobs—they need as much time as possible to get accustomed to the idea that they will be working with the new technologies. A sudden appearance, with little advance notice, is likely only to heighten jobholders' fears and concerns. In one case examined by the Public Agenda, the company concerned placed a new robot in the corporate cafeteria. The sole purpose was to permit the company's workers an opportunity to "get to know" the robot—to see it, touch it, play with it, learn about it, watch what it could do, in sum, to demystify it. Time and again in Public Agenda interviews, corporate managers stressed how big a factor "fear of the unknown" is and how important and relatively simply it is to dispel this fear ahead of time. Yet it takes planning and a certain sensitivity to the quite human anxieties of the jobholders who are to be affected. In the Public Agenda's research, this "fear of the unknown" was evident with all kinds of jobholders, up and down the corporate ladder. It was by no means limited to blue-collar workers on the factory floor. It appeared every bit as important among senior executives confronted with the need to adapt to the use of desk-top computers, electronic mail, communications, and work stations, as well as among middle managers and supervisors being asked to discard their paper and pencils for the computer. By the testimony of some executives, in fact, senior and middle managers have proven even slower to adapt than front-line workers. Often, they require as much or more care and feeding if they are to make the transition to the new technologies successfully. No doubt, it will be pointed out that substantial advance notice of the introduction of new technologies runs a certain risk for management. The earlier the workers know what is coming, the more time they have to organize to oppose it, particularly if it entails a major

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impact on their jobs. This has been one of the key issues in the growing national debate over plant closings and is likely to be a major part of the discussion over the new technologies. Much depends on the particulars of the situation—the specific industry and company involved, the company's corporate culture, its history of labormanagement relations, and most important, the quality of trust and communications between management and employees. Advance notice can hardly be expected to alleviate all problems having to do with the introduction of the new technologies if a basically sound relationship between management and labor does not already exist. Still, jobholders are unlikely to accept and adapt smoothly to technologies that alter their jobs substantially without some time to get used to the idea. It is asking too much to expect otherwise. Based on the cases we have examined, as a rule the risk of advance notice seems well worth running. SHARE THE KNOWLEDGE OF THE ECONOMIC AND COMPETITIVE REALITIES OF THE COMPANY WITH EMPLOYEES.

One result of the economic turmoil of the past decade is a growing realization on the part of jobholders of just how dependent their jobs are on the continued competitive vitality of their companies. In everlarger numbers, they have come to appreciate that sales and profits cannot merely be assumed, and that if there are no sales and no profits, there will be no jobs. Clearly, this has been a factor in the willingness of the auto, rubber, food, airline, and other unions to make wage and benefit concessions they would not even have considered a few short years ago. However begrudgingly, however much they would have preferred otherwise, increasing numbers of workers have demonstrated a readiness to accept lower levels of compensation in the interests of preserving their companies, industries, and jobs. In a variety of cases examined by the Public Agenda, management has used the economic circumstances of the country, and of their particular industries, as the basis of a productive dialogue with their employees. Through a variety of means—specially produced film series, plant newsletters, corporate magazines, face-to-face discussions between management and workers—the message has been conveyed: Here is the situation in the country and in our industry. Here is what we have to do to remain competitive. Our success in doing this will determine our future viability as a company, and the future level of work and jobs we will have available. Managers report significant results from these efforts. They have found their employees for the most part quite capable of grasping the economics of their company and industry and appreciative of the

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company's taking the initiative to share the information with them. They have also found their employees well aware of the impact that the decline in competitiveness has had on certain core American industries, and what this has meant in terms of the loss of jobs. Finally, they have found their employees, as a result of their heightened awareness, more determined not to let their own company's business deteriorate in a similar manner, more willing to tailor their demands to the requisites of maintaining competitiveness, more appreciative of the importance of new technologies to heightened productivity. Whether this sensitivity to the demands of competitiveness will persist and perhaps grow among workers remains to be seen. In part, no doubt, it has been a product of the recent deep recession and high rates of unemployment. If the current recovery is durable, profits rise, unemployment declines, and threatened industries are restored to a healthier condition, workers will have a less compelling incentive to keep wage and benefit demands at a level consistent with increases in productivity. More important, however, may be the longer-term attitude and policies of management. However sound and durable the current recovery proves to be, it is not likely to lessen the need for the technological transition that is upon us—and the substantial dislocations that this transition will entail. Openness, trust, believability, and sound communciations with employees will, therefore, continue to be a key to whether jobholders understand and accept the role and importance of the new technologies. INVOLVE EMPLOYEES DIRECTLY IN THE INTRODUCTION OF THE NEW TECHNOLOGIES.

The affected jobholders may not at first be familiar with the capabilities of the new technologies and how they work. But, more often than not, they know their jobs better than anyone else in the company. Once armed with a basic knowledge of the new technologies, they can help management determine how best to use them. As one executive put it in an interview with the Public Agenda, "Who knows the job better than the person who has done it eight hours a day, five days a week, for the past 20 years?" In one case examined by the Public Agenda, a major, diversified manufacturing firm maintains its own development center for new technology. It brings the workers who are to be affected into the center to assist in the applications design of the new technology. In another case, a company purchasing a whole new technological process for a portion of its production sent the workers who were to be affected to Western Europe to work with the manufacturer of the technology. In

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yet another case, when a firm decided to install computer controls on its factory floor, it gave its own production engineering staff the responsibility for determining what was needed, tailoring it as appropriate and developing an in-house maintenance capability. This was an engineering staff that had little previous experience with computers, that essentially had to learn from scratch. From the company's point of view, this approach meant a slower transition. Management admitted that it could have moved faster by simply purchasing existing hardware and software and arranging for the standard maintenance contract from the outside supplier. The advantages of doing it the chosen way, however, more than compensated for the greater time involved. The company's own employees readily adopted the new technology as "theirs." They viewed the design and development task as a new challenge and found that they could meet that challenge. They insured that the technology was appropriate to the production processes of the particular plant. They developed an in-house capability that will save the company money and serve it well over the longer term. These are precisely the advantages that were pointed up time and again by those executives who stressed the importance of jobholder involvement in any major technological innovation. INVEST ADEQUATELY IN EMPLOYEE TRAINING AND RETRAINING.

The new technologies will give heightened importance to jobholder training and retraining. They will demand skills not currently available in adequate supply in our workforce. They will change so rapidly that a continuous updating of jobholder knowledge and skills will be required. In increasing numbers of cases, the time when a jobholder could expect to acquire a set of skills for a specific job or occupation, and have these skills serve the jobholder adequately for an entire work life, is rapidly passing. Likewise, from management's point of view, insuring that the company has an adequate supply of human talent skilled in the latest technological advances is becoming an increasingly important key to maintaining competitiveness. Here the Japanese appear to be well ahead of us. They spend substantially more than most U.S. firms on worker training. Also, where we typically separate the functions of the machine operator from those of equipment maintenance, the Japanese often spend the extra time to train the operator to know thoroughly what goes on inside his machine. They give him the first-level responsibility for its maintenance and for keeping it adjusted to maintain quality standards. The need for periodic retraining is likely to exist throughout the corporate structure, not just at the lower levels. To give but one example: In previous decades, chemical engineers were taught to build

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petrochemical plants using oil and natural gas feedstocks and tremendous temperatures and pressures to crack and reassemble molecules. The chemical plants of tomorrow, however, are more likely to use genetically engineered microorganisms operating at room temperatures and pressures and requiring an almost totally different basic technology. This illustration will have its counterparts throughout a wide range of scientific, technical, and other specialized occupations, requiring regular and frequent updating of knowledge and skills, and often substantial periods of advanced study at universities. The above comments concern the training and retraining that will be required in order for a company to insure for itself a workforce capable of producing competitively with the new technologies. A related issue involves the retraining for continued productive employment of those people whose jobs will vanish forever as a result of the coming of new technologies. Unfortunately, we cannot anticipate occupational changes with much precision. On the issue of skills demand, for example, our current system of projection is simply not very comprehensive, sophisticated, or reliable. As Neal H. Rosenthal, chief of the Occupational Outlook Division of the Bureau of Labor Statistics, has pointed out in discussing the much-talked-about shortage of machinists: "Existing Federal programs do not collect data on current shortages of workers in specific occupations, and information about future occupational shortages is very limited." 15 Or, as the Congressional Office of Technology Assessment has put it: "Historically, attempts to forecast detailed changes in occupational employment have met with limited success." 16 This problem is compounded by the rapidity with which the new technologies are evolving, and the resulting uncertainty about the impact they may have on jobs and jobholders even in the near term. Whatever the limitations on our ability to project with precision, we cannot ignore the problem. For competitive economic reasons, we must provide people with skills that are or will be in short supply. It is also in our interests to head off the social tensions that would be generated by even a large minority of jobholders who are permanently precluded from the workplace because their skills have been made obsolete, without their having had an opportunity to acquire new skills more in demand. A wide range of specific policies are being proposed, discussed, and analyzed for dealing with these structurally displaced workers. One analyst has suggested an Individual Training Account jointly financed by employer and employee. Others have proposed employment vouchers, which low-skilled, wrong-skilled, or unemployed workers could cash in for on-the-job training; the government would

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share the training cost with individual companies. Still others have recommended greater use of the Unemployment Insurance system for training purposes. 17 These and similar ideas are important. They should lead to effective actions. Whatever the specific solutions, they should accommodate the following general propositions: • Increasingly, training and retraining will need to be treated as a permanent feature of economic life, something that will be needed not once or twice but periodically throughout a jobholder's worklife. • The private sector will need to assume an increasingly prominent role in identifying skill needs and developing and conducting training and retraining programs. Private business and industry are in a much better position than government at any level to identify current and upcoming job vacancies, the skills required to fill those vacancies, and the training efforts best designed to supply the needed skills. • The training and retraining of jobholders should be linked as directly as possible to available or soon-to-exist jobs, but also provide workers with the basic skills and flexibility to make continuing job-related adjustments. This dictates some caution in relying on the projections of the availability of jobs, and the skills they will demand, too far into the future. However, almost all jobs also have certain fundamental skill and attitudinal requirements, such as a sensitivity to quality standards, the ability to communicate effectively, and the ability to handle basic mathematical and statistical tasks. • Job training should be clearly distinguished from public-service and public-works employment. Too often in the past, government-financed "training" programs have been used simply to provide people with jobs without giving them the skills required to move into available private-sector employment. This was the history especially of the now-defunct Comprehensive Employment and Training Act (CETA). If there is a case for public-service or public-works employment, it should be made, supported, and financed on its own merits, not confused with training. • Finally, flexibility should be the hallmark of anything we attempt in the area of job training and retraining. As previously pointed out, we simply cannot project with much certainty or accuracy which skills will be in short supply a few years from now. We need to avoid training people for jobs that we think will be there but that may in fact not materialize in the numbers or with the requirements we currently anticipate. We would be far better off

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giving people the basic skills for continuing job adaptation in an age of evolving technology. PROVIDE EMPLOYEES THE INCENTIVE OF SHARING IN THE PRODUCTIVITY BENEFITS RESULTING FROM THE NEW TECHNOLOGIES.

In the Public Agenda survey, fewer than one in four jobholders (23%) said they are working at their full potential. Three-quarters (75%) said they could be significantly more effective than they are now. Yet, only 12% said they believe they would be the primary beneficiaries of harder and more effective work on their own part. As long as this conviction dominates the workforce, it will be difficult at best to motivate jobholders to increase the quantity and quality of their work. If a high level of jobholder skill and commitment is required to make new technology work effectively, workers are going to need to be convinced that their willingness to cooperate will be properly rewarded. One approach is to tie wage and benefit increases more directly to gains in productivity and profits. Traditionally, American unions have strongly resisted such arrangements, in part because they make worker compensation dependent on factors beyond worker control. As new technology alters the nature of jobs and the role of jobholders over the coming years, however, this approach to compensation may become more important and more attractive as a reward mechanism. Management and labor both may need to reexamine their traditional attitudes on this issue. Another approach is to increase employee participation in ownership of the company. According to the National Center for Employee Ownership, more than 6,000 firms now have some form of employeeownership plan, compared to only a few hundred ten years ago. An Iowa University study showed that firms with such plans had better productivity gains than comparable firms without such plans.18 Whatever the precise form, productivity-tied compensation packages for jobholders are likely to be an increasingly prominent feature of the workplace landscape, for front-line workers as well as for middle- and higher-level managers. They are as natural to the technology- and information-based workplace as seniority, equal-payfor-equal-work, and similar rules were to the old industrial system. EXPLORE NEW FORMS OF EMPLOYEE JOB SECURITY.

Time and again in the Public Agenda interviews, corporate executives identified job security as the overriding concern about the new technologies among their employees. People worry that they will be replaced by the machine.

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Historically, guaranteed employment has not been a prominent feature of the contract, formal or informal, between American workers and management. For the most part, management has felt justified in letting workers go when their retention could not be defended on near-term economic grounds. Likewise, workers have not hesitated to move on when a better job offer came along. The concept of "lifetime employment"—which characterizes a certain portion of the Japanese economy—has never played much of a role in the American workplace. With the declining competitiveness of certain core American industries, the rise in unemployment and the additional displacement threat posed by the new technologies, the idea of exploring new forms of job security tailored to the American scene is, however, becoming increasingly attractive. Ford and General Motors, for example, are working jointly with the United Automobile Workers on experimental programs offering guaranteed lifetime employment in at least six different plants. While these programs are too new to suggest any firm conclusions and have not to date been trouble free, they at least reflect a corporate-union willingness to try to tackle cooperatively the deepseated job-security fears of workers. The printing plant studied by the Public Agenda can serve as one model for handling the job-security issue when introducing the new technologies. When jobholders were first informed of the decision to bring new technologies into the plant, management made it unmistakably clear that no employees would lose their jobs as a result of this move. Here is how the management notice read, in part: The introduction of new technology . . . is an important factor in maintaining our competitive position in the marketplace. Equally as important is our reputation as an employer who provides a high level of job security. After all, [our] employees are one of [our] most valuable assets. Therefore, as new technology is introduced into an area, [our] policy will be to provide training to every employee whose job is made obsolete due to technology. In other words, no permanent employee will be laid off due to technological change.

These and other cases suggest more can be done to provide greater job security than has been typical in traditional American labormanagement relations. No doubt there are many variations on the general theme that will be necessary to fit individual corporate situations. What is required is a shift in management attitudes toward employees, and perhaps more careful forward planning in the area of human-resource needs. Among jobholders, particularly unionized jobholders, the challenge will be to be willing to adjust, to adopt a more flexible attitude toward job classifications and responsibilities. Equally important is that managers implement a steady course of

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modernization instead of deferring investment in new equipment and processes until a crisis of obsolescence occurs and there is no alternative to massive and permanent lay-offs. Job security for people already employed inevitably will have a negative impact on those who are first-time job seekers. If employers accept the responsibility for permanent employment of their present workforce, the only way new entrants can find employment is through expansion of the economy, retirement of present workers, and the creation of new companies to exploit the new technologies. In part, the reduced flow of new entrants over the next decade will help meet this problem. But aside from demographics, the first and third routes will be directly dependent on the introduction of the new technologies, while the second will be dependent on a more productive economy in which fewer workers can produce the goods and services needed by a growing retired population. A much-debated aspect of the job-security issue is whether, over the long run, the new technologies will result in a substantial decrease in the total number of jobs available in the economy. Some observers argue no, emphasizing that technological advances have, historically, always created more jobs than they have destroyed. They point to the automation scare of the late 1950s and early 1960s, and to the fact that the dire predictions then abroad never materialized, that during the 1970s we added some 20 million new jobs to our economy. Others vigorously dispute this optimistic outlook. They stress that microelectronics is radically different from any technology we have ever before faced, that its all-pervasive applications may well result in substantial net job losses. 19 Our view of this issue is that it is simply too soon to know what the long-term impacts will be. The technology is so new, it is developing so rapidly, that its consequences in terms of total job availability are significantly beyond our ability to predict with any confidence. Using macroanalysis to project the match among jobs, skill requirements, and people is simply inadequate. This complex task must be done at the micro level, with the focus on specific industries and technologies. As one analysis, perhaps the most comprehensive to date, put it: "The reviewer of the literature cannot but be struck by the relatively poor factual base on which the present debates are conducted. The controversy appears clearly to be ideological in nature." 20 Technology, moreover, is by no means the only factor influencing the demand for and the availability of jobs. Economic growth, consumer demand, the size and composition of the labor force, the nature and direction of international competition, basic shifts in the economy—these and other factors all have an important bearing. The longterm prospects, in addition, have less to do with the technologies

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themselves than they do with the policies and approaches we adopt in dealing with these technologies. Additional jobs can be generated, to give but one obvious example, by reducing the standard work week. A steady decline in the length of the average work week was the rule for decades before World War II. There is no reason why the decline cannot be resumed. Work sharing has already been used by some companies in this country, and more broadly in Europe, to reduce layoffs during recessionary periods. With the substantial productivity benefits promised by the new technologies, it could become even more attractive as a means of spreading less work among more people. Nor is there any foreseeable lack of tasks to be accomplished in our society. We have a severe shortage of qualified science and math teachers in our schools. Our universities suffer from a major shortfall in engineering faculty. Both conditions hamstring our ability to remain economically competitive over the long run, given the increasing importance of new technology. Day-care centers and a wide range of health-care programs could be bolstered by more human talent. Much of our environment continues to need rejuvenation and protection. A substantial portion of our roads, bridges, and other public facilities needs rebuilding. The problem is not the absence of important tasks, but rather having the level and distribution of resources necessary to carry them out. If the new technologies prove to be anywhere near as productive as they promise, and if we are successful in tapping their potential, they could well free us up to get on with other useful work.

TOWARD WORKING TOGETHER

To summarize, the new technologies are leading to a radically different world economy. The rapid, smooth, continuous development and application of these technologies will be central to our ability to restore and sustain our competitiveness. The process of managing the new technologies effectively, however, will be neither simple nor easy. Substantial changes will be required in attitudes, habits, and practices—in both the private and the public sectors, on the part of both managers and employees. These changes affect not one but virtually all of our major social and economic institutions and interests. They will require a sustained, joint effort over time. If we are to make best use of the new technologies, we must, in short, learn to: 1. Avoid looking upon the new technologies as a short-cut solution to all of our problems. This means understanding the complexity of what it

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takes to develop and apply them effectively, the investments in skills, resources, and time that are involved. It means not expecting technologies to solve problems that they cannot solve in the near term. 2. Think of people as more, not less, important to the overall production process. This means educating them adequately for the workplace of the future, training and retraining them on a more continuous basis, managing them in ways that stimulate, rather than stifle, their commitment and contribution to the job. 3. Emphasize initiative and innovation, the rapid, continuous development and application of new products, processes, and services. This means creating a more entrepreneurial, less rigid and fractionated workplace environment. It also means learning to consider change—constant and often rapid change—as the norm rather than the exception, maintaining flexibility in virtually everything we do, not locking ourselves into policies and practices that quickly become obsolete and hinder our ability to adjust quickly to technological advances. 4. Find ways to introduce the new technologies so that the legitimate interests and concerns of jobholders are accommodated. This means telling employees what is going to be done and why, and how it is going to affect them. It means involving people in the design, development, and application of the new technologies. It means providing people with the training they will need to work productively with the new technologies. It means finding ways to share the benefits of the new technologies equitably and insuring that people continue to have productive work to do. In part, these are underpinnings of future social and political stability. They are also economic necessities, keys to the smooth, effective, most productive introduction of the new technologies. Finally, we have a pressing need to search out those situations in which we—management, labor, government, and education—can work together, devoting our combined talents and energies to solving the problems of transition in the most equitable and productive ways possible. We are all too familiar with the essentially adversarial spirit that has long dominated relationships among our major social and economic institutions. Suspicion has been particularly marked in relations between business and labor, and, in more recent decades, between business and government. Even where the guiding tone has not been adversarial, as with education, it has been apart and aloof. The emphasis has been on maintaining the separateness, prerogatives, and integrity of one's own particular institutions. To a large extent, such tensions are built into our Constitutional system and the history of our social, political, and economic processes. The notion has been that the best way of assuring the greatest good for the greatest number is to protect the ability of each group to

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compete, first and foremost, for its own interests. This notion is far from all bad. It has served us reasonably well for over 200 years. There is, however, considerable room, within the larger context of our historical and cultural traditions, for working more cooperatively together. The unparalleled economic expansion of the decades immediately following World War II provided us the luxury of overlooking that fact. The depth and seriousness of our current economic problems, the nature of the issues that must be confronted if we are to make the transition to the new technologies successfully, have stripped us of that luxury. The task is not to deny our tradition of competing interests, which would be impossible to do in any event. It is, rather, to smooth it out, to search for practical areas where joint action is not only possible but makes sense. The key to doing so successfully will be a sense of fairness on the part of all those involved. Each affected institution and interest must be convinced that it is shouldering no more than its equitable portion of the burden of change—and sharing fairly in the gains. To pull apart will delay the transition to the new technologies, inevitably making it more disruptive. To pull together will significantly enhance our chances of success. NOTES

1. The nonprofit, nonpartisan Public Agenda Foundation has been examining key issues in the workplace for the past several years. Two reports— "Putting the Work Ethic to Work" and "Work and Human Values: An International Report on Jobs in the 1980s and 1990s"—are available from the Public Agenda, 6 East 39th Street, New York, NY 10016. A third report—"Technology and Human Resources"—will be issued in 1984. While drawing heavily on the Public Agenda's work in this area, the authors are solely responsible for the views, observations, and recommendations presented in this discussion. 2. These examples are drawn from Tom Forester, ed., The Microelectronics Revolution (Cambridge, Mass.: M.I.T. Press, 1981); and from Colin Norman, Microelectronics at Work: Productivity and Jobs is the World Economy, Worldwatch Paper No. 39 (Washington: Worldwatch Institute, October 1980). A lengthy list of comparable examples could be presented from a wide range of sources, including the Public Agenda's research. 3. "America Rushes to High Tech for Growth," Business Week, 28 March 1983, p. 84. 4. Henry M. Levin and Russell W. Rumberger, "The Educational Implications of High Technology," Project Report No. 83-A4, Institute for Research on Educational Finance and Governance, School of Education, Stanford University, Palo Alto, Calif., February 1983. 5. For a more extensive discussion of this issue, see ibid.

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6. See "Struggling Industries in Nation's Heartland Speed Up Automation," The Wall Street Journal, 4 April 1983, p. 1. 7. Bro Uttal, "What's Detaining the Office of the Future?" Fortune, 3 May 1982, p. 196. 8. See Daniel Yankelovich and John Immerwahr, "Putting the Work Ethic to Work," The Public Agenda Foundation (New York, 1983). 9. Results are based on personal interviews with a national sample of 846 people, 18 years of age or older, who worked for pay 20 hours a week or more. Results are weighted to reflect the actual composition of the labor force. 10. Throughout this discussion, all references to Public Agenda case studies indicate studies conducted as a part of the Public Agenda's project "Technology and Human Resources." 11. See Henry M. Levin and Russell W. Rumberger, "High-Tech Requires Few Brains," Washington Post, 30 January 1983, p. C5. 12. The details of this case are drawn from a series of Public Agenda interviews with the management officials involved. 13. All survey results presented here, except those from the Public Agenda and from C. A. Pesko Associates, were made available by The Roper Center, University of Connecticut, Storrs, Conn. 14. "The Evolving Role of the Secretary in the Information Age" (Minolta Corporation Business Equipment Division, Ramsey, N.J., 1982). 15. Neal H. Rosenthal, "Machinist Shortage: A Look at the Data," Occupational Outlook Quarterly (Bureau of Labor Statistics, U.S. Department of Labor, Fall 1982). 16. "Automation and the Workplace, Selected Labor, Education, and Training Issues: A Technical Memorandum" (Office of Technology Assessment, U.S. Congress, Washington, March 1983). 17. See Pat Choate, "Retooling the American Work Force: Toward a National Training Strategy" (Northeast-Midwest Institute, Washington, July 1982); Robert Reich, "Industrial Policy," The New Republic, 31 March 1982, p. 39; "Employment and Training Strategies in a Changing Economy" (summary of remarks by Kenneth McLennan, vice-president and director of Industrial Studies, Committee for Economic Development, American Enterprise Institute Public Policy Forum on Conditions of Growth, December 6 - 9 , 1982). 18. Reported in The Wall Street Journal, 26 July 1983, p. 1. 19. For varying discussions of this issue, see "The Consequences for Employment," chapter 6 in The Microelectronics Revolution, ed. Forester; Norman, Microelectronics at Work; "Robotics and the Economy" (a staff study prepared by Richard K. Vedder for the Subcommittee on Monetary and Fiscal Policy, Joint Economic Committee, U.S. Congress, March 26, 1982); Richard W. Riche, "Impact of Technological Change" (OECD's Second Special Session on Information Technology, Productivity, Working Conditions and Employment, U.S. Department of Labor, October 1981). 20. "The Impacts of Computer/Communications on Employment in Canada: An Overview of Current OECD Debates" (Institute for Research on Public Policy, Halifax South, N.S., November 1979).

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10. THE WORK ETHIC AND ECONOMIC VITALITY Daniel Yankelovich

John Immerwahr

Thoughtful observers of America's economic situation generally recognize that the nation's human resources are a key element in economic recovery. Most analysts agree, for example, that in the coming decades, both the newer high technology and knowledge intensive industries and the more conventional "smokestack" industries will require a tremendous upgrading of the skills of the American workforce. A failure to do this could have as severe an impact on recovery as would failures in technology, capital formation, or any of the other "harder" factors of production. There is even agreement that less tangible "soft" factors of production such as creativity, loyalty, entrepreneurship, high standards of quality, and a strong work ethic are related to economic vitality. Indeed, one can argue that a central reason why Japan has succeeded so well, and put the United States at such a comparative disadvantage, is Japan's ability to mobilize a workforce that is highly motivated and intensely committed to quality workmanship. Yet for all of the agreement that soft factors are central to economic recovery, most economists—and managers—have concentrated their efforts on other aspects of the problem because intangibles are extremely difficult to quantify and measure. And even when they can be measured, it is difficult to see what can be done to change them. For example, if it turned out (as some fear) that work-ethic values are in short supply among American jobholders, what could policymakers do to reinvigorate them? Since there is no shortage of other pressing problems, it seems to make sense to direct one's energies to dearly measurable areas that are more amenable to action. In this paper we focus directly on these seemingly "mushy" problems for economic recovery, and we attempt to develop three major points.

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1. The centrality of work-ethic values. We maintain that in recent years changes in the workplace have made healthy work-ethic norms critically important to the nation's economic vitality. Specifically, we argue that individual jobholders have gained greater control or discretion over the amount and quality of effort they invest in their work. At the same time, the increase in discretion has ben accompanied by problems that lead many jobholders, by their own admission, to withhold effort and give less to their jobs than they could give—and indeed, less than they are, in principle, willing to give. The combination of increased discretion and decreased effort pinpoints work-ethic norms as a key concern in any comprehensive program for economic recovery. 2. Practical action is possible. We suggest that problems of decreased worker effort and an apparently faulty work ethic are actionable. This conclusion grows out of a series of survey findings that show that work-ethic norms are surprisingly strong in the United States; indeed, they may even be growing stronger. The problems of poor work performance lie rather with faulty incentives and rewards. Changing the incentive system, however, is easier to accomplish than reversing broad cultural trends. 3. Recommendations. We offer specific actions that the country, and particularly business managers, can take to reinforce work-ethic norms in ways that address the problem of decreased effort. We have not attempted to detail solutions for particular companies or industries. Instead we offer some general guidelines as a framework for discussion and debate. Most of the solutions we discuss are not easy to implement; motivating people is never a simple subject. We therefore review some of the obstacles associated with their implementation. Our analysis and recommendations are based on research done as part of Jobs in the 1980s and 1990s, a three-year international project conducted in the United States by the Public Agenda, with parallel projects in Britain, Israel, Japan, Germany, and Sweden. The culmination of the research in the United States was two attitude surveys, a regional study involving personal interviews with 500 working Americans in the Puget Sound area (summer 1981), and a nationwide study involving longer personal interviews with a cross section of 845 working Americans (summer 1982). In this article we discuss only a portion of the data; full reports on both the national and international projects are available from the Public Agenda Foundation.1 MORE DISCRETION, LESS EFFORT Economists use the concept of discretionary income to describe the income that remains after a person's fixed and necessary expenses and

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taxes have been paid. Discretionary income is significant because it is the portion of income over which the individual exercises greatest control. Our study of the workplace points to an equally important variable, which we call discretionary effort. By this we mean the difference between the maximum amount of effort and care an individual could bring to his or her job and the minimum amount of effort required to avoid being fired or penalized. The concept of discretionary effort focuses our attention on that portion of a person's effort that is controlled by the jobholder, rather than by the employer or the nature of the work itself. Like discretionary income, discretionary effort varies widely from job to job and from person to person. Compared to tenured college professors, for example, who have loosely defined tasks and little supervision, workers in fast-food restaurants have comparatively little discretion over how much or how little effort they devote to their work. The concept of discretionary effort also focuses our attention on intangibles such as the quality of education, creativity, loyalty, and commitment to the work ethic. In high-discretion jobs, the presence or absence of these factors makes a great deal of difference to the effectiveness of an individual jobholder. In jobs where the range of discretionary effort is comparatively low, factors such as creativity or a strong work ethic have little effect on a worker's productiveness. TOWARD A HIGH DISCRETION WORKPLACE

Through most of this century the main thrust of American industry was to minimize the amount of discretion among frontline workers. Management theory and practice, characterized by the principles of "scientific management," sought to increase productivity by reducing work to a series of simple, routinized tasks, and by centralizing managerial control of output and performance. The goal was to make productivity independent of individual creativity and motivation—to maintain, as much as possible, a "low-discretion" workplace. A number of developments over the last 10 to 20 years indicate that this is no longer possible. Although not fully understood by many managers and labor leaders, the American workplace has changed—indeed has been transformed—and principles of management that worked well in the past are now stymied by new realities. New jobs, new technologies, new workers have all contributed to a new high-discretion workplace. New jobs. The past several decades has seen a tremendous change in the kind of jobs held by most working Americans. One of the most significant changes has been a move away from blue-collar to whitecollar jobs. In 1920, only one out of four (25%) jobholders held white-

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collar jobs, and almost twice this number (48%) held blue-collar jobs. Over the next 60 years, the proportion of white-collar jobs rose steadily—to 43% in 1960 to over 53% in 1981. The proportion of blue-collar jobs, on the other hand, has declined slowly; by 1981 only 44% of all jobs were blue-collar jobs. Today managers and professionals, for example, outnumber unskilled laborers by about five to one.2 This shift toward white-collar jobs seems to have had a direct impact on the amount of discretion in the workplace. The Public Agenda research documents the fact that white-collar jobholders are much more likely to have high discretion jobs. Almost half of all white-collar jobholders (49%) say that they have a great deal of freedom about how to do their job, in contrast to only a third of bluecollar workers (33%) who report a corresponding amount of freedom in their work. Since the percentage of white-collar workers has increased, we can assume that the total amount of discretion has also increased. Exactly the same argument can be made about another major shift in the workplace, the movement from jobs in industry to jobs in the service sector. In 1950 goods-producing jobs made up 41% of the workplace while service jobs accounted for 59% of all jobs. By 1981 the number of goods producing jobs had dropped to 28%, and service sector jobs had risen to 72%. Some service sector jobs have little discretion, and in some areas service sector jobs have become so "Taylorized" that the discretion once available to service workers has been reduced. But our research shows that service sector jobs generally have more discretion than goods-producing jobs. The Public Agenda found that 44% of service sector jobs have high levels of discretion, as opposed to 36% of jobs in the goods-producing sector. Thus the growth in service sector jobs also indicates that there is more discretion in the workplace. These measures do not exhaust the growth of discretion. New technologies and new values have increased discretion even for bluecollar and manufacturing workers. New technologies. Most observers agree that we are now at the beginning of a second industrial revolution that is in many ways more far-reaching than the first. One of the most impressive differences is the way the new technology increases the amount of discretion in the workplace. The steam engine and the assembly line made it possible for complex products to be built by an uneducated and unskilled immigrant labor force. By simplifying and dividing tasks, the technology of the first industrial revolution made the individual worker less important. The new technology has the opposite effect. The jobs created in a high-technology, knowledge-intensive economy are geared

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to skilled and educated employees. Rather than making jobs more trivial, monotonous, and uncreative, the new technology usually gives jobholders more discretion over their own output. The computer and the robots can do the real drudgery and leave people to do the thinking and the work that requires skill and discretion. Some of the critics of the new technology have argued that it reduces discretion, but our data present a different picture. Close to half of American jobholders (44%) say that they have experienced significant technological changes on their jobs in the last five years. Just under three quarters of this group (74%) say that the changes have made their work more interesting, and more than half (55%) say that technological changes have given them greater independence. New technology thus has the effect of making industry much more dependent on the activities of individual jobholders. As Andrew Knight, editor of The Economist puts it, "the more one thinks technology, the more one has to think of people." New workers with new values. There has also been a change in the composition and values of the workforce. Education levels, for example, have risen sharply. Between 1959 and 1977, the percentage of high school graduates in the workforce rose from 32% to 42%, and the percentage of college graduates nearly doubled, jumping from 10% to 18%. There have also been dramatic changes in the family responsibilities of jobholders. Instead of having a workforce made up largely of male heads of households, it is now predominately composed of workers who are single or single parents or come from dual wage-earner families. In 1960, for example, only 12% of mothers with children under six also held paying jobs; today that percentage has quadrupled to 48%. These changes have contributed to changes in attitudes. In the past, many workers were willing to sacrifice a great deal of their autonomy in the workplace in exchange for a good income and an increasing standard of living for themselves and their family. This was particularly true for male heads of households; although their jobs may not have been especially rewarding or have given them a sense of autonomy, they were compensated by the status and respect that came to them as family breadwinners. Today the terms of this "unwritten contract" have been modified in a variety of ways: • The ethic of male self-sacrifice has deteriorated. In 1968, for example, 86% of the population equated the role of being a good provider and sacrificing for the family with that of being a "real man." By 1978 this figure had dropped to 67%. Why should having a paid job automatically entitle a man to respect and special

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treatment if his wife also holds a paid job and is working just as hard?3 • The degree to which jobholders are willing to surrender their autonomy in the workplace has also eroded. According to an estimate by the Work in America Institute, "ten years ago, 70% of industrial workers were willing to accept managerial authority with minor reservations. Today the reverse finding has emerged: younger, more educated workers resent 'authoritarianism.' "* • Many people have come to question whether the U.S. economy can still provide the material payoff that was the reward for hard work and sacrifice of autonomy. In 1968, 58% of the public agreed with the statement "hard work always pays off." This figure dropped to 44% by 1978, and our research shows that only 36% endorse this view today. The result of all of these changes is a redefinition of what it means to have a job. People are no longer willing to surrender their autonomy on the job in exchange for material rewards and for status outside of the workplace. Even in today's more difficult economic times, a job has come to mean more than just a source of income. This change has increased the amount of discretion that people want to exercise. At the same time it has diminished management's ability to exert unchallenged authority over jobholders—further increasing the amount of discretion in the workplace. The high-discretion workplace. Discretion cannot be readily quantified, nor do we have an easy way to track changes in discretion over time. But the factors we have just cited all point both to an increase in the number of high-discretion jobs, and to changes in the incentive system that have the effect of putting decisions about effort into the hands of jobholders rather than managers. Our hypothesis is that the American workplace has, in regard to discretion, come almost full circle. In the beginning of the nineteenth century, most workers held high-discretion jobs as farmers and craftsmen. In 1800, for example, approximately 80% of all American workers were self-employed. Then during the nineteenth and early twentieth centuries, the workplace moved toward more low-discretion jobs. Now we now find ourselves returning to a situation where control over the pace and quality of work is in the hands of the individual. Recent Public Agenda studies support this hypothesis by documenting the considerable amount of discretion that now exists in the workplace as experienced by jobholders themselves. The research shows that only a fraction of the workforce now describe themselves as holding low-discretion jobs. Specifically, only 21% of our nationwide sur-

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vey say that they have little freedom to decide how to do their own work, only 19% say that they exercise little control over how much effort they put into their work, and a mere 10% say that they exercise very little discretion of the quality of the work that they do. The vast majority of the workforce feel that control over how they do their jobs, over the amount of effort they put into their jobs, and over the quality of their work rest largely in their hands rather than in the hands of their employers and managers (table 10.1). The Public Agenda research also allows us to draw a portrait of today's high discretion jobs. If we take "freedom to decide how to do my work" as the most general measure of discretion, and then look at the job characteristics of those who say that they have a great deal of freedom (43% of the workforce) we see that these jobholders are more likely to be better educated, to hold white-collar or service jobs, and to have experienced technological changes. The low-discretion group (21% who have little or no freedom) are more likely to be union members, to hold blue-collar jobs, and to hold jobs characterized by dirt, noise, and pollution (table 10.2). DETERIORATING WORK EFFORT

The growth of discretionary effort in the workplace has focused attention on the role of human resources in the overall vitality of the nation's economy. To the extent that managers can no longer stimulate effort through the existing reward system and through traditional methods of supervision, they must rely on the internal motivations of jobholders to guarantee high levels of effort and good quality work. Our overall economic situation demands that the workforce use this increased range of discretion to devote more effort, quality, and commitment to their work. We cannot hope to avoid unemployment and a decline in our standard of living unless we can compete effec-

TABLE 10.1 Discretion on the Job A great deal

Some

Little or none

63 45 43

25 34 33

10 19 21

(%)

Discretion over quality Discretion over effort Freedom to decide how to do my work

(%)

(%)

NOTE: All tables are from the Public Agenda's 1982 survey of 845 working Americans.

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TABLE 10.2 Types of Jobs Held by High- and Low-Discretion Jobholders

White-collar Some college education Experienced technological changes on the job Manufacturing sector Blue-collar Union member Workplace with dirt, noise, and pollution

HighDiscretion Jobholders (43%)

LowDiscretion Jobholders (21%)

(%)

(%)

61 53 49

39 39 39

17 39 14 28

29 61 31 57

tively in the world economy. Effective competition requires that we match in at least some way the utilization of human resources exemplified by Japan and some of our other competitors. Unfortunately, there are signs that the level of effort and motivation have not kept pace with the increase in discretionary effort. The evidence suggests that many American jobholders are giving less than their maximum effort. There are indications that rather than increasing efforts to respond to the new competitive realities, work behaviors are deteriorating. We begin with the testimony of workers themselves. The Public Agenda research found that most people say they are giving considerably less to their jobs than they believe they could give and are, in principle, willing to give. Fewer than one out of four (22%) say that they are performing to their full capacities and are being as effective as they are capable of being. Nearly half of the workforce (44%) say that they do not put a great deal of effort into their jobs over and above what is required. A majority feel that under the right conditions they could significantly increase their performance. Objective studies of the workplace support these assessments. Analysts of work behavior have reported that considerable work time is spent on nonproductive activities. D. J. Cherrington, for example, clocked actual work behaviors over a two-year period, and found that only half of the workers' time (51%) was related to the job—the other half (49%) went for coffee breaks, late starts and early quits, personal activities, waiting, and otherwise idle time. 5

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What is even more significant than the amount of nonproductive time are the indications that effectiveness seems to have been decreasing. The Public Agenda found that a strong majority of jobholders (62%) believe that people are just not working as hard as they used to. The fact that respondents in surveys say that work effectiveness has decreased does not in itself prove that work behavior has actually changed. But it is difficult to discount such widespread impressions, particularly when they are shared by leaders in the business world as well. A study conducted jointly by Louis Harris and Amitai Etzioni in 1980 found that business leaders (62%) and even labor union leaders (62%) also believe that people are not working as hard as they did ten years ago. 6 One direct and concrete sign of the decline in work behavior comes from a study conducted by the University of Michigan's Institute for Social Research. Researchers measured work behavior by asking a sample of workers to keep a detailed diary of their activities on the job. These diaries were used'to compare the nominal number of hours on the job with the amount of time people actually spent working (as opposed to time spent in breaks and other nonproductive activities). Not surprisingly, the number of actual hours worked fell considerably below the nominal worktime. But a more revealing finding is that between 1965 and 1975 the gap between the actual time worked and the "official" work hours increased by more than 10%. The researchers noted a parallel drop in the rate of productivity increase. Productivity growth rates rose by 3% from 1955 to 1965, but then slowed to an annual average rate of 1.9% between 1965 and 1975. The researchers suggest that if their findings were extrapolated to all American workers, this 10% decrease in the amount of work time alone—quite apart from such factors as insufficient investments or aging equipment—could account for almost all of the slowed tempo of productivity growth in the decade from 1965 to 1975.7 Taken together, these findings suggest that there is a core of truth in the popular impression that people are not working as hard as they used to and that this factor may have contributed to the slowdown in competitive vitality that the U.S. has experienced in the past decades. In short, the country now appears to have a workplace where more workers have more control over their jobs and exercise this control by working less. If this is true, there is a tremendous potential for improved effectiveness in the American workplace.

IS THIS PROBLEM ACTIONABLE? The commonly accepted explanation for declining work effort is a weakening of the norms that govern work. The Harris/Etzioni study

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found, for example, that more than seven out of ten Americans (73%) believe that motivation on the job is not as strong today as it was ten years ago. A leadership study done for Motorola by Yankelovich, Skelly, and White in 1981 found that leaders also share this view. Almost all of the leaders (87%) felt that a failure in work motivations is a key reason for the diminished competitiveness of the United States in facing the Japanese challenge. If this analysis were correct, little could be done in the short run to improve work behavior. The type of cultural norms that govern work change very slowly, and there is little that either government or industry leaders can do in the short run to quicken the pace or influence those changes. A failure in the work ethic, however, is not the only conceivable cause of deteriorating work behavior. In order to grasp this point, we need to make a crucial distinction between cultural norms and institutional practices that either reinforce or weaken them. Complex behavior patterns, such as holding back effort on the job, grow out of an intricate relationship between cultural values and objective factors that influence them. When a problem with behavior arises, there is a tendency to place the blame on a deterioration of the norms. But it is also possible that the fault lies with the institutions that either fail to support the norms or actually punish them. Our findings, and those of other organizations, suggest that this is precisely the situation in the workplace. The evidence shows that work ethic norms are in surprisingly good health in America and may even be growing stronger. It also indicates that a major cause behind the decline in worker effort is that managerial practices do not take advantage of the work ethic and indeed they sometimes thwart it. If our analysis is correct, then, we have cause for believing that economic vitality and productiveness can be improved. It is far easier to change institutional practices so that they better support existing norms than it is to make changes in the norms themselves.

THE SURPRISINGLY HEALTHY WORK ETHIC

A number of surveys offer considerable evidence that as a cultural norm the work ethic has wide currency in contemporary America. A 1980 Gallup study, conducted for the U.S. Chamber of Commerce, found that an overwhelming 88% of all working Americans feel that it is personally important to them to "work hard and to do their best on the job." The study identifies "a widespread commitment among U.S. workers to improve productivity," suggests that "there are large reservoirs of potential upon which management can draw to improve performance and increase productivity," and explicitly concludes that

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a faulty work ethic is not responsible for the decline in our productivity.8 Recent Public Agenda studies provide more detailed support through an examination of what might be called the "unwritten work contract"—the assumptions that each individual makes about what he or she will give to the job and expects to get in return. Respondents in our survey were presented with four alternative work "contracts." The first two reflected the historically familiar view that work is "Adam's curse"—an unappealing but unavoidable burden. One of these contracts represented work as an unpleasant necessity, and the other characterized a job as an essentially economic transaction in which a person exchanges work for pay. The second two contracts presented work as intrinsically appealing and attractive. One offered a narrow version of this view by describing work as interesting and desirable in its own right but limited in the claims it should make on a person's energies and commitments. The last presented a strong version of the work ethic, describing work as an activity with an intrinsic moral value of its own. The study found a significant number of jobholders—about one out of four and a higher proportion of those in blue-collar jobs—who subscribe to one of the two non-work ethic conceptions. Nine percent said that they regard their work essentially as "a business transaction, the more I get paid, the more I do." An additional 17% have adopted the view that work is a necessary but disagreeable chore, subscribing to the view that "work is one of life's unpleasant necessities; I would not work if I did not have to." A bumper sticker on one worker's car put this sentiment more succinctly: "Work sucks, but I need the bucks." But the overwhelming majority of the U.S. workforce (73%) rejected these two historically important conceptions of work. The study found that a majority (52%) align themselves with the strong form of the work ethic: "I have an inner need to do the very best job I can, regardless of pay." Twenty-one percent adopted a more limited commitment to their jobs, acknowledging a positive value in their work but still wanting to make their greatest personal investment to their nonwork lives: "I find my work interesting, but I wouldn't let it interfere with the rest of my life." Both Public Agenda research and other studies show that people want to be involved in their work and want to help their employers be more effective. The Gallup/Chamber of Commerce study found, for example, that 60% of workers say that they would like to be "more involved in efforts to get people to do their best on the job." 9 The Public Agenda found that three out of four jobholders (76%) believe that they could be helpful in improving the quality and efficiency of their work.

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Large percentages of the workforce also want to be pushed to work more effectively. When the Public Agenda respondents were asked to describe the qualities that they look for in a boss, nearly two-thirds (62%) said that they prefer a boss who is very demanding in the name of high quality workmanship. Only 36% said that they prefer a boss who "doesn't put as much pressure on you, but who doesn't demand as much." Thus although there may be problems with work behavior, large numbers of Americans have strong work values. They believe in work and in doing a good job, and they do not mind being pushed in the interest of high quality. SOURCES OF THE WORK ETHIC

The wide currency of the work ethic in the United States is by no means an accident. Our research shows that it is closely correlated with a number of other factors. As always with correlations, the direction of causality is unclear. What is clear is that many of the factors related to the work ethic have become more prevalent in the last several decades and give every indication of becoming even more widespread in the years to come. This in turn suggests that the work ethic may also be increasing. Upgraded jobs. There is a clear connection between the work ethic and the upgrading of jobs from low- to high-discretion work. If most jobs remained low discretion, low-autonomy jobs where one "pair of hands" could readily be replaced by any other, we would hardly expect to find many people saying—as 52% of our respondents did— that they work because of the intrinsic attractiveness of their jobs, regardless of pay. The natural home of the modern work ethic is an environment of high-discretion jobs, where work conveys a sense of purpose, challenge, and accomplishment. The connection between the nature of the job and adherence to the work ethic is particularly clear if we compare people with lowdiscretion jobs to those who have more freedom about how to do their work. While the work ethic is widespread among all America jobholders, it is more common among those who have high-discretion jobs (table 10.3). Education. Education is another factor that is closely related both to high discretion on the job and to adherence to the work ethic. Generally speaking, better educated jobholders are more inclined to feel that work has an intrinsic moral value. In this context, it is interesting to contrast jobholders who are college graduates with those who have a high school degree or less. The college graduate jobholders are much more likely to subscribe to the strong form of the work ethic (table 10.4). Over the last several decades both education levels and

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TABLE 10.3 Discretion and the Work Ethic

Strong work ethic Limited commitment No inherent value to working

High-Discretion

Low-Discretion

(%)

(%)

57 20 22

44 18 31

the amount of job discretion have been increasing. Their close correlation with a commitment to a strong form of the work ethic helps to explain the wide currency of the work ethic and also suggests that it may be growing stronger rather than weaker. The new values: expressivism. Another source of reinforcement for the work ethic is a broad cultural shift toward the values of personal growth and self-development. A large number of studies have documented a significant value shift in all of the advanced industrial democracies during the last three decades.10 After two world wars and a worldwide depression, all of these countries enjoyed more than a generation of prosperity and peace in the era after World War II. To a large extent, the people who grew up in this period take for granted the security and affluence that their parents worked for so strenuously and instead place great emphasis on what we call the values of "expressivism." Although these values grew out of the affluence of the fifties and sixties, they have proven to be durable in the economic slowdown of recent years. Observers have given a variety of names to the new values—for example, "reproductive" (Zetterberg), "post materialist" (Inglehart), and "inner directed" (Mitchell)—but whatever they are called, there is overwhelming evidence that they have

TABLE 10.4 Education and the Work Ethic

Strong work ethic Limited commitment No inherent value to working

College Degree or More

High School Degree or Less

(%)

(%)

63 19 17

47 21 31

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come to play a major role in all of the highly developed industrial countries.11 In The World at Work, the international report for Jobs in the 1980s and 1990s, we discuss the values of expressivism in detail. They are, in general, familiar to all students of the baby-boom generation. One of their most important components is a focus on a new meaning of success. Rather than defining success in terms of externals—large homes in good neighborhoods, expensive cars and clothing—those who hold expressive values see success in terms of inner intangibles. They value personal self-expression and fulfilling one's potential as an individual. They place a great emphasis on autonomy and freedom of choice, reacting uneasily to most forms of rigid hierarchy and to exclusion from decisions that affect their lives. It is frequently said that the new values have undercut the traditional values of hard work. Many people believe that the new values lead to a form of narcissism and self-absorption that is inconsistent with productive work. Two-thirds (64%) of the leaders surveyed in the 1981 Motorola/Yankelovich, Skelly, and White survey said that the "focus on self" among American workers was a major obstacle preventing the United States from effectively responding to the Japanese economic challenge. As we will see, the values of expressivism do bring new demands to the workplace. But expressivism is not incompatible with hard and effective work. In the Public Agenda survey we isolated a small group of jobholders (17% of the workforce) who hold a strong version of expressivism. For these jobholders the primary motivation for working is to develop oneself as a person, rather than to survive or to improve one's standard of living. Significantly, the jobholders who adopt this strong form of expressivism almost universally endorse the work ethic. More than seven out of ten of those who work for selfdevelopment (72%) endorse the strong form of the work ethic, as compared to 52% of the total population. There seems to be a relationship, then, among four analytically distinct factors: the work ethic, the upgrading of jobs, the educational level of the workforce, and the focus on expressive values. All of these factors are mutually supporting. As jobs become more challenging and more autonomous, and as people become better educated and focus more on personal growth, they are also likely to see work as having a positive and central place in their lives. They are also much more likely to bring greater demands to their jobs. As we will see in the next section, the degree to which these demands are met will have a great deal to do with whether the work ethic is harnessed and channeled into more productive work. Taken together, these findings paint a picture of a very healthy set

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of social norms relating to work. The popular conception of a deteriorating work ethic is badly off target. There is, as we have seen, a problem with work behavior. But the problem is not, as we have argued, with deteriorating work ethic norms. We now turn to an examination of the causes of the problem and to the steps that can be taken to harness the power of the work ethic as part of a program to revive the nation's competitive vitality. TAPPING THE ECONOMY'S HUMAN RESOURCES If many Americans have an inner need to give their best to their jobs, and if increasingly they have a great deal of control over their levels of effort on the job, what is preventing them from giving more to their work? Why do they hold back? And what steps can be taken to encourage them to give more. Our findings suggest that the problem, in its simplest terms, arises from the fact that managerial skill and training have not kept pace with the changes that have affected the workplace. The trend toward greater discretion on the job is outrunning present managerial practices. Our hypothesis is that incentive and managerial systems are out of synch with changing values and attitudes. As a result, the actions of managers blunt rather than stimulate and reinforce the work ethic. In a low-discretion workplace, such actions may not have been particularly harmful, but in a high-discretion workplace, they can be fatal to effort and quality. Our primary focus here is on steps that can be taken by managers to correct these mistaken practices. We do not mean to imply that managers are the only ones who can take steps to reinforce the work ethic. The ultimate decision to give or withhold effort must be made by jobholders themselves, and a variety of leaders in government, education, and labor also need to reinforce work ethic values. But managers are in a particularly favorable position—they hold the "action levers" that have a significant effect on how much commitment people will invest in their jobs, or to put it another way, how much discretionary effort people will invest in their work. In this section we outline four main directions for change. The first two—reducing disincentives and distinguishing between satisfiers and motivators—grow directly out of our own research and are illustrated with new and, we believe, significant findings from our own study. The second two—enforcing quality standards and reexamining the status and authority system—have been extrapolated from our findings, and we have illustrated them with anecdotal and qualitative material, rather than with projectible survey results. The chart

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below summarizes some of the recommendations in terms of a handful of dos and don'ts. A LIST OF DOS AND DON'TS FOR STIMULATING THE WORK ETHIC DO NOT permit situations to develop where the interests of employees run counter to the well-being of the firm—e.g., by introducing new technology in a way that threatens employees' job security or overtime. DO NOT attempt to improve standards of quality unless you are prepared to accept its full costs—e.g., discarding substandard products, paying more for better components, or transferring or dismissing people who cannot do quality work. DO NOT permit a significant gap to develop between management rhetoric and the actual reward system—nothing feeds employee cynicism as much as management blindness or insincerity about what forms of behavior really "pay off." DO NOT pretend that programs designed to increase productivity are really intended to enhance job satisfaction and the dignity of work. DO NOT support special privileges for managers that enhance the status of managers by widening the gap between them and those who do the work—e.g., giving bonuses to managers at the same time that employees are being laid off. DO tie remuneration directly to performance that enhances the efficiency and effectiveness of the enterprise. DO give public and tangible recognition to people who keep standards of quality and effort that exceed average satisfactory job performance. DO accept wholeheartedly the principle that employees should share directly and significantly in overall productivity gains (however defined). DO encourage jobholders to participate with management in defining recognizable goals and standards against which individual performance can be judged. DO give special attention to the difficulties that middle managers face in supporting and enforcing programs to restructure the workplace. 1. Reduce disincentives. The most serious problem for many existing managerial and incentive systems is that they undercut and destroy

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the work ethic. One startling finding of the survey is the degree to which the American workplace has weakened the link between a jobholder's pay and his or her performance. The Public Agenda found that almost half of the workforce (45%) believe that there is no relationship between how good a job they do and how much they are paid. Another 28% say that there is some relationship between their pay and their performance. But only 22% see a really close link between compensation and performance in their jobs. In addition, most Americans do not think they themselves will be the primary beneficiaries if they work harder and more effectively. Only 13% believe this. Most people believe rather that the benefits will go primarily to their employers (48%) or at best will be shared equally by themselves and their employers (29%). Our cultural beliefs support the idea that individuals will succeed through their own effort and hard work. Weakening the link between pay and performance sends jobholders a message about how their employers and managers feel about the work ethic. When people receive equal rewards regardless of effort or achievement, the implicit message from management is: "We don't care about extra effort, why should you?" Jobholders also see little connection between their pay and any increased productivity of their companies. In the Gallup/Chamber of Commerce study only 9% of jobholders thought that the workforce would be the primary beneficiaries of improvements in productivity. Most assumed that the beneficiaries would be others—consumers, stockholders, management, or society in general. By contrast, a 1982 study of Japanese workers, done by the Asian Social Problems Institute, found that 93% of Japanese workers believe that they will benefit from improvements in their employers profitability. Many people in the workforce are deeply concerned about the lack of connection between their efforts and their pay. The Public Agenda found that more than six out of ten working Americans (61%) said that they want their present job to give greater emphasis on tying pay to performance. The problematic nature of the weak link between rewards and effort also becomes clear when people are asked to explain why work effort has declined. Close to three-quarters of the workforce (73%) concur that work effort has declined because "quite often everyone gets the same raise no matter how hard they work." Fifty-eight percent of those who want a closer link between pay and performance on their own job also say that it would make them work harder. This concern about a lack of connection between performance and reward is not restricted purely to monetary rewards. More than seven

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out of ten working Americans (70%) say that they want more recognition for good work on their present job. (Only more pay received as high a rating.) And 58% of these said that they would work harder on their present jobs if they did receive more recognition for their efforts. These findings together show that most Americans receive a message from their jobs that runs counter to their own work ethic norms. People want to work hard and are inclined to do a good job, but they see that the workplace does not reward or recognize people who put in extra effort. Under these conditions, people who live up to their work ethic norms feel like fools. Why should they work hard if they receive no more reward than those who put in less effort? The lesson for managers is clear: Managers who want to reinforce work ethic norms need to find some way to reward and recognize effective effort. 2. Focus on improving productiveness rather than enhancing job satisfaction. There have been frequent attempts to restructure incentive systems to provide greater support for the work ethic. These attempts have often failed to distinguish between satisfaction with a job and effectiveness in doing it. Intuitively, it seems plausible that a satisfied jobholder will be an effective worker, a view that has led some managers to attempt to improve motivation by improving job satisfaction. But research conducted for the National Science Foundation by Katzell and Yankelovich (1975) has shown that this approach tells only part of the story: increased satisfaction by no means always means increased effectiveness.12 The Public Agenda findings have confirmed and elaborated this finding. Some incentives do enhance both motivation and satisfaction. Our recent research suggests that interesting work, for example, is one such factor. But other factors increase job satisfaction without necessarily increasing motivation, as jobholders themselves acknowledge. Most people say that convenient location or good fringe benefits add to the agreeableness of their jobs, but they also say that these factors do not encourage them to work more effectively. Indeed, some improvements that make jobs more satisfying, such as congenial coworkers and a pleasant supervisor, may be attractive precisely because they do not require any effort or commitment from a jobholder. The Public Agenda research also revealed a third category of factors, which increase motivation without necessarily increasing job satisfaction. Most jobholders made a surprisingly sharp and clear distinction between motivating factors—which center on work ethic values such as responsibility, a chance for advancement, and challenge— and other factors that primarily provide satisfaction (table 10.5). Jobholders are concerned with both satisfiers and motivators. When asked to identify the features that would improve their jobs, they

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TABLE 10.5 Productiveness vs. ]ob Satisfaction Factors that enhance productiveness Would work harder for

Makes job more agreeable

Both

48

22

19

45 43 41 40

27 31 34 27

22 16 17 20

38 37

30 33

15 17

36 36 35

28 35 31

14 18 20

(%)

Good chance for advancement Good pay Pay tied to performance Recognition for good work Job enables me to develop abilities Challenging job Job allows me to think for myself A great deal of responsibility Interesting work Job requires creativity

Top satisfiers

(%)

Makes job more agreeable

Would work harder for

Both

61

15

13

56 56

12 12

12 12

54 52

17 19

13 12

49

21

16

49 49 45 45

20 18 27 24

12 15 18 18

(%)

A job without too much rush and stress Convenient location Workplace free from dirt, noise, and pollution Working with people I like Get along well with supervisor Being informed about what goes on Flexible work pace Flexible working hours Good fringe benefits Fair treatment in workload

(%)

(%)

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(%)

mention factors that enhance productiveness such as "recognition for good work" (70%) and "a good chance for advancement" (65%) as frequently as they mention satisfiers such as "good fringe benefits" (68%) or "job security" (65%). Table 10.6 shows the qualities that most people want more of on their present jobs. The asterisk indicates whether the feature is primarily a motivator, that is, related to productiveness, or if it is primarily related to job satisfaction. The distinction between motivators and satisfiers helps to explain the somewhat ambivalent feelings that American jobholders have about their managers. Many people like and respect their managers. Nearly seven out of ten (69%) say, for example, that their managers care more about getting the job done than they do about bossing people around. Six out of ten (61%) say that morale in their place of work is good or even excellent. American managers also get good marks in comparison with the view of their managers that workers in other countries hold. The international research found that German jobholders, for example, are two or three times more likely than Americans to complain about mistreatment from their managers. Germans were much more likely to say that their managers criticize them in front of other workers, give them unreasonable workloads, or are inconsiderate to employees who have an emergency. But the positive feelings that Americans have about their jobs and managers change dramatically when the focus shifts from satisfaction to productiveness. Three-quarters of the workforce (75%) believe that the inability of managers to motivate the workforce is a key reason why people are working less than they could. TABLE 10.6 Desirable Job Characteristics Want more of on present job

Motivator

Satisfier

77 70 68 65 65 62 61 61

45* 41* 27 48* 29 36 43* 34

27 34 50* 22 43* 35 31 36

(%)

Good pay Recognition for good work Good fringe benefits Chance for advancement Job security Interesting work Pay tied to performance Job allows me to learn new things

(%)

(%)

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A focus on job satisfaction, in other words, does not necessarily enhance work ethic values; indeed, it may even undermine these values. Again, the lesson is clear: If managers want to capitalize on the considerable human potential that already exists in the workforce, they must focus on motivators as well as satisfiers and not confuse the one with the other. 3. Enforce high standards of quality. Nothing corrodes the work ethic more than the perception that employers and managers are indifferent to quality. Conversely, a strict, even harsh, emphasis on the highest standards of quality reinforces the conviction that work has an intrinsic worth and meaning. Many observers of the workplace have noted that a manager's expectations have a tremendous impact on workplace performance. Studies show that the highest performance is achieved by jobholders whose supervisors expect—and insist upon— high performance.13 One theme that emerges from a recent study by Thomas Peters and Robert Waterman of very successful companies in America, In Search of Excellence, is that these leading companies place an incredible emphasis on service and quality. Caterpillar Tractor is one example of this "quality obsession." Caterpillar offers customers forty-eight-hour guaranteed parts delivery service anywhere in the world; if it can't fulfill that promise the customer gets the part free. That's how sure Cat is, in the first place, that its machines work. Once again, we are looking at a degree of overachievement that in narrow economic terms would be viewed as a mild form of lunacy; lunacy, that is, until you look at Caterpillar's financial results. 14

Setting high standards of quality requires that a firm be ready to make sacrifices to prove that it really does want quality. Managers who have been successful in using higher quality standards to produce greater commitment report that jobholders initially tend to be cynical and suspicious of such efforts. Many employees also reject the added pressure until they are convinced that the company, too, is willing to assume the extra hardships that higher quality can demand. The chief executive of a high-technology company put it this way: We initiated a quality program in one of our plants but at first no one seemed to take it seriously. At one point, however, we scrapped a whole production run of products because they weren't at an acceptable level. We might have let them pass a few months ago, but they didn't measure up to the new standards. It was only at that point that the employees started to take the quality program seriously; they had to see that we really meant it, and that we were willing to pay for it.

The strategy of using improved standards as a means of reinforcing the work ethic may involve restructuring jobs. Traditionally, en-

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forcing standards of quality has been the prerogative of quality control inspectors. But when the issue is work commitment as well as quality control, a more appropriate approach is to place greater responsibility for quality on workers themselves. This approach may involve farreaching redesigns of work practices and procedures. In this connection, it is useful to contrast the practice of some comparable American and Japanese industries. Many American manufacturers of products such as automobiles and color television sets use an acceptable quality level (AQL) goal. This means that they allow for a certain number of defects in the units produced. Quality control is maintained by testing the products after they are produced and reworking defective units. In one American color television plant, as many as 50% of all sets had to be removed from the production line for reworking.15 By contrast, some Japanese companies set a "zero-defect" goal which tries to eliminate defects before they occur. An average Japanese television factory requires that fewer than 1% of the units be reworked because of defects, and Japanese televisions have a much lower repair record than most of their U.S. competitors. To a certain extent, the "zero-defect" approach involves special technology. Japanese television manufacturers have high quality specifications for the components and extensive preproduction testing. The assembly process is also more completely automated—allowing less possibility for human error. Nonetheless, the "zero-defect" system essentially involves a different approach than our own to the soft factors of production. Japanese televisions are produced on an assembly line that can be controlled by individual workers, and each worker has a greater responsibility for removing defective sets from the line. The "zero-defect" system necessarily presupposes a workforce that is highly conscientious and chiefly concerned with quality. If workers are indifferent to quality, the system cannot work, and a company is better off using the traditional U.S. postproduction inspection system. But establishing a "zero-defect" system sends a message to the employees that management is prepared to trust their discretion and is willing to spend money to insure a better-quality product. The result is a mutually reinforcing system where the production system both encourages and presupposes the work ethic. An "acceptable quality level" system, on the other hand, downgrades the work ethic and contributes to its erosion. In sum, the decision to upgrade quality should not be made without accepting in advance the likelihood of costly trade-offs and sacrifices. But at the same time, it should be recognized that a rigorous insistence on high standards of quality is an important way to harness the immense potential of the work ethic.

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4. Reexamine the status and authority systems. The most radical and difficult set of recommendations deals with status, authority, fairness, and prerogatives in the workplace. The traditional organization of the American workplace embodies a centralized control system, with clearly specified job descriptions and lines of authority. Such organization often distinguishes sharply between those who manage and those who do the work, a distinction reinforced by equally sharp status differences, large pay differentials between managers and hourly workers, less constraining rules of conduct for managers, separate dining facilities, and other prerogatives that uniformly reflect the fact that managers possess power and control. Such differences also reflect the assumption that individual jobholders are less central to the success of the enterprise than are managers. Companies with this perspective see no contradiction in giving management a bonus while workers are laid off or are asked to agree to "givebacks." The question is: Can this sort of traditional organization call forth the feelings of loyalty and identification with the goals of the enterprise that are necessary in the new context of the American workplace? We think not. In a high-discretion workplace, symbols of status and privilege that are not distributed in accordance with performance are seen as "unfair" and are likely to undercut the work ethic and high levels of performance. Military officers recognize that one way to win the commitment necessary to insure extremely high levels of effort and risk in situations that demand virtually total discretion is for leaders to share the hardships of their troops. The standard advice to young officers goes something like this: "If you never eat, drink, or rest before all of your men do, they will follow you into the gates of Hell." To put it aphoristically, soldiers respond to leadership, not management. Although the military example is extreme, it underscores a point of central importance, namely, that commitment is compatible with authority. But it is not compatible with authority that takes advantages of its privileges at the expense of its followers. High commitment requires a sense of shared responsibilities, goals, and burdens, and this means that those lower in the hierarchy must be able to see themselves and their superiors as sharing a common fate. Once the workers in the trenches are convinced that those in authority are "only interested in themselves, they don't care what happens to me," the basis for high commitment is undermined. When people feel, "We're in this together," working cooperatively and with mutual respect toward a common goal, the basis for commitment is reconfirmed; this is true regardless of whether the form of organization is democratic, paternalistic, or hierarchical.

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Managers who wish to reinforce the work ethic and encourage high commitment in a high discretion workplace must reexamine the traditional assumption that authority and status require a monopoly on power, prerogative, and privilege. The literature abounds with examples of managers who have avoided the temptation to monopolize privilege—to the benefit of their organizations. One business executive interviewed for the project illustrated this understanding with a concrete example: We sent in a new manager to try to institute a new approach to management and productivity. When he got there, he noticed that there were a few reserved parking places right near the entrance and that everyone else had to park a bit further away in the main lot. The best parking space was already reserved for him as the general manager. He also noticed that the mail-delivery boy had to use his car many times during the day to drive back and forth to other buildings. The new manager gave the prime parking spot to the mail-boy, and the manager parked his own car out in the main lot with everyone else. It was a little thing, but it had a tremendous impact in convincing everyone that this guy cared more about getting the job done than he did about preserving his own status.

One way to enhance the work ethic, in other words, is to be more mindful of the negative impact of the exercise of prerogative and the inherent danger in building bureaucracies with many levels of supervision and status. Such forms or organization work against the process of giving individuals as much control and responsibility for their own work as possible and do not encourage a sense of shared goals. Many organizations that have been successful at winning high levels of commitment are characterized by relatively flat organizational charts and by status differences that are not invidious: they do not shout the message, "Managers are a class apart." Potential problem areas. As any manager knows, it is much easier to describe the steps that might be taken to harness the economy's human resources than it is to put them into effect in a particular company. The plan of action for an individual firm will depend on many factors—its products and services, its size, the type and level of its technology, its competitive situation, its methods of production, and above all, the "culture" of the organization. Many intangibles will count—the attitude of the union if there is one, the outlook of the chief executive, and the degree of trust between employer and employees. In a recent study, Working Together, John Simmons and William Mares describe a large number of workplace experiments, some of which have been spectacularly successful in producing gains in productivity and quality.16 But experience also shows that even the most

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successful experiments meet tremendous resistance, and many last no more than four or five years. Our own interviews suggest that one of the most important problems is the resistance of middle managers. This is especially critical when issues of status and authority are at stake. Although decisions to change management styles usually come from the top, the burden of carrying out these changes falls upon middle managers. Typically, they are asked to give up some of their own power and status in order to help with higher commitment from their subordinates. Sidney Harman, president of Harman International Industries, has been a pioneer in workplace innovation. He puts the difficulty this way: One of the most critical factors in any attempt to restructure the workplace is the role of the middle manager or floor supervisor. Typically such a person has risen from the ranks after 15 or 20 years of playing a subordinate role. To ask the newly liberated middle manager to yield that conventional power without addressing the consequences is a guarantee of failure. Unless provision is made for expansion of the responsibilities of the middle manager, he or she will surely find ways to subvert the program—indeed, the middle manager is positioned ideally to do just that.

The concerns of middle managers extend farther than a loss of the symbols of power and status. A flatter organizational chart means fewer supervisors and managers. Many middle managers feel that "participative" management styles may mean that they will participate themselves right out of their jobs. Actual practice has often confirmed these fears. A great deal of laudatory attention has been given, for example, to the Motorola factory in Franklin Park, Illinois. The company was purchased by Matsushita in 1974 and was radically redesigned and restructured. The Quasar television set has since gone from one of the worst to one of the best in reliability among Americanproduced color televisions. But what is less often noted is that Quasar cut 25% of its white-collar employees, including one whole layer of first-line managers. 17 Given the reality of this and other forms of resistance, we cannot stress enough the need for proceeding slowly and cautiously in restructuring the workplace. Almost all of our national experience with changing basic institutions shows that there are tremendous dangers in tampering with such systems. Even the most thoughtful changes have unintended consequences that may outweigh the gains to be achieved. Worse still are half-hearted solutions that are implemented without a clear understanding of their full implications. Our interviews show that ill-conceived and partial attempts to increase motivation can se-

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riously backfire and can be far worse than no change at all. The remarks of one respondent, a chemist, are typical of a theme that ran through many interviews: About ten years ago we had to redo our sample compositing room. It was all going to be modernized. They asked the eight or nine chemists who worked there to come up with a plan. "You're down there all the time," they said, "give us your thoughts." Everyone said, "this is our chance to design a workplace that really makes sense." We had many meetings in people's homes. Everyone agreed that a sloped floor to the drain should be built so that you could hose down all the raw materials quickly and efficiently. Some of our people were very good at drafting, so we made blueprints of exactly what we wanted and sent it all to management. You can guess what happened. They spent $45,000 to remodel that room and they put in a straight floor. My enthusiasm for my company has been beat out of me. So now my enthusiasm is for me. I do a professional job, I can cover my bases. But as far as the fate of my company, as long as there is a signature on my paycheck every week, I couldn't care less. The American workplace is entering a new e r a — a n era in which the discretion of its workers can mean the difference between success and failure in restoring America's economic vitality. Despite claims to the contrary, the American work ethic is still a vigorous and impelling force in shaping the attitudes and potential performance of jobholders. Today's managers need to understand that the techniques developed to run a low-discretion workplace no longer call forth the commitment of high-discretion workers. Indeed those strategies undercut the work ethic values held by many jobholders. New strategies are necessary. They will not be easy to carry out, but they are an important part of any program of economic recovery. NOTES 1. A more detailed account of these findings is available in Putting the Work Ethic to Work by Daniel Yankelovich and John Immerwahr (New York: Public Agenda Foundation, 1983). The findings of the international project will be reported in The World at Work, by Daniel Yankelovich et al., with a preface by Cyrus Vance (New York: Octagon Press, 1984). We are deeply indebted to Harvey Lauer, of the Public Agenda Foundation, who played a major role in designing and analyzing the survey on which much of this study is based. We are also indebted to Harris Deinstrey and Lisa Belsky for their assistance in editing this report. The major survey on which these findings are based was conducted in August and September 1982 among a national cross-sample of 845 working Americans, 18 years of age or more, who worked for pay at least 20 hours a week. The results are weighted according to sex and occupation (blue-collar/ white-collar).

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2. Sar Levitan and Clifford Johnson, Second Thoughts on Work (W. E. Upjohn Institute, 1982), p. 93. 3. Yankelovich, Skelly, and White study for American Council of Life Insurance, 1981. See also Daniel Yankelovich, New Rules (New York: Random House, 1981), where the theme of changing values is developed in considerably more depth. 4. Jerome Roshow and Robert Zager, Productivity Through Work Innovations (New York: Pergamon Press, 1982), p. 23. 5. D. J. Cherrington, The Work Ethic (Amacom, 1980), p. 110. 6. Louis Harris Associates, Amitai Etzioni, Perspectives on Productivity: A Global View (Sentry Insurance Company, 1981). 7. Frank Stafford and Greg J. Duncan, "The Use of Time and Technology by Households in the United States" (Institute for Social Research, Working Paper, June 1979). Similar conclusions have been reached through a different methodology by Samuel Bowles, David M. Gordon, and Thomas Weisskopf in Beyond the Wasteland (New York: Anchor, Doubleday, 1983), chap. 6.

8. Ronald Clarke and James Morris, Worker Attitudes Toward Productivity, U.S. Chamber of Commerce, 1980, p. 26. 9. Ibid. 10. Ronald Inglehart, The Silent Revolution (Princeton: Princeton University Press, 1977). 11. Yankelovich et al., The World at Work. 12. Raymond Katzell et al., Work, Productivity, and Job Satisfaction (New York: Harcourt Brace, 1975). 13. Cherrington, Work Ethic, p. 155. 14. Thomas J. Peters and Robert H. Waterman, Jr., In Search of Excellence (New York: Harper and Row, 1982), p. 171. 15. Ira Magaziner and Robert Reich, Minding America's Business (New York: Harcourt Brace Jovanovich, 1982), p. 179. 16. John Simons and William Mares, Working Together (New York: Knopf, 1983), Appendix I. 17. Ibid., p. 222.

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DISCUSSANTS Phyllis A. Wallace During the past two years my colleagues at the Sloan School of Management at M.I.T. have been engaged in research on the "new industrial relations." The focus of this research has been largely on work practices at the plant level, such as problem-solving by small groups of employees, technology and work organization, and strategic planning for management of human resources by firms. My comments on the two papers prepared for the panel on managing motivation and technology reflect these perspectives at the level of the enterprise. Lindsay, Rubin, and Cohen, in their paper "The Need for New Private and Public Policies," should draw a sharper distinction between the micro-effects where there probably will be some severe displacements and the overall macro-effects where there will be growth in some industries. Their prescription of a heavy emphasis on retraining is well taken, but how will the private sector meet the enormous expenditures that retraining may require? Will training facilities be on-site classrooms or will some training be better done in off-site locations? The authors do not focus enough on what happens at the enterprise level. At a specific enterprise level the sweep of technology may be quite dramatic, and questions will be raised about how easy it will be to retrain people who are going through computerization, robotics, or other forms of advanced technology. The principle that employers have to provide job security and assurance undergirded by positive personnel programs as they retrain is an important starting point, but it does not carry us all of the way through the transition. There will be some very tough transitions. Because of these transition difficulties, many employers may opt for the green-field route and not try to retrain or readapt the existing workforce. These employers will set up new plants, attract some of the younger workers who are available, and get off to a flying start. This is what is happening in high technology industries, and meanwhile there are large numbers of permanently displaced auto and

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steel workers. It will be costly and difficult to retrain a 45-year-old automobile worker and provide those skills required for high technology jobs. The distinction between people being willing to have technology come, but being very worried about the consequences of it on their job security has been documented in a recent study on productivity by the Committee for Economic Development.1 Resistance to change represents the biggest drag on productivity. Thus, the attitudes on the introduction of technology are quite fragile and could swing from favorable acceptance of technology to the extreme opposite, depending on the business cycle. High unemployment and a lot of microdisplacement (enterprise by enterprise) may impede the transition. Lindsay et al. sense this and emphasize the importance of positive personnel policies. Good communication is essential in acquainting workers with the nature of the new technology and reasons for the introduction of the new technology. The authors also discuss the need for giving workers a stake of some sort, but they do not spell out what they have in mind. Are they looking for an enterprise-by-enterprise profit-sharing or gain-sharing? Later they talk about the need for joint action but do not indicate what they mean—tripartite industry committees or limited labormanagement committees? In Europe there is considerable interest in formal joint technology committees, but they may not wish to go that far. There is some evidence that these formal joint technology committees slow things down as much as they may facilitate the transition. The Yankelovich-Immerwahr paper introduces the notion of discretionary involvement, but other social scientists should be aware that there is an economic literature on on-the-job supply withdrawal while you still work. Sumner Slichter, the Harvard economist, wrote in the 1920s that workers "were able to withhold output on a substantial scale and the efforts of management to exact more output merely stimulated more concerted efforts—to withhold it." 2 The industrial relations literature on effort bargaining, effort being interpreted in the broad sense of commitment to your job, has emerged over the past half century. Certainly, people want more challenge in their work, but too often efforts to improve the quality of work life (QWL) involve merely adding comfort and convenience but not challenge to a job. That is where all of the experimentation is taking place with teams, different supervisory styles, and new patterns of responsibilities for workers. Another perspective on challenge comes from the automobile industry where lifetime job guarantees in the collective bargaining contracts

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have encountered strong resistance from some workers. These workers, many on indefinite layoff, want to participate in the employers' job guarantee experiments but not on the terms specified by management. 3 Yankelovich and Immerwahr provide good numbers for many of the trends that management has been aware of for some time and has been working to solve. The cutting edge is not identifying the fact that we have a new breed of worker. The real story is how to change a culture, how to get a workforce that is engaged, how to get supervision to change. It is supervision at the middle level that is hardest to change. The organization today can be viewed as an alliance between top management which has a vision of where things have to go and knows all of the competitive pressures, and the typical employee who is better educated and who wants to participate. There is almost a common cause between top management and the bottom of the organization. The people who are threatened and most on the spot are those in the middle. "All the other changes in industrial relations on the production floor now being tried out equally diminish the authority and reduce the control of the supervisor and transfer power to the worker: flexible benefits, employee share-ownership, productivity bonuses, profit-sharing and so on. All are based on the proposition that the worker takes responsibility, has control, tells rather than being told."4 More details on the methodology might be provided by the Yankelovich-Immerwahr paper. Otherwise, the work-ethic research may be seen as not reliable, particularly since sweeping generalizations are made. Several surveys need to be conducted over a brief time span to validate the findings of what appears to be a limited survey for this report. The Survey Research Center at the University of Michigan conducted three surveys on quality of employment over an eight-year period. 5 One is able to comment on trends as well as transitory activities from this longitudinal data base. To substantiate that a transformation is under way to a high discretion workplace for white-collar workers, one must differentiate between the low and high echelons of the occupational hiearchy. More discretion is demanded by MBAs, recent graduates of the elite management schools, but little discretion is given to the armies of young women who operate the CRTs in the automated offices of large companies. The finding that almost 45 percent of the workforce believes that there is no relationship between performance and pay and that 61 percent said they want their present job to give greater emphasis on tying pay to performance is so striking that one raises questions about the timing and the scope of the Yankelovich-Immerwahr surveys. If

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the surveys were undertaken when Americans were experiencing double-digit inflation and voluntary wage guidelines, such an environment external to the workplace might somewhat bias answers on the linkage of pay and performance. The 1977 Quality of Employment Survey, with a national probability sample of over 1,500 employed persons, showed only 39 percent of respondents reporting that they earned less than they deserved compared to others doing similar work. 6 Many large companies conduct annual surveys of their employees in order to identify issues of major concern to workers. The results of these surveys frequently indicate what must be done in order to keep companies union-free. It is difficult to tell whether these large nonunion companies are well represented in the Yankelovich, Skelly, White survey. Recently, labor market economists have examined explicit and implicit employment contracts and have concluded that approximately 80 percent of the nonagricultural and nonconstruction workforce of the U.S. appears to be employed where last-in-first-out termination policies are linked to compensation policies under which employees with less-than-average company services are paid below the value of their current contribution and those with greater-than-average service are paid above it. 7 A final cautionary note on pay and performance. The combination of technological changes and the demographics of the first half of the 1980s will reduce opportunities for advancement and good pay. The large baby-boom class, a well-educated and ambitious cohort, may be consigned to the ranks of middle management or worse as they compete for the jobs of senior management. The bulge in middle management will require a major effort to motivate these managers. Is the restructuring of the incentive systems to provide greater support for the work ethic required? Not necessarily. Following the Yankelovich-Immerwahr list of " D o s and Don'ts for Stimulating the Work Ethic" is a good beginning.

NOTES

1. Robert B. McKersie and Janice A. Klein, "Productivity: The Industrial Relations Connection," in Stimulation of U.S. Productivity Growth (Committee for Economic Development, forthcoming). 2. John Dunlop, ed., Potentials of the American Economy: Selected Essays of Sumner H. Slichter (Cambridge: Harvard University Press, 1961), p. 168. 3. "Lifetime Job Guarantees in Auto Contracts Arouse Second Thoughts Among Workers," The Wall Street Journal, 18 April 1983, p. 29. 4. Peter Drucker, "Twilight of the First Line Supervisor," The Wall Street journal, 7 June 1983, p. 30.

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5. 1969, Survey of Working Conditions; 1973, Quality of Employment Survey, and 1977, Quality of Employment Survey (University of Michigan, Survey Research Center). 6. Graham L. Staines and Robert P. Quinn, "American Workers Evaluate the Quality of Their Jobs," Monthly Labor Review, January 1979, p. 6. 7. James L. Medoff and Katharine G. Abraham, Involuntary Terminations Under Explicit and Implicit Employment Contracts (Sloan School Working Paper #1190-81, January 1981), p. 30.

Thomas J. Murrin During the last four years, we at Westinghouse Electric have been concentrating on quality and productivity improvement. We have been doing this in the hope of enhancing our international competitiveness and our profit performance. In the course of these efforts, we have sponsored trips to Japan by about five hundred of our management and professional people and about fifty of our union presidents and vice-presidents. We did not really anticipate that sort of "exodus" when we started. It results, frankly, from the discovery that in Japan most of the sophisticated companies—at least in my judgment—are doing better in what it takes to be outstandingly successful in quality and productivity than most American companies, unfortunately, including our own. I have been visiting Japan for about twenty years; several times in many of those years. For the first seventeen of those years, I went as a "teacher"; for only the last three years, as a "student"—and this makes an extraordinary difference. If you go there to teach something, the Japanese will listen very respectfully and treat you as if you were "nine-foot tall." If instead you swallow your pride and ask with some genuine humility what is it they have done with the information they have been getting from us and others and if you really appear sincere about it, you will find it to be an extraordinarily educational experience, I assure you. Unfortunately most of what they are doing they originally got from us. Let me cite a few of the "lessons learned." First, we have learned the critical importance of quality with regard to productivity—and with regard to international competitiveness. If I make no other point, I want to stress the extraordinary importance of quality, that quality contributes to, rather than detracts from, productivity improvement, and that this is something that is now cherished by most, if not all, of our customers. That, to us, was a surprising finding. We always were convinced we were a quality outfit. We would almost "fight to the death"—at

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least take some bruises—over anyone's assertion that we were not. But we had a conventional wisdom that assumed that to really produce high quality goods and services, you had to take more time, use more materials, spend more money—in general, utilize more resources. We had a sort of a "Rolls-Royce vision" of quality. It turns out that this conventional wisdom is unsound. It is perhaps a trite phrase—but also a profound one—that if you do it right the first time, you end up producing a quality product or service using fewer resources. And this is about as good a definition of productivity improvement as there is. We have also learned—somewhat to our embarrassment—that we in management have to change quite fundamentally our attitudes and discard many of our outmoded business practices. We have learned that we have to get more of our people, ideally all of our people, involved in this process if we are going to really succeed. One of the simple but very effective things that we did when we began about three years ago to concentrate in the area of word processing demonstrates the effectiveness of worker involvement. We discovered that within about thirty miles of our headquarters in downtown Pittsburgh, Westinghouse was buying seven different brands of word processor; most of which did not talk electronically to each other—and all of which were claimed by their respective operators to be "the best." Thank goodness we did not launch a sophisticated study as we typically had done earlier—with computer experts and outside consultants—to figure out which brand of word processor was the best. Instead, somebody made the very obvious suggestion that we get the people who operated the word processors together—and ask them to figure out, in whatever way they choose, which word processor is the best. And to assure them at the outset that we are very serious about the analysis, because if they do come to a consensus, their selection will become the standard for the entire corporation. Initially, our biggest problem was that they did not believe we were committing this to their judgment. They thought this was sort of a "ding-dong" project that somebody at headquarters had dreamed up—but we assured them we were serious. They went through the process. Apparently, they had some donnybrooks among themselves—but they came to a unanimous selection. There was tremendous excitement within the group when they celebrated at a party that evening what to us might be a very mundane matter—but to them was an extraordinary accomplishment: having been selected on behalf of the corporation to choose in whatever way they thought appropriate the corporation's standard for word processors! The selected word processors have worked magnificently ever since. I think it has some-

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thing to do with their involvement and their contribution—and the modest, but valued recognition that they got. Where such efforts have been well implemented—and this has been particularly true in one of our large groups in which we have about twenty thousand people—they have increased our annual productivity improvement from about 2 percent a year to 7 percent a year. And what is really exciting is that that organization is quite convinced it can soon get to about 10 percent! What that means is that if we are part of an organization that has a real 7 percent per year productivity improvement rate, in about ten years, we will double our output without any additional investment of resources. And if we get to 10 percent, in about seven years we will double our output without any incremental expenditure of money, time, space, labor, whatever. In our studies in Japan, we have discovered dozens of Japanese companies—many of them competitors—who have for the last ten years averaged a 10 percent per year productivity improvement rate! And have every confidence that that will continue! Fortunately, we think that we know how they do it—and most of the things they do, we think we can do pretty quickly. Some of them we cannot. The Quality and Productivity Improvement Program we have is quite simple. It centers on three kinds of initiatives. The first is people initiatives. For example, we now have in the corporation about two thousand Quality Circles with about twenty thousand of our people involved. And we have many organizational units that hope to get 70 percent or more of their people involved over the next few years. The second initiative is technology. Here we are putting major efforts in the office—and I think the need and the opportunities for this are well discussed in some of the other papers that are part of this volume. As a country, we have neglected office productivity and quality for decades. We now have some extraordinary opportunities with word processors, personal computers, video- and teleconferencing, high-speed facsimile voice switching, and overall, an incredible array of new hardware and software systems that can and should revolutionize the way our white-collar people work. And third, as I have already touched on, quality. Quality is "free"— as Mr. Crosby suggests. Quality does beget productivity and profitability—and perhaps most important, people satisfaction. It should be intertwined with technology and people programs. Finally, what I think we need particularly in our United States is some effective mechanism to bring us closer together into a more effective team. Symposia like this is one mechanism for that. Unfortunately, there seem to be few others. There is no spontaneous phenomena that I know of in our country drawing our dispar-

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ate segments of society together. It is rare that I am privileged to be on a panel such as that brought together by the Wharton/Reliance Symposium where academe, government, business, and labor are all represented. John T. Joyce A recent report by the New York Stock Exchange entitled "People and Productivity: A Challenge to Corporate America" asks the question: How can we improve the productivity of our people? The papers here by Daniel Yankelovich and John Immerwahr and by Franklin Lindsay et al. address this question and make several recommendations. These include more effective education of our workforce, better training of our managers in the human side of the organizations they run, more employee involvement in decision-making, and sharing the financial gains of better company performance. These recommendations are constructive, but, in the first, I would change the word effective to better, and workforce to our society. It is not enough that we educate more mathematicians, scientists, and engineers; we must provide our whole society, not just the workforce, with a good general eduction. I would like also to underscore the point that YankelovichImmerwahr made that we need an effective demand for quality. My organization, the International Union of Bricklayers and Allied Craftsmen, approximately ten years ago established a design award for architects, the Louis Sullivan Award. The first award went to an architect who works out of New York City but whose work appears throughout much of the United States and other countries as well, Oberuck Franzen. We noticed when we compared Franzen's work with that of many of the other architects who have since received the award that, aside from design factors, there is one way in which his buildings stand out. The craftsmanship in his buildings is exceptionally good, whereas the craftsmanship in the other buildings is uneven. Some of it is good and some of it is bad. We were interested in finding out why the craftsmanship in a building by Franzen is superior, and so we spoke to some of the men working on the construction site of the School for Fine Arts in Harlem, New York City. Those we spoke to said that it was the first job that they had worked on that was a design by Franzen and that what made a big difference to them was that either Franzen himself or one of his key people was on the job almost every day and available to answer any questions that came up. Franzen always discussed with them what it was he wanted to achieve and how best to achieve it within the cost constraints. What the craftsmen and the foreman most

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appreciated, however, was that if any work was defective, Franzen would order it knocked down and they would have to rebuild it. This meant to them that they were dealing with someone who cared about the one thing that they could uniquely contribute to the building process, and that is their craftsmanship. That is something that too frequently gets overlooked in discussions about the so-called people problem of our industrial situation. This sense of personal pride and contribution fits with a tradition from another branch of the tile trades we represent, tile setters. For generations they have always guaranteed their work. This is a personal guarantee, not an institutional one. That is, if any of the work that they install is defective, they will go back on their own time and at their own expense and replace it. That brings me to another point. I object to the use of the term human resource because it implies one is thinking about the workers as some kind of commodity, an object of the economic process. Both papers cited above, for example, imply that giving more importance to the worker is solely a means to improve productivity and that if the suggested steps are not followed, the only consequence, however serious, will be our slipping behind in world competition. I certainly agree that that would be unfortunate, but I see much more at stake. I see our industrial relations at stake, because there is an inextricable link between industrial peace and social peace. I take exception also to the Yankelovich-Immerwahr findings that workers today are satisfied with their work and that they feel that they are in control. That is a situation that I do not find among our own people, although the fact that they are craftsmen and not blue-collar workers might be significant. But also, even as I talk to workers in other industries, including the service industries, I do not find a feeling of satisfaction or a feeling that they are in control of all that affects them as workers. My final point is that much of the public discussion about whether workers can contribute to the solution of the production problems suggests that this matter is optional. It should not be. As I see it, the primary mission of organized labor in the years ahead will be to remove the option of considering this kind of question. In other words, it is an imperative that has to be faced. Stan Lundine Human resource development, as expressed by the YankelovichImmerwahr paper and others, is primarily the job of management, not of government. Labor must be willing to respond and the govern-

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ment certainly has a role, but the primary responsibility rests with management. What is the government's role in human resource development? First, the government should encourage cooperation between labor and management through a variety of ways, among them, by directly making government resources available where labor and management want to participate but need some third-party assessment. Second, the government should provide what I call skills development opportunities. Most of the people whose skills need enhancing are already employed. In many instances, the private employer is simply not able to provide the necessary skills development. It is important, too, that skills development be linked to the real jobs of the future. The fundamental error in job training that we have made in the past is not to have a direct link between skills improvement and the job opportunities of the future. Third, much more attention should be paid to general educational advancement in our country. William Brock speaks to that need elsewhere in this volume. It is incredible when you consider the average educational competence of people in our society. Several contributors emphasize the importance of science and math education. It is terribly important that we have postgraduate fellows in science and engineering. In fact, our entire society must become technologically literate if we are to understand the issues that we will be confronted with in the future. The government needs to place more emphasis on encouraging both more study of the basics of education and more study in technical fields. Fourth, the government should support research specifically on the subject of how the link between technology and human factors affects productivity. Very little research, particularly of a participatory nature, is being done in this area. I think it should be done, under both public and private sponsorship. The government has a direct role in this sort of research since the public return on research investments may actually be greater than the private return. It would be very difficult for even a large corporation to undertake heavy investments with large public returns. The entire subject of the imposition of technology on workers and the effect of that imposition on productivity, however, cannot be overlooked. Fifth, the government should set a good example by encouraging worker participation in its own decision-making. When the government introduces new computers and never talks to the people who use them, or institutes any kind of regulation without consulting the people who will be affected by it, the results will almost always be

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inadequate. The government has been content to preach about what management and labor should do to increase productivity and efficiency, without getting its own house in order. We should also pay attention to the Yankelovich-Immerwahr findings. The government should reward employees according to what they actually produce and the quality of their work, not according to the size of the staff and the budget that they can build around themselves. One of the greatest challenges that we have is finding a way to run government right. Finally, as the government and the private sectors begin to interact, whether it be in trade policy or in a national industrial strategy, we should look for ways to insure that we get commitments to quality, to productivity, and to worker involvement in return for government assistance. The Chrysler loan guarantee, which I was directly involved in, is an excellent example, I think, of the sort of quid pro quo arrangement that we should look for. Government participation in the Chrysler case was contingent on certain commitments that were agreed to by management and labor. Those commitments are the very cornerstone of the success of the Chrysler deal. The Chrysler deal required real sacrifices from all parties that were involved. In return, we have gotten better management, better labor-management relations, more incentives, and better productivity. The government should not grant trade protection, or other types of government assistance, without asking for something from labor and industry in return. That "something in return," I believe, should be investments in research and development, in productivity, and in the relationship between new technologies and the worker. Although the preceding papers emphasize the need for services and high technology investments, I firmly believe that the U.S. needs a strong manufacturing economy. While it is true that the percentage of workers engaged in manufacturing has decreased in the last few years, this should be seen as a sign of success and increased productivity, not to failure. Just as fewer workers with increased output was a sign of success in agriculture, so is it in manufacturing. I also do not believe in some kind of mythical service society. In fact, Mark Twain, who spent a good deal of his life in my district, in Elmira, New York, once said that we cannot get along just by everyone's doing everyone else's wash. I do not think we can get along just by performing services for one another either. It is essential that we have a strong internationally competitive manufacturing economy, and we will have it only if we pay attention to the relationship between technology and people.

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Although our companies are beginning to realize the importance of this relationship, government is not. Corning Glass, the largest company in my district, is involved in fiberoptics. This new technology will potentially provide tremendous employment opportunities in the next few years. Even in the steel industry, increased productivity and efficiency is dependent on the use of new technologies and on the relationship between those technologies and the workers. I am not advocating government intrusion into the market. Nor do I believe, however, that the government should reward industries that make long-term investments in productivity. Before being elected to Congress, I was mayor of Jamestown, New York, a small manufacturing town with enormous economic problems in the early 1970s. In Jamestown, we formed a labor-management-government partnership which resulted in the complete turnaround of that economy. It reduced unemployment and increased job opportunities and the quality of working life for the people in the industries there. We turned Jamestown around by using in-plant labor-management cooperation councils and quality of worklife teams, and we did it with an overall strategy of where we were trying to go. We brought Cummins Engine into the community by proving that labor-management cooperation on investment, on the introduction of new technologies, and on methods of productin make sense. It resulted in higher productivity, better jobs, and more rewards to be bargained over. We now have, at the Cummins plant, a very highly automated manufacturing process where robots and work teams build new and better engines. It is the most productive plant in the company's entire industrial experience, both in the U.S. and abroad, and at least part of their success stems from labor-management cooperation and from having a strategy based on commitments. Government did not cause Cummins Engine to be a success. A very progressive company and some progressive workers have made it happen. It is important to realize, though, that without a government strategy to encourage cooperation and productive investment, much of the Cummins and Jamestown successes may not have been possible. Government should look for ways to answer the basic questions of how we can encourage cooperation, how we can collaborate to achieve our collective goals, and what useful role the government can play in encouraging the adaptation of new technologies to methods of production and in examining the implications of its adaptation for the worker and society.

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SUMMARY REPORT F. Gerard Adams

The "people" problem—how to direct and motivate people in the age of new technology—is a central issue of current efforts to improve American productivity and economic flexibility. The human element is the most intangible, the most difficult. Paradoxically, the shift of the economy away from mass production and blue-collar employment increases the discretionary character of work behavior and complicates the "people" problem. New technology not only threatens workers with replacement by machines, but often also gives them greater freedom to determine how they spend their time, effectively or ineffectively. Rising living standards and a changing social order also threaten to undermine traditional work standards. The question of how to achieve high productivity and, particularly, high quality is most important today in a world where mobility of capital and technology enable many countries to compete in the manufacturing of advanced products. Consequently, management of motivation, the appropriate ways of organizing the workplace and providing incentives, has a critical element in assuring the continued growth and competitiveness of American industry. Surveys show that the work ethic is not dead. But a "commitment gap" between potential and actual performance appears to be widespread. Many people believe that workers are not working as hard as they used to, that their effectiveness has declined, and that workers are spending fewer productive hours on the job. Workers as well as management are concerned with achieving higher performance and better quality standards. It appears that quality is consistent with higher productivity and, often, lower cost. And quality leads to greater job satisfaction and motivation. According to Daniel Yankelovich and John Immerwahr, improved motivation calls for closer links between reward and performance. But rewards must not be defined narrowly. Rewards are not only

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monetary income. The links between reward and performance also involve recognition of good performance and worker participation in decision-making and in the definition of his work task. The pioneering efforts at Westinghouse described by Thomas Murrin demonstrate how new approaches to job definition, decision-making at the workplace, and forward-looking personnel management, can help to improve worker satisfaction and productivity. Not all contributors to this section on managing motivation are in agreement on the need for a closer link between pay and work effort, but no one disputes that workers respond if their efforts are appreciated and are rewarded in nonfinancial as well as financial terms. There is a distinction between what satisfies people on the job, what makes work more congenial, and what makes the worker more effective. Failure to recognize this distinction, according to Yankelovich, has been a barrier to work performance. The world of the workplace has become increasingly dynamic. Rapidly changing technology makes workers as well as machines obsolete. New skills with emphasis on verbal, technical, and mathematical knowledge are taking the place of older crafts which called for physical strength and craft skills. Functions being carried on by young workers now will cease to exist long before they leave the labor force 40 years later. The economic recession and shifts in industrial structure away from the smokestack industries toward high technology have exacerbated the problem. Workers laid off by the heavy industries in the East and the Midwest often will not find comparable employment. For that matter, many drop out of the labor force and will not even work again. Clearly the combination of technological shifts and economic recession is creating major human readjustment problems. Ultimate responsibility for dealing with these questions rests on both the private and the public sectors. According to Lindsay et al., it is the responsibility of management to plan ahead to avoid worker obsolescence. Human resource development on the job is largely the task of the private sector. But government can play a role not only in assuring high levels of economic activity but also on the micro level by supporting education and training, aiding labor mobility, sponsoring research on labor adaptation, and so forth. Stanley Lundine particularly calls for government-private sector interaction to encourage productivity and adaptation to new technology. On the national level, there is a need for building a consensus on cooperation between labor and management in the new economy with government providing helpful participation. There is also need for more research on how the objectives of improved work perfor-

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mances can be achieved. But many more opportunities exist on the community level where business, labor, education, and, most of all, government can work together. This sentiment is echoed by others. According to Phyllis Wallace, the transition to the new technologies will be tough. The workers' concerns about job security must be met if labor is to cooperate with the introduction of new technology and if adaptation is to take place. Because locations of jobs and skill requirements are badly matched with location of workers and worker abilities, some people may face long periods of unemployment or may drop out of the active labor force. Work sharing has been proposed as a solution for technological unemployment. But it is likely to be disruptive in terms of work scheduling and would have negative consequences for productivity. All of the papers in this section express concern about the length of time needed for and difficulty of retraining workers who become technologically unemployed, the mechanisms that could be developed to make cooperation between management and labor possible, the measurement of productive performance and the appropriate incentives, the creation of new jobs by the new technology, the international differences in wage rates and investment per job, and U.S. competitiveness around the world. Most of the papers agree that there must be a focus on the need to provide better incentives and there must be an improved focus on quality of performance and of the product. There are considerable opportunities for reorganizing the workplace for achieving these objectives. Representatives of the labor unions take a somewhat different view on these questions than do representatives of the business sector. But the differences are only of degree, not so much in the posing of issues as in the particular mechanisms for resolving them. There is clearly much agreement on the human issues on: the need for increased flexibility in jobs; the need for improved incentives; the need for greater involvement of workers in workplace decisions; the need for more education and training and for training as a lifetime effort. Furthermore, there is agreement on the primary role of the private sector in solving the people problem and on the need for cooperation between government, business, and labor, particularly on the local level in dealing with the human issues posed by new technology. One cannot help asking: "If there is so much agreement, why has so little been done? What are the barriers that have prevented many enterprises from dealing more directly and effectively with their people problem? If the private sector has the predominant role in dealing with the people problem, how can private management be persuaded

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to do its job? What, and why, are the failures of the educational system? What are the forces that stand in the way of adapting workers to the new technologies? And what human barriers are there to introducing the new technologies and perhaps to adapting the new technologies to the workers? What is the role of the public sector, and how can the public sector, the business sector, and labor work more closely and cooperatively?" These are the human challenges of the age of the new technologies. Here and there are important signs of progress, as this meeting demonstrates. But much still needs to be done.

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Savings and Investment

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11. SAVING IN THE U.S. ECONOMY John B. Shoven

INTRODUCTION In policy circles there has been near unanimous agreement that the United States does not save enough. The argument is made that the U.S. capital stock is inadequate because of the low saving rate which, in turn, is often attributed to the heavy taxation of income from capital. The heavy taxation results partly from a tax system that is not designed to be neutral to high rates of inflation, such as were experienced in the 1970s.1 The consensus that low saving is a contributory factor in the poor economic performance of the U.S. contrasts sharply with the views of economists during and after the Great Depression of the 1930s. Then, armed with the ideas of Keynes's General Theory, many worried that "over saving" could cause a recurrence of the pre-World War II macroeconomic catastrophe. The "Paradox of Thrift," emphasizing that the prudent saving policy for the individual household could be counterproductive for the economy, was a fashionable idea. In the early Keynesian models, saving was often modeled as a simple linear function of income. This structure was given some empirical support by the work of Edward F. Denison who, in 1958, reported a striking constancy in the gross private saving rate. While Denison (1958) was careful to point out that his evidence did not rule out a significant interest elasticity for saving, a frequent interpretation of his results took them to show that this elasticity was zero. The concern with over-saving has certainly subsided and the role

I would like to thank Michael Lanza, Janet Stotsky, and Michael Wachter for very helpful comments. I also would like to acknowledge that my thoughts were clarified on many of these issues in discussions with Charles Ballard. I suppose I still have to take responsibility for the paper's shortcomings.

Saving in the U.S. Economy 187

of saving in the economy has received renewed attention within the past ten years. There are a number of reasons for this. First, the U.S. personal saving rate is one of the lowest in the world and there has been increasing concern about American competitiveness. Second, a significant development in the theory of consumption-saving decisions was introduced by the Modigliani-Brumberg (1954) life cycle model and the Friedman (1957) permanent income hypothesis. The implications and extensions of these theories and their competitors has been an active area of research impinging on Denison's findings. Third, there is increasing recognition of the government's role in and influence on saving behavior. The government is a direct participant in the saving/investment market according to its own budgetary posture, and currently, the U.S. Federal government is a massive dissaver. Also, the government certainly influences corporate and personal saving in many ways, including its tax policies, the Social Security system, and the regulation of retirement and private pension systems. The strengths of these influences is the subject of much economic research in this area. The purpose of this paper is to review and assess a number of the issues regarding saving in the U.S. In the next section, I present new data on saving in the U.S. by sector from 1946 to 1982. The data conflict with a number of common notions including the constancy of the aggregate saving-GNP ratio found by David and Scadding (1974). The new information shows that households, businesses, and government are each important and variable sources of saving for the economy, resulting in a fairly volatile total saving-share of GNP. It also indicates that saving hit an unprecedented low in 1980-82; in fact, aggregate saving was negative. In the third section, I briefly review the literature that has developed on the elasticity of saving with respect to the real after-tax interest rate. This is followed by a section covering the life-cycle model and the intergenerational model and their implications regarding saving. The importance of inheritances and bequests in determining the aggregate capital stock is surveyed. The fifth section raises the important issue of Social Security and saving. This has been an extremely active area of research, but nothing resembling a consensus has yet emerged. The saving field is plagued by inadequate data to test the existing theories. This does not deter me from positing a hypothesis of my own regarding the impact that the 1983 Social Security legislation may have on household saving. Clearly, in a discussion of saving behavior, the role of taxes is important. I review the taxation of capital income in the U.S. and discuss two estimates of the effective marginal rates. The sixth section

Policy Areas—Savings and Investment 188

of the paper analyzes possible changes in the personal and corporation income taxes and addresses the question of how long is the long run for capital deepening tax policies. The final substantive section examines the importance of international capital markets and notes that these may break the classical link between saving and investment in the economy. The advisability of saving incentives in the tax code may depend crucially on the functioning of world capital markets and intercountry tax agreements. The paper concludes with a personal assessment of what we know and what we do not know regarding saving. The usual plea for more data and more research is made.

COMPONENTS OF SAVING One of the difficulties in discussing saving is that different authors have different definitions of saving. Most examine gross personal household saving, although others look at only the funds households provide to the business sector. Still others attempt to look at aggregate gross private saving in the economy. Ultimately, the entire economy is owned by its citizens and therefore any attempt to examine a narrow component of saving will be plagued by the substitutability of the saving of different sectors. For example, business saving is clearly a substitute for personal saving, although possibly an imperfect one. A number of authors similarly argue that government saving is a close substitute for household saving.2 An issue that has received insufficient attention in the literature is the great difficulty in measuring saving. For the most part, we have very little direct data regarding saving. Most authors determine saving as the residual of somewhat erroneous income data and highly questionable consumption figures. This paper uses a different approach. Saving is probably best thought of as the change in, or accumulation of wealth. That is, the amount a person, household, firm, or government has saved during a year is the increment in the net wealth of the person or institution. The most straightforward way, then, to measure saving is to compare two balance sheets (one at the beginning and one at the end of the period) of the entity under consideration. If both balance sheets are expressed in the same units (such as dollars of constant purchasing power), then saving will just equal the change in net worth. The problem with implementing this approach is that we have little wealth data for the U.S. Detailed cross-section household wealth data is extremely scarce and the distortions caused by inflation create many difficulties in computing real corporate balance sheets. The gov-

Saving in the U.S. Economy 189

ernment sector is the worst in that no official attempt is made to construct balance sheets. The assets of governments, including defense equipment, social overhead capital, and large natural resource holdings, are particularly difficult to value. Attempts are being made, including an ambitious project currently directed by Michael Boskin at Stanford. The point that should be recognized, however, is that measuring saving, which is most fundamentally defined as the change in net worth, is at least as difficult as gauging net worth itself. There are at least two sets of national balance sheets available; those compiled by Raymond Goldsmith (1982) and those prepared by the Flow-of-Funds division of the Federal Reserve System (1983). While both share many properties, I have chosen to use the latter source. The FOF national balance sheets do not take into account the tangible assets owned by federal, state, and local governments. Other than that, they attempt to record the current value of all assets and liabilities in the economy,3 including owner-occupied housing, consumer durables, inventories, and depreciable plant and equipment. Clearly, the valuation task is a difficult one and the numbers should not be trusted to the seventh significant figure (which is published). Table 11.1 shows the net worth of seven sectors of the economy, stated in current dollars for 1945-82. The figures for the government sectors are the liabilities held by private investors. The total net worth of the economy grows from $481 billion at the end of 1945 to $9,800 billion by the end of 1982. Total net worth amounted to 2.31 times GNP in 1945 and 3.21 in 1982. The bottom half of table 11.1 shows the calculated saving in current dollars of each of the seven sectors. Saving was determined by

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1 - 1

where P, is an index of prices. Since the net worth data are end-ofyear totals, I have used the December Consumer Price Index (CPI) levels to calculate saving. There is always room for disagreement regarding which deflator is most appropriate, but I chose the CPI since it is computed monthly, and because its use is theoretically consistent with my view that all of the economy's assets are ultimately owned by consumers whose appropriate cost-of-living deflator is the CPI. 4 A number of facts are apparent in the lower half of table 11.1. Rows 10, 11, and 12 show the private saving to GNP ratio, the total saving to GNP ratio, and the total saving to net worth ratio (which can be interpreted as the growth rate of the country's net tangible capital stock). The first fact which is apparent is that all three ratios

Policy Areas—Savings and Investment 190

are quite volatile through time. All are at or near local maximas in 1950,1955,1972, and 1978. The variance and the most recent situation are highlighted by comparing the 20.1 percent total saving to GNP ratio of 1978 with the unprecedented negative 9.6 percent figure for 1982. This is just the most dramatic move in some very volatile series. The second striking fact about the data of table 11.1 is that the composition of saving fluctuates a great deal. Each sector, households, the various forms of business, and government, display volatility in their contribution to total saving. For example, in 1946 and 1947 government saving (the reduction in the real debt in the hands of private investors) amounted to almost all saving in the economy. This can be contrasted with 1975 when governments were large dissavers, absorbing about half of private saving. The recent saving data of this table, particularly for 1981 and 1982, are nothing short of astounding. They indicate that this country has been dissaving at a rapid rate and, in fact, has not done any significant saving since 1978. In 1982, only households and financial institutions did any saving in real terms. The net worth of nonfarm, noncorporate businesses and of farms went down in nominal terms from 1981 to 1982 and fell sharply in real terms regardless of which price index is used. In real terms, nonfinancial corporations were also large dissavers. The sharpest fall in net worth in percentage terms was for farms. The nominal value of several categories of their physical assets actually fell (no wonder agricultural equipment manufacturers teetered on the brink of bankruptcy) while their outstanding liabilities rose considerably. Total private net worth rose in nominal terms by just over 2 percent from 1981 to 1982. To call this saving, however, is to fall victim to inflation illusion. In fact, the private sector was a large and significant dissaver for the first time in postwar history. Add to that the fact that the Federal government was running record deficits and you have accounted for a country whose real net worth fell by 3 percent (about 10 percent of GNP) in one year. Needless to say, the evidence of table 11.1 conflicts with the Denison (1958) and David-Scadding (1974) reports of a constancy in private saving rates out of GNP. It should be noted that the data and approach used in those studies are very different, and that even the concept being measured is at variance. They calculate gross-of-depreciation saving rates, while I have included only net saving or wealth accumulation. It seems plausible that net saving is the concept of more fundamental importance. Also, I have implicitly included real asset revaluations caused by depreciation, obsolescence, speculation, or whatever, which they have not. This is a complicated issue on which universal agreement is unlikely. I should stress, however, that the

Saving in the U.S. Economy 191

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U.S. Government Deficit in the 1980s 269

average 4.7 percent of gross national product. The retained earnings of corporate businesses, measured net of taxes, depreciation and artificial inventory profits due to the use of first-in-first-out accounting methods, have declined sharply relative to gross national product during the last decade, but the relative growth of depreciation allowances (adjusted to reflect true economic depreciation) has more than offset that decline. In sum, the economy's gross private saving has actually grown slightly in comparison to its total output. Because more than all of the increase has consisted of depreciation, however, the economy's net private saving (equal to gross private saving less depreciation) has declined in relative terms. The private sector, including both households and businesses, is not the only source of saving. The economy's total saving consists of private saving plus the saving—or, importantly, the dissaving—of government. In large part because of the surpluses associated with funding the pensions of teachers and other employees, state and local governments have increasingly added to total gross saving since the mid-1960s. 3 By contrast, the Federal government's budget deficit has grown steadily over this period—from a balanced budget on average during the 1950s, to average deficits of 0.5 percent and 1.9 percent of gross national product in the 1960s and 1970s, respectively, to a peacetime record 4.9 percent of gross national product in 1982. This growth of dissaving by the Federal government has more than balanced the growth of saving by state and local governments, so that the economy's total saving has not kept pace with its private saving. In 1982 the total gross saving rate was at its lowest point since World War II. Because saving is what finances investment, so too was the gross investment rate. Although the U.S. economy's total gross investment rate has shown little change (actually a small increase) in recent years, except for 1982, what presumably matters for productivity growth is not total investment but only the additions to productive plant and equipment—and, moreover, not gross investment but investment net of depreciation. New installations that merely replace earlier ones that have worn out through time and usage, or that have become obsolete as technologies change, do not represent further accumulation of capital. In the sense that matters here, therefore, the part of saving offset by depreciation correspondingly does not represent a genuine setting aside of the economy's resources to provide for its future. What matters instead is net saving and net investment. Table 13.2 indicates the composition of gross private domestic investment, as shown in table 13.1, among business plant and equipment, residential construction, and inventory accumulation. In addi-

Policy Areas—Government Deficit and Business Cycle 270

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