An Answer to Arthur F. Burns: The President's Council of Economic Advisers
An Answer to Arthur F. Burns By the President's Council of Economic Advisers Economists ARE fond of saying (though tired of being told) that economics is not an exact science. It is thus not...
...These disclaimers reveal that a label is a poor Substitute for analysis...
...It is faster growth, not the closing of the gap, that is the primary objective of increased private investment in plant and equipment and increased public investment in human beings...
...In his speech, Burns suggested that the basic economic theory guiding the policies of the Kennedy Administration is actually " revised version of New Deal economic thinking...
...These programs operate, swiftly and surely to narrow the demand gap...
...2) that the unemployment rate corresponding, on the average, to reasonable capacity output is 4.6 per cent...
...Burns foresaw in April that "Full employment may well be reached some 15 or 18 months from now," without any further special stimulus to the economy...
...We agree with other witnesses before the Joint Economic Committee that this large "latent surplus" in the Federal budget at present levels of expenditure makes full recovery more difficult...
...When the gaps implied by this procedure are compared with unemployment rates in the 1953-60 period the conclusions are: (1) that real GNP was above potential throughout the period 19531957, and indeed that the recession of 1954 was a period of above-potential output...
...The Council's confidence in its trend projection arises from the...
...The most detailed method used by the Council to estimate the 1960 gap is an analysis of the increase in output which would result from a reduction in the unemployment rate to 4 per cent...
...As Burns himself shows, a sharp reversal of the Federal fiscal position contributed to the premature end of the recovery...
...In his April 21 speech, Professor Burns stated that "we would be courting inflation and a gold crisis if we now arranged new governmental spending programs so that they would mature when the economy is already advancing without them...
...non-production workers, in particular, tend to be under-utilized in recession and their productivity rises as business picks up...
...These factors are not in dispute among the majority of economists...
...Burns criticizes the Council's "gap" analysis...
...The annual growth rate of 3.5 per cent was selected after a study of trends in labor force and labor productivity...
...Its exponents feared that full employment in a mature economy was impossible unless private consumption and government expenditure moved in to plug the hole left by severely declining investment opportunities...
...The Council must dissent from Burns' implicit view that the enactment of such programs—all of them evoked by urgent national needs— will "court inflation and a gold crisis...
...We have examined Burns' suggestions in this light...
...The Council believes that all governmental programs must meet the severe test of social priority relative to other public and private uses of the nation's economic resources...
...Here, Burns' thesis is challenged by President Kennedy's Council of Economic Advisers, whose chairman is Walter Heller, and whose members are Kermit Gordon and James Tobin...
...This is true of government spending to promote long-term economic, growth, and of government outlays for social welfare...
...Another suggestion was to start the 3.5 per cent trend in the second quarter of 1947...
...The Council is not in any sense proposing that the monetary and fiscal brakes be removed from our economic machine...
...A third suggestion was to fit a trend rising at 3.9 per cent per year between actual GNP in the second quarter of 1947 and actual GNP in the second quarter of 1957...
...In a year of urgent needs and great opportunities there is little reason to lose precious time, production and employment...
...The Council, together with many other economic analysts, takes a 4 per cent rate of unemployment as representing substantially full employment under present conditions...
...He also concedes that the Council's theory "need not cause anxiety...
...At first glance, it seems paradoxical that a reduction in the unemployment rate by 2.4 percentage points would yield a percentage expansion in output more than three times as large...
...Such studies were the basis of the Council's gap figures...
...For example, accelerated tax refunds and veterans' insurance dividends, temporary unemployment compensation payments, and aid to dependent children of the unemployed all expand consumer markets...
...If we were to equal the pace of recovery from the 1954 and 1958 recessions, the unemployment rate would exceed 5 per cent in the third quarter of 1962...
...On the contrary, in our statement of March 6, we assigned responsibility for the growth of unemployment and economic slack in recent years to "deficiencies in total demand," rather than to "changes in the structure of industry and manpower...
...The 1958-59 recovery was accompanied by a much larger Federal deficit than we will experience in 1961-62...
...In the future, measures to improve geographic mobility, the skill structure of the labor force, and the health and education of workers, should allow the target rate to be lowered...
...It is thus not surprising that Arthur F. Burns, first chairman of the Council of Economic Advisers under President Eisenhower, differs on some important points from the conclusions reached by the present Council...
...and that, in this case, the label is wrong...
...3. Burns also applauds the Kennedy Administration for many of its programs for dealing with the recession, and for recognizing the need for revising the tax laws to stimulate private investment...
...We have not stated, nor do we believe, however, that a Federal surplus is incompatible with full employment...
...We would not support for purposes of recovery any programs which cannot meet this test...
...So it is also not surprising that on some important issues Burns comes to conclusions which parallel or coincide with the Council's views...
...This is implicit in his assertion that the American economy may well return to full employment in 15 to 18 months (from April...
...The gap simply amounts to the difference between the actual output of the economy and the output which could be achieved at reasonably full employment...
...Given this conservative definition of full employment, the fourth-quarter 1960 unemployment rate of 6.4 per cent (seasonally adjusted) meant that excess unemployment amounted to 2.4 per cent of the labor force or 1.7 million workers...
...Considerable agreement in prescription reflects considerable agreement in current diagnosis...
...We have compared the percentage gaps between potential and actual GNP implied by this trend with unemployment rates observed in every quarter beginning in 1953...
...The middle of 1955 was chosen as a base partly because it represented a period of full employment but also—and this Burns fails to note—because the results thus obtained were confirmed by independent gap estimates made by the Council and others...
...We welcome the establishment of a broad area of agreement and hope that controversy can be focused where there are substantial differences of analysis and opinion...
...Nor are the lessons learned from the errors of the past irrelevant to our present problem...
...The distinguishing feature of the "secular stagnation" theory formulated in the 1930s was pessimism about the prospects for high private investment...
...With respect to governmental policies of restraint, he asserts that "they were pushed with excessive vigor and they were not checked in time...
...The basic reason, we are told, is that there has been a retardation of investment...
...tightening of money and credit by the Federal Reserve authorities...
...economy in recovering from the 1949, 1954 and 1958 recessions—is basic to the Council's analysis, Burns failed to mention it in his critique of our estimate of the gap...
...Another of the ways in which the Council estimated potential output, and reached an 8 per cent gap estimate for the fourth quarter of 1960, was by passing a trendline rising at 3.5 per cent per year through the actual output series at the middle of 1955...
...What we have stressed is the need for a rational allocation of the implicit surplus among increased government outlays, decreased taxes, and debt retirement to achieve higher levels of investment for growth consistent with full employment...
...Having chosen this melancholy term to characterize the Council's position, he quickly distinguishes the Council's "stagnationism" from that of earlier economists by calling the Council's version a "gay and optimistic theory...
...The difference between Burns and the Council in diagnosis concerns the probable speed of full cyclical recovery...
...BUT HERE agreement ends, controversy begins, and labels are attached...
...4. Even in his critique of the Council's analysis of the "gap" between actual and potential output, which occupies most of his attention, Burns discloses large areas of agreement: He agrees that there is a gap, that "reasonable full employment" has been reached only fleetingly since 1956, that the peak from which the 196061 recession began was too low, and that the economy needs to do more than recover the ground lost in the recession...
...Such measures as reduction of interest rates for small business, tax credits for investment, and expenditures for research, operate more slowly but have the virtue of simultaneously expanding demand and accelerating growth in productive potential...
...In every recession there is slack which must be taken up by expansion of demand...
...Arthur F. Burns, first chairman of the President's Council of Economic Advisers during the Eisenhower Administration...
...It is attested by the unemployment rate and by excess capacity throughout American industry...
...Quite the contrary: Far from suggesting that more rapid growth is beyond our reach, we have shown that our economic potential—the true measure of our capacity to satisfy needs—has been growing throughout the postwar period at faster-than-historical rates...
...We did not anchor it in 1947 or 1957, because to do so carries implausible implications about the performance of the economy in particular years and about the level of unemployment corresponding, on the average, to reasonable capacity output...
...But a reasonable estimate of potential output can be derived from careful quantitative studies of the regularities of postwar economic life...
...The Council has not contended that there is any qualitative difference between the present recovery problem and earlier ones...
...Unfortunately, Burns has drawn attention away from issues and analysis by his emphasis on labels...
...Although this computation —carefully anchored in the actual experience of the U.S...
...The Council has expressed no such pessimism about private investment or growth...
...fact that it implies gaps which bear a close and reasonable relation to observed rates of unemployment in 1960 and previous years...
...But the very existence of brakes permits the machine to go faster with safety...
...2) that the unemployment rate corresponding, on the average, to reasonable capacity output is 6 per cent...
...This is doubly regrettable because the label he has chosen—"stagnation" or "neo-stagnation"—simply does not fit the Council's economic views...
...On the contrary, we believe that there is room for such stimulation of the economy, and that public expenditures of high social utility ought not to be deterred by fears that the economy will soon be up against its capacity to produce...
...Rapid growth would be impossible under such circumstances...
...Burns points out that if other potential growth rates and other base points are chosen, they imply results for the 1960 gap which differ, sometimes substantially, from ours...
...In retrospect, expenditure programs begun in 1958-59 and continuing or maturing in 1960 would not have been poorly timed...
...The size of the gap cannot be measured with precision because the level of potential full employment output cannot be directly observed...
...If the recovery moves more rapidly than we now expect, these brakes can be applied to avert inflationary hazards...
...the difference in prescription concerns the possibility of perverse timing of expansionary fiscal measures beyond those proposed before his speech...
...The Council has on various occasions mentioned the same points as reasons why the upswing after 1959 came to an end well short of full employment...
...We believe our analysis, based on careful research, to be sound and his criticism mistaken...
...and confusion in Government and business circles and loss of momentum following the steel strike...
...Moreover, the needs of the nation, the growing "latent surplus" produced by the revenue system, and the general growth of the economy indicate that there is economic room for the increases in Federal expenditure recommended by the President since April...
...Our prescription for acceleration of growth has been consistent and clear: It calls for a high-investment economy, a high-research economy, a high-education economy...
...As this evidence strongly confirms, the Council's choice of a trend-line for potential output was not capricious...
...Indeed, in our testimony we pointed out that the powerful Federal tax structure would generate a considerable budget surplus at full employment, an issue which Burns ignores...
...The Council does not hold the view that the gap is endemic to the American economy, or that it would not give way to standard fiscal and monetary measures to expand demand...
...This figure is too high to serve as a longrun goal, but it is accepted as an interim target which could be achieved under current circumstances without serious inflationary risk...
...The Council has consistently stressed that the distance to full employment, not the drop from the previous peak, is the true measure of the magnitude of the recovery problem...
...This misinterpretation is surprising in view of the pains the Council took to distinguish the problem of the gap from the problem of growth...
...Second, full employment brings an increase in average hours worked as part-time jobs are converted into full-time jobs and as overtime work increases...
...To accept this potential trend one must also believe (1) that actual output was above potential throughout the years 1955-56, during which time the unemployment rate fell to 3.9 per cent in only one month...
...2. The Gap: Facts and Estimates...
...According to Burns, "The problem of recovery that we face is not very different from that which we faced in 1949 or in 1954 or in 1958...
...One suggestion was to use a 3.5 per cent trend of potential Gross National Product (GNP) anchored in the second quarter of 1957, when the unemployment rate was also near 4 per cent...
...But a time of economic slack may be an opportune occasion for initiating programs of high national priority which have been waiting for room in the government budget and in the economy...
...We do not neglect the problem of structural unemployment, but neither do we believe that the relatively high unemployment rate at the cyclical peak in May 1960 can be traced to special structural factors...
...In the light of slower growth in the last few years than in the immediate postwar period, our contention has been that the growth of our economic potential can be and should be accelerated...
...The four most important points of agreement seem to be these: 1. Burns gives three mutually reinforcing explanations for the short and incomplete character of the 1958-60 recovery: the shock of the "violent shift" of the Federal cash budget from deficit in 1959 to surplus in 1960...
...On the contrary, they would have given the economy a sustained stimulus just when the inevitably temporary stimulus of rapid inventory build-up was exhausted...
...The major operational difference between Burns' position and that of the Council concerns current policy—the degree and duration of desirable fiscal stimulus...
...Burns misread the Council's explanation of the gap when he said: "But what, it may be asked, is the large and growing gap due to...
...But if economics is not an exact science, neither is it guesswork...
...In our June 19 issue we published an article entitled "The New Stagnation Theory," adapted by the editors from a recent speech delivered at the University of Chicago by Br...
...Third, a rapid increase in productivity per worker typically accompanies the fuller use of resources in an economic recovery...
...The gap problem is that demand has not been keeping up with the estimated 3.5 per cent annual increase in potential supply...
...In its initial year, it was also stimulated by a strong inventory build-up in anticipation of the steel strike...
...2) that the unemployment rate corresponding, on the average, to reasonable capacity output is 4.6 per cent...
...We conclude from this review of the evidence that an 8 per cent figure for the gap in the fourth quarter of 1960 is grounded in persuasive evidence...
...These programs, if adopted, would increase Federal expenditures in fiscal 1962 by $724 million...
...To be plausible, alternative trends using different growth rates and different base periods should also have this important property of consistency...
...The Council's computation showed that a reduction of unemployment to the 4 per cent level Would be accompanied by an increase of 8 per cent in output...
...A large part of President Kennedy's program for economic recovery consists of measures to expand consumption...
...While it is not physically impossible for recovery to proceed that rapidly, current evidence suggests that it is highly improbable...
...The explanation is that full employment conditions have a number of favorable effects on output in addition to the basic one of putting the jobless back to work...
...But some programs are reversible...
...Undertaken in a time of economic slack, however, such increases have the welcome added virtue of helping to promote recovery by swelling the demand for goods and services...
...A Council member said in our oral testimony of March 6 before the Joint Economic Committee: "[We] would not accept the idea that we have a chronic or growing long-run problem of unemployment but, rather, that we have a problem of unemployment that we can defeat by fairly standard fiscal and monetary means provided these are applied resolutely enough...
...Continued to 1960, this trend yields a gap of $26 billion instead of our figure of $32 billion...
...Without such figures, it should be noted, the Council would not have the economic benchmarks required to carry out the intent of the Employment Act of 1946...
...3. The Gap: Explanation...
...The existence of a gap at present is not in doubt...
...According to our calculation, the percentage gap at the trough of the 1960-61 recession was greater than at the 1954 trough but about the same as at the 1958 trough...
...2. Burns apparently accepts the Council's position that it is weak aggregate demand, not an unyielding core of structural unemployment, that stands between us and a 4 per cent unemployment rate (which he considers "virtually full employment...
...And we did not use a higher growth rate than 3.5 per cent because of significant evidence that the rate of growth of potential in recent years has been lower than from 1947 to 1953...
...The major points of disagreement seem to be these: 1. "Neo-Stagnation" Theory...
...First, new members are attracted into the labor force as job opportunities increase...
...the important question is how much...
...We attributed the inadequate growth rate, not the growing gap, to "retardation of investment...
...It also implies: (1) that output was above potential from the very beginning of 1955 to mid-1957...
...The growth problem is that this 3.5 per cent annual increase falls short of an adequate rate of growth in our capacity to produce...
...Since April 21, in the course of the present recovery, President Kennedy has recommended to the Congress new or expanded programs in the fields of space, national defense, training and retraining of unemployed workers, foreign aid, and several others...
...According to the Council's estimates, full recovery in the third quarter of 1962 would require a 14.8 per cent increase in real GNP over the current quarter, and full recovery in the last quarter of 1962 a 15.8 per cent increase...
...The budget must not, of course, he built up by irreversible commitments during recessions to a level which would be regarded as undesirable at full employment...
...Recovery has not proceeded at this pace in any comparable postwar period of expansion, except in 1950 under the stimulus of the Korean conflict...
Vol. 44 • July 1961 • No. 27
