Thank you very much.

I would like to ask about the rest of the program for today. [Discussion off the record.]

Senator METCALF. We will be in recess until 1:30.

[Whereupon, at 12:30 p.m., the committee adjourned, to reconvene at 1:30 p.m., of the same day.]

AFTERNOON SESSION

Senator METCALF. The committee will be in order.

We are pleased to have-are you a doctor, Professor Houthakker? Mr. HOUTHAKKER. I suppose I am.

Senator METCALF. Well, we give everybody the benefit of all the titles they have. We have Dr. Houthakker here from the Department of Economics, Harvard University, and we welcome you again before a committee of Congress. You are an expert in testifying, and I notice you have a prepared statement, which is not too long, so go right ahead.

STATEMENT OF HENDRIK S. HOUTHAKKER, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY

Mr. HOUTHAKKER. Thank you, Mr. Chairman. I am grateful for the privilege of testifying before this committee on S. 4145. Before dealing more specifically with this bill, I would like to say a few words about our general economic situation and its relation to this proposed legislation.

The problem which our economy faces at the present time is an unusual one. Until a few years ago it was safe to say that we had to cope with a recession or with inflation, but not with both at the same time. The fiscal and monetary policies which we adopted with the passage of the Employment Act of 1946 were especially directed at curing recessions, or even better at preventing them, but our approach to the inflationary pressures that emerged from time to time was a much more hesitant one. In fact, we have not so far found any effective way of curing inflation other than slowing down the economy, which has frequently led to recession. Moreover, the efforts to overcome a recession tended to plant the seeds for a subsequent inflation; only rarely in the period following World War II have we had a combination of reasonably full employment and reasonable price stability. Fortunately the inflation or the unemployment which we have had during the remainder of this period has until recently been either mild or short lived.

The combination of inflation and unemployment was first observed in Britain during the 1960's and became known there as stagflation, a word that refers in part to the stagnation of economic growth characteristic of a prolonged recession. Stagflation first made its appearance in the United States in 1970-71, when we had a mild recession, during which the general price level continued to rise, albeit at a reduced rate. Since then inflation has accelerated sharply to its present rate in excess of 10 percent per year, yet there has also been a decline in real GNP and growing unemployment, the two chief characteristics of a recession. This state of affairs puts economic policymakers before a dilemma. The

usual medicine for inflation, a slowdown in the economy, threatens to aggravate the recession, yet the equally usual medicine for a recession, namely fiscal and monetary stimulation, might have an adverse effect on an already disruptive inflation. Clearly we have to rely on new measures to deal with this new situation.

How is it that rapid inflation can coexist with unemployment and other evidence of considerable slack in the economy? That is the question to which we have to find an answer if we want to understand the phenomenon of stagflation and find a remedy for it. Let us observe first that in a competitive market for a single product the emergence of an excess of supply over demand generally leads to a fall in price. Thus a clothing store that finds itself with more sweaters on hand than it can sell at the current price normally announces a sale, where the price is set low enough to get rid of the surplus; indeed, the sale price may well be below the cost at which the sweaters were originally acquired from the manufacturer.

This is not, however, what we find in a market where competition is absent or weak. Just now, for instance, we see automobile producers halting production and laying off workers rather than lower the prices of their cars, which would not only keep their employees at work but also have a favorable effect on the general price level. In fact, the automobile makers recently raised their prices by a large amount despite considerable softness in the demand for cars.

The economy as a whole is an aggregate of markets, some of them competitive and some of them not. If competition is sufficiently widespread the economy as a whole will react to an excess of supply with a fall in the general price level, just as it will respond to an excess of demand by inflation. But if competition is not sufficiently strong the economy as a whole will behave rather like the automobile industry, where rising prices and declining output go hand in hand. This suggests that stagflation is intimately related to the weakness of competition, and that measures to strengthen competition are essential in attacking stagflation.

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Next we must ask why competition is so weak as to permit stagflation. There are several reasons for this. The automobile industry, instance, is highly concentrated. Perhaps antitrust action would be effective in bring better price-output performance to this industry, but it has not been attempted so far.

In many other markets lack of competition is a direct result of Government intervention rather than inaction. Thus agricultural marketing orders, important in milk, fruit and vegetables, stifle competition by allocating territories, curtailing output or permitting the destruction of so-called surpluses. The Postal Service enjoys a legal monopoly which enables it to charge ever higher prices for ever poorer services. Various import quota schemes protect domestic industries from foreign competition. And so one could go on; the list of industries where the Government thwarts the beneficial action of market forces, usually at the behest of trade organizations or labor unions, is long indeed and still growing. Just recently the Congress passed a cargo preference bill-I understand I am wrong about this bill, that the conference report is still before the Senate which would raise the cost of petroleum for the alleged benefit of merchant seamen,

or at least of their union leaders; fortunately, the Congress has not yet passed this bill, and the President has not signed it. Competition is not dead in the American economy, but it is losing ground steadily and this is one of the principal reasons for our increasing vulnerability to inflation.

This hearing is concerned with the regulated industries and I shall therefore confine the remainder of my remarks to them. Regulation, generally speaking, is the antithesis of competition. It is justified where competition cannot flourish anyway, as in the case of a natural monopoly. There is no question that the telephone industry needs to be regulated, and it may even be conceded that in the 19th century there was a case for regulating the railroads. However, the 19th century is behind us, and the railroads have long ceased to be the only means of efficient transportation.

Yet regulation has not only been continued, but it has been extended to trucking, an industry that is eminently suited to competition because there are no major economies of scale. The purpose of this extension was not to protect shippers from possible exploitation by carriers, but to permit these carriers to operate as a cartel. To see how it contributes to inflation one need only observe the unseemly eagerness with which the Interstate Commerce Commission grants general rate increases while discouraging new entry or cuts in tariffs. A powerful lobbying organization, the American Trucking Association, has seen to it that these cosy arrangements are not disturbed by the various reforms that have been proposed by both Democratic and Republican Presidents.

While the Interstate Commerce Commission is the best-documented instance of the use of regulation to serve the interests of an industry rather than of the public at large, it is by no means the only one. The Civil Aeronautics Board under its present chairman has made no secret of its single-minded devotion to the profits of the airlines rather than to the interests of passengers and shippers. The Federal Maritime Commission is an indispensable element in the system of shipping conferences.

The record of other regulatory commissions is probably better, though it could certainly bear investigation. A critical review of the regulatory performance of these and other agencies, including those at the State level, is long overdue in any case. For this purpose, the term "regulation" should be interpreted broadly, including not only the regulatory commissions but also the regulatory activities of the Departments of Agriculture, Labor, Commerce, HEW, and others.

I am therefore in general sympathy with the purposes of S. 4145. Indeed, I consider regulatory reform to be a crucially important weapon in the struggle against stagflation, though it will have to be accompanied by measures to stimulate competition in many other parts of the economy. Perhaps it would be even better to legislate regulatory reform itself rather than a study of regulatory reform. In the case of surface transportation there is certainly enough in the legislative record to enact needed reforms without further delay. Desirable though this would be, as a veteran of some of these reform efforts, I recognize the strength of the opposition which has usually succeeded in immobilizing such proposals in friendly subcommittees. An authoritative study commission might help in providing momen

tum for reform and in obtaining better documentation for regulatory reform in the lesser known areas. The deadline of 1 year envisaged for the final recommendations appears to be reasonable.

Senator METCALF. This seems to be an appropriate place to interrupt you, Dr. Houthakker. I have to go over and vote, and as soon as my name is called I will be right back and continue the hearings. So with your permission we will take a recess, subject to the call of the Chair.

Mr. HOUTHAKKER. Certainly.

[A brief recess was taken.]

Senator METCALF. Very well, we will be back into session, and we are delighted to have you continue, Professor Houthakker.

Mr. HOUTHAKKER. Mr. Chairman, what concerns me about S. 4145, however, is that it does not provide for adequate followup through the legislative process. Although the Commission would make "specific recommendations for legislative actions," experience suggests that proposals for regulatory reform are not viewed with much enthusiasm in some of the standing committees of Congress, by which I do not mean this committee. The fact is that these committees were responsible for the special interest legislation that has contributed so much to inflation and inefficient use of resources, and that they cannot always be expected to disappoint industry lobbyists by reserving themselves. I have already mentioned the trucking lobby, whose millions of dollars appear to be used skillfully in the preservation of the status quo. The nefarious activities of some of the dairy organizations have already led to conflictions. The cargo preference bill, already mentioned, is yet another reminder that money talks in Congress even where its sources are dubious to say the least. Indeed, anyone who desires to find the areas where reform is most needed could usefully start by determining which lobbying organizations spend the most money.

It would therefore be desirable if the bill included provisions for a special congressional committee to consider the study commission's recommendations. Some years ago, in the subsidy study organized by the Joint Economic Committee, I suggested the establishment of a Joint Committee on Special Benefit Porgrams, which would see to it that legitimate concern for particular sectors of the economy is not exercised at excessive cost to the general public. This may or may not be the right forum, but in any case it is most important that any proposals emerging from the study receive prompt and balanced evaluation without undue interference from pressure groups. The right of citizens to petition Congress should not be abridged, but neither should congressional committees allow themselves to be influenced primarily by organizations whose point of view is necessarily partial and whose methods of persuasion sometimes raise serious questions of ethics.

What I would like to see as the result of the Commission's study is a thoroughgoing modernization of the regulatory process rather than its abolition. Competition can and should be relied upon to a much greater extent than has been the case in recent years, but there are areas where a modest amount of Government supervision continues to be needed. This does not necessarliy mean that all existing regulatory commissions should be preserved. Conceivably the only thing

to do with the ICC is to abolish it, thus leaving the 80-odd years of rules it has accumulated to the historians and starting with new laws suitable to the 21st century rather than the 19th.

However, such a drastic solution might take too much time, and a more evolutionary approach, aimed at scraping off the barnacles rather than scuttling the ship, might provide more effective relief. In any case I am not in favor of combining the three transportation agencies into a single one; even in regulation itself competition has its advantages. Neither do I favor the idea of single administrators rather than collegial bodies; this idea would in practice transfer much of the power to the staff of the regulatory agencies or to the courts; however, the number of commissioners should not exceed five, except for the Federal Reserve Board. Furthermore, there should be stricter standards for the qualifications of commissioners, many of whom appear to have been selected for their political connections rather than for their professional expertise. At the risk of seeming to promote my own industry I would like to endorse a recommendation made by the Stigler Task Force some years ago to the effect that more economists should be appointed to regulatory commissions.

In conclusion, I venture to express the hope that Congress will treat this legislation as a matter of urgency. Our economy is in serious trouble although the widespread fear of a return to the 1930's is without foundation. We may well be in for a prolonged period of sustained inflation, excessive unemployment, and sluggish growth unless we reinvigorate the economy by greater reliance on its mainspring, private competitive enterprise. Action is needed on many fronts, and the results will not be immediate, but the time to start is now. Thank you, Mr. Chairman.

Senator METCALF. Thank you for your statement. We are glad to hear from an economist. Sometimes we hear too much, and they, like lawyers, just create additional confusion. Maybe it would be better just to keep them in a consultant's capacity and let the decisions be made by someone other than professionals, such as the legal profession or the economists. Anyway, we certainly need a statement such as yours.

Now, you start, I think, with the proposition that you are conceding that we are going to have such a study commission. The mere fact that I for one introduced a bill for that proposition is no evidence that I am going to support a bill. I just think that some reform-and I am going to take the word that was suggested this morning-some review is probably necessary. But could it not be done just as well by Congress and the various congressional committees? I know that you take a dim view of a couple of these subcommittees, but do you not think we could look into this whole matter as far as our congressional activities are concerned?

Mr. HOUTHAKKER. Senator, in the first place, I would like to make clear that I do not presume to anticipate you or the position of the committee as a whole, and I realize that you introduced this bill by request. Nevertheless, I would hope you would give serious consideration because the outlook for regulatory reform by other routes is, I think, distinctly bleak.

There was a proposal to reform transportation regulation under the Kennedy Administration, and again under the Nixon Administration.