Choose Economic Freedom

Enduring Policy Lessons from the 1970s and 1980s

George P. Shultz, George P. Shultz, John B. Taylor, Milton Friedman, Milton Friedman

• Publisher: Hoover Institution Press
• Year: 2020
• Print ISBN: 9780817923440
• eBook ISBN: 9780817923464
• Edition: 1
• Topic: Economics
• Subtopic: Business General
• Index: Economics

What are the keys to good economic policy? George P. Shultz and John B. Taylor draw from their several decades of experience at the forefront of national economic policy making to show how market fundamentals beat politically popular government interventions—be they from Democrats or Republicans—as a recipe for success.

Choose Economic Freedom reconstructs debates from the 1960s and 1970s about the use of wage and price controls as tools of policy, showing how brilliant economists can hold diametrically opposed views about the wisdom of using government intervention to spur the economy. Speeches and documents from the era include a recently unearthed memo from Arthur Burns, Federal Reserve chair, in 1971, in which he argues in favor of controls.

Under Burns's guidance and in the face of stubborn inflation, Nixon introduced wage and price guidelines and freezes. But over the long run, these became a drag on the economy and ultimately failed. It wasn't until the Reagan administration that these controls were reversed, resulting in a vibrant economy.

The words of iconic economist Milton Friedman—whose "free to choose" ethos inspired the free-market revolution of the Reagan era—along with lessons Shultz and Taylor learned from the front lines, demonstrate that tried-and-true economic policy works.

CHAPTER ONE

Guidelines

Debated and Implemented

LET’S BEGIN in 1962. Those were the days of a new and energetic Kennedy administration wanting to expand the economy but worried about inflation. In 1962, the president’s Council of Economic Advisers used their annual Economic Report of the President¹ to issue a set of guidelines for wage and price changes designed to set the sights of labor and management on wage and price changes in a way that would keep inflation under control. They outlined voluntary, productivity-linked “guideposts” to stabilize wage and price setting in industries they said exercised market power. The concerns about inflation were underlined by Lyndon Johnson’s Vietnam War and Great Society spending. People called it a guns-and-butter economy and continued to worry about inflation. The White House increasingly found itself involved in manufacturing-industry wage negotiations and in publicly warning businessmen not to raise consumer prices. Concerned that these guidelines might lead to wage and price controls, George Shultz and his Chicago colleague Robert Aliber pulled together a conference on the subject in April 1966. It turned out to be a very productive meeting attended by top-notch economists of all persuasions, including George Stigler, Allan Meltzer, then CEA chair Gardner Ackley, and future labor secretary John Dunlop. The papers and proceedings were published in a book, Guidelines, Informal Controls, and the Market Place.² The discussions were intense but not reassuring. There was widespread support for the guidelines, little concern that they might lead to wage and price controls (see appendix D), and an almost “So what?” attitude toward such controls if they materialized.

Many influential people attended the conference, but the stage was set by Milton Friedman, then of the University of Chicago, who would win the Nobel Prize in economics in 1976; and Robert Solow of the Massachusetts Institute of Technology, who would win the Nobel Prize in 1987. We quote these economists at length because these two brilliant thinkers broadly argue the merits of intervention and their extended statements are worthy of consideration. The complete document of their speeches and comments on each other’s statements is found in the book Guidelines, Informal Controls, and the Market Place.

In his statement, Friedman argues against wage and price guidelines or guideposts, pointing to the harms they cause—including that it is in the business’s and the economy’s interest to violate government requests (and perhaps even legal mandates)—and showing that inflation is a “monetary phenomenon” caused by bad monetary policy:

Entirely aside from their strictly economic effects, guidelines threaten the consensus of shared values that is the moral basis of a free society. Compliance with them is urged in the name of social responsibility; yet, those who comply hurt both themselves and the community. Morally questionable behavior—the evading of requests from the highest officials, let alone the violation of legally imposed price and wage controls—is both privately and socially beneficial. That way lies disrespect for the law on the part of the public and pressure to use extralegal powers on the part of officials. The price of guideposts is far too high for the return, which, at most, is the appearance of doing something about a real problem.…³

Yet, the central fact is that inflation is always and everywhere a monetary phenomenon. Historically, substantial changes in prices have always occurred together with substantial changes in the quantity of money relative to output. I know of no exception to this generalization, no occasion in the United States or elsewhere when prices have risen substantially without a substantial rise in the quantity of money relative to output or when the quantity of money has risen substantially relative to output without a substantial rise in prices. And there are numerous confirming examples. Indeed, I doubt that there is any other empirical generalization in economics for which there is as much organized evidence covering so wide a range of space and time.⁴

Friedman then compares the harms of “open” inflation (without wage and price guidelines) with the harms of “suppressed” inflation (with wage and price guidelines) noting that guidelines make the problem worse:

Open inflation is harmful. It generally produces undesirable transfers of income and wealth, weakens the social fabric, and may distort the pattern of output. But if moderate, and especially if steady, it tends to become anticipated and its worst effects on the distribution of income are offset. It still does harm, but, so long as prices are free to move, the extremely flexible private enterprise system will adapt to it, take it in stride, and continue to operate efficiently. The main dangers from open inflation are twofold: first, the temptation to step up the rate of inflation as the economy adapts itself; second, and even more serious, the temptation to attempt cures, especially suppression, that are worse than the disease.

Suppressed inflation is a very different thing. Even a moderate inflation, if effectively suppressed over a wide range, can do untold damage to the economic system, require widespread government intervention into the details of economic activity, destroy a free enterprise system, and along with it, political freedom. The reason is that suppression prevents the price system from working. The government is driven to try to provide a substitute that is extremely inefficient. The usual outcome, pending a complete monetary reform, is an uneasy compromise between official tolerance of evasion of price controls and a collectivist economy. The greater the ingenuity of private individuals in evading the price controls and the greater the tolerance of officials in blinking at such evasions, the less the harm that is done; the more law-abiding the citizens, and the more rigid and effective the governmental enforcement machinery, the greater the harm.…⁵

The guideposts do harm even when only lip service is paid to them, and the more extensive the compliance, the greater the harm.

In the first place, the guideposts confuse the issue and make correct policy less likely. If there is inflation or inflationary pressure, the governmental monetary (or, some would say, fiscal) authorities are responsible. It is they who must take corrective measures if the inflation is to be stopped. Naturally, the authorities want to shift the blame, so they castigate the rapacious businessman and the selfish labor leader. By approving guidelines, the businessman and the labor leader implicitly whitewash the government for its role and plead guilty to the charge. They thereby encourage the government to postpone taking the corrective measures that alone can succeed.

In the second place, whatever measure of actual compliance there is introduces just that much distortion into the allocation of resources and the distribution of output. To whatever extent the price system is displaced, some other system of organizing resources and rationing output must be adopted. As in the example of the controls on foreign loans by banks, one adverse effect is to foster private collusive arrangements, so that a measure undertaken to keep prices down leads to government support and encouragement of private monopolistic arrangements.

In the third place, “voluntary” controls invite the use of extralegal powers to produce compliance [see appendix D]. And, in the modern world, such powers are ample. There is hardly a business concern that could not have great costs imposed on it by antitrust investigations, tax inquiries, government boycott, or rigid enforcement of any of a myriad of laws, or on the other side of the ledger, that can see no potential benefits from government orders, guarantees of loans, or similar measures. Which of us as an individual could not be, at the very least, seriously inconvenienced by investigation of his income tax returns, no matter how faithfully and carefully prepared, or by the enforcement to the letter of laws we may not even know about? This threat casts a shadow well beyond any particular instance. In a dissenting opinion in a recent court case involving a “stand-in” in a public library, Justice Black wrote, “It should be remembered that if one group can take over libraries for one cause, other groups will assert the right to do it for causes which, while wholly legal, may not be so appealing to this court.” Precisely the same point applies here. If legal powers granted for other purposes can today be used for the “good” purpose of holding down prices, tomorrow they can be used for other purposes that will seem equally “good” to the men in power—such as simply keeping themselves in power. It is notable how sharp has been the decline in the number of businessmen willing to be quoted by name when they make adverse comments on government.

In the fourth place, compliance with voluntary controls imposes a severe conflict of responsibilit...

Table of contents

• Contents
• Preface
• Chapter One: Guidelines: Debated and Implemented
• Chapter Two: Wage and Price Controls: Bad Economics Brings Bad Policy
• Chapter Three: Damage Control as the Economy Fights Back
• Chapter Four: Reversal and Reform: Good Economics Generates Good Policy
• Chapter Five: Orthodox Policies and Strategic Thinking Work
• Appendix A: Timeline of Key Events
• Appendix B: Letter from Arthur Burns to President Nixon, June 22, 1971
• Appendix C: Economic Strategy for the Reagan Administration: A Report to President-Elect Ronald Reagan from His Coordinating Committee on Economic Policy, November 16, 1980
• Appendix D: Frequently Asked Questions
• References for Further Reading
• Acknowledgments
• About the Authors
• Index