Robert Higgs is Professor of Economics at the University of Washington. He is popular as a lecturer on economic and monetary affairs. His writings include numerous articles as well as books on The Transformation of the American Economy, 1865-1914, and Competition and Coercion.
Wage and price controls in a market economy are, according to Shultz and Dam, like an organism: they pass inevitably, and quickly, through a “life cycle.” Perhaps a more instructive analogy is the military diversionary tactic that sends a platoon to mount a surprise attack on the flank of an advancing enemy division. This preposterous little counteroffensive may throw the enemy into momentary confusion, force him to divert men and equipment to other sectors, even compel him to withdraw temporarily from certain occupied territories. But none of this can last. Unless a genuinely powerful force is brought forward, the enemy will regroup and overrun the audacious platoon’s position.
On October 24, 1978, President Carter ordered his platoon, the Council on Wage and Price Stability (COWPS), to attack the advancing wage and price structure of the American economy. Sure enough, a certain amount of market confusion, price distortion, and resource real-location ensued. Of course, the President’s diversionary tactic, the “voluntary” wage-price guidelines, did not halt what everyone was calling Public Enemy No. 1. In fact, inflation accelerated. After rising 9 percent in 1978 and 13 percent in 1979, the consumer price index (CPI) zoomed upward at an annual rate of 18 percent during the first quarter of 1980 before subsiding to somewhat lower double-digit rates. But while they had no effect on accelerating inflation, the guidelines did have other effects during their first year. They imposed substantial reporting costs on hundreds of large firms; disrupted several important collective bargaining negotiations, twice helping to bring about costly and disruptive strikes; induced distortions in the economy’s structure of relative prices, with consequent artificial shortages of various goods and services and reductions in overall economic efficiency and consumer welfare; and exacerbated a variety of social conflicts.
New Rules, National Accord, and Pay Committee
In the summer of 1979, the Council began to float its own proposals and to solicit suggestions for changes in the pay and price standards during the second program year, which began on October 1. The consensus was that the standards had to be loosened, as no one seemed willing to retain the original guidelines—holding pay increases to 7 percent and price increases to half a per centage point less than the annual rate during 1976-77—when inflation was running at 13 percent. Proposals varied widely. Unhappy with the uniform price deceleration rule, Barry Bosworth, the director of COWPS, wanted to set separate price targets for every industry in the economy. Negative reactions to this sweeping proposal soon led to its abandonment. The Council also pro posed to require firms operating under the less restrictive profit-margin standard to absorb more of their uncontrollable cost increases.
By August it had become apparent that the new price standard would be little changed. Ultimately the administration settled on the requirement that firms hold the rate of increase in their average price during the first two program years to no more than during the base period 1976-77. This implied that firms which had complied with the price deceleration standard during the first program year could raise their prices about one percentage point more during the second program year. The Council also implemented a number of minor changes in the price-restraint rules, including its own proposal to reduce the amount of uncontrollable cost increases that firms could pass through to their customers.
The greatest difficulties surrounded proposals for new pay standards. Organized labor had opposed the first-year rules and even challenged them, unsuccessfully, in the courts. With the presidential election on the horizon, the administration longed to placate the union bosses, who openly opposed certain COWPS proposals, such as a two-year cumulative pay standard similar to the two-year price standard. Aware of their powerful bargaining position, the union leaders made strong counter-proposals. They wanted to set the wage standard equal to the rate of increase in the CPI plus the long-term rate of increase in manufacturing labor productivity, which would have blown the lid completely off the pay standard. They also proposed the establishment of a tripartite board to set, modify, and hear appeals from the wage standards on an ad hoc basis. As the start of the second program year approached, the union leaders continued to negotiate with Alfred Kahn, the chairman of COWPS, and G. William Miller, the newly appointed Secretary of the Treasury.
Leaders in the administration recognized that the proposed pay board had much to recommend it as a political ploy. Not only would it please the AFL-CIO, but it would also shift the blame for unpopular decisions—indeed for inflation itself—onto the board. Because the board would represent business, labor, and the “public,” its decisions might appear more equitable and hence receive more compliance. The government would be left to play its political games outside the adversary context inherent where COWPS alone formulated and enforced the rules. While effectively abandoning its attempt to enforce stringent standards, the administration would not have to make an embarrassing disavowal of its previous commitment to a pay guideline program. In short, the pay board was Good Politics.
On September 28, 1979, President Carter and the AFL-CIO announced that they had entered into a National Accord. This “historic document” turned out to be a hodgepodge of highfalutin declarations and vague, mutually incompatible policy proposals. While asserting that “the war against inflation must be the top priority of government and of private individuals and institu tions,” it maintained that this war “should not mean acceptance of higher than otherwise levels of unemployment.” The Accord said nothing specific about the guidelines program except to endorse its continuation with “greater public participation.” All it really accomplished was expressed in its final paragraph, which declared that “the essence of this National Accord is involvement and cooperation . . . . It is our purpose to establish procedures for continuing consultations between American labor leadership and the Administration.” Besides the AFL- CIO, the Teamsters and the United Auto Workers endorsed the Accord. Thus did the Carter administration formally mend its relations with organized labor.
As part of the deal, the President announced the formation of a Price Advisory Committee and a Pay Advisory Committee. Everyone understood that the former, a group of six “public” representatives, was a pure formality. The latter, however, was a key concession to the union de mands. It was chaired by John Dunlop, a Harvard economist who had headed President Nixon’s Cost of Living Council and served as Secretary of Labor under President Ford. Besides Dunlop, the Pay Committee included five other “public” members and six each from business and the unions.
The Pay Committee moved slowly. Although a second-year pay standard was due by October 1, the board took months to resolve its internal conflicts. Labor members wanted the board to invest itself with broad discretionary power to validate individual pay agreements on an ad hoc basis. Business members preferred to retain a single numerical pay standard applicable across the board. “Public” members feared that a compromise, which called for pay agreements to fall within a prescribed range, would effectively establish the upper limit of the range as the de facto standard and make a mockery of the compromise. In January the contentious members finally agreed to the compromise, but not until March 14, 1980, did President Carter publicly endorse the Committee’s major proposal. This called for pay increases to be held within a range of 7.5 to 9.5 percent during the second program year. It also established that the value of cost-of-living adjustments (COLAs) would be computed, for purposes of determining compliance, on the as sumption of a 7.5 percent rate of inflation. In practice, these standards were tantamount to no standards at all for labor unions with COLAs in their contracts.
The Guidelines Program as an All-around Nuisance
Not content with the hundreds of reports received by its small staff during the first program year, COWPS requested even more reports in 1980. Previously, only companies with annual sales over $250 million, about 1,200 firms, had to report. Early in 1980 the Council required that all firms with annual sales over $100 million, some 2,900 companies, file quarterly reports. Reporting costs had reached, in the words of a Fortune writer, “untold millions of dollars” during the first year; they must have reached much higher in 1980. A single firm, TRW, Inc., was said to be spending about $1 million per year, mainly for extra employees to handle the extra paper work. This compulsory reporting, required only of large firms, constituted an unlegislated new approach to antitrust policy, for it imposed a penalty on bigness per se.
The Council’s capacity to back up its threats diminished in the second program year. During the first year it had forwarded the names of definite noncompliers to the Office of Federal Procurement, which was authorized by the President to withhold government contracts of $5 million or more. But no one had ever actually been denied a contract, not even the notoriously unrepentant noncomplier, Amerada Hess. The labor unions had strongly objected to the government’s threat to withhold federal contracts—a threat that employers were using as a club in labor negotiations—and precisely this grievance had led them to challenge the guidelines in the courts. As part of the deal that produced the National Accord, the administration made a “gentleman’s agreement” not to invoke this sanction against non-compliers. Still, the government publicly retained the option to violate its private gentleman’s agreement. Therefore, the managers of many large firms with substantial government contracts, like Charles R. Allen at TRW, insisted that “the voluntary wage and price guidelines are mandatory for us.”
Distortions and Inequities
So COWPS continued to threaten, negotiate, make deals, and build up its public enemies list of noncom-pliers. General Motors, held to have violated the pay standard, agreed to compensate by holding down the prices of its products. Ford, also in violation of the pay standard for its agreement with the United Auto Workers, came into compliance by agreeing to restrain further its pay increases for managerial employees. Chrysler, already foundering in a sea of troubles, was forced to renegotiate its contract with the UAW. Yet not everyone would make a deal. By mid- October, 1980, the Council had compiled an enemies list of 36 companies which had not complied with the guidelines and would not make amends acceptable to the President’s men.
Wherever COWPS trod in the labor markets it left a mark of inequity. The major source of these distortions was the preferential treatment of workers with COLAs—the preference arising from the implausible assumption of 7.5 percent inflation used in evaluating the COLAs. A contract that compensated workers for two-thirds of the increase in the CPI, for example, could award them a 4.5 percent wage increase outright plus the COLA and still be considered in compliance (4.5 + [2/3][7.5]—9.5—the upper limit of the permissible range of pay increase). If inflation actually turned out to be a mere 12 percent, such a contract increased the workers’ compensation by 12.5 percent (4.5 + [2/3]—12.5). Thus, unionized workers with COLAs in their contracts fared much better than other workers. Not only was this directly discriminatory, but it also represented a clear encouragement of unionization. Several surveys confirmed that the guidelines distorted wage patterns in many labor markets. Personnel managers blamed the pay standards for increased turnover and diminished morale among their employees.
COWPS also produced a variety of distortions in the product markets. For example, the aluminum industry, troubled by guidelines-induced shortages during the first program year, fared no better in the second. An international price disequilibrium stimulated a surge of exports, exacerbating the domestic shortage, as the guidelines kept the U. S. price down while foreign prices soared. In February, 1980, American producers posted an ingot price of 66 cents per pound, while foreign buyers were paying over 90 cents. When COWPS abruptly changed its rules with respect to the timing of permissible price changes in March, 1980, pro ducers had to roll back some previously announced price increases for fabricated products to offset their increased ingot prices. The artificial price juggling dictated for major producers by the erratic guidelines created a cost-price squeeze for smaller companies specializing in extruded aluminum products. Under the distorted price structure, many of these smaller firms feared that they would soon have to go out of business. Such are the unintended consequences of twisting the market price structure out of its normal configuration.
Early in 1980, with inflation roaring along at an unprecedented 18 percent rate, panic set in. A number of vocal economists, including Gar Alperovitz, head of the National Center for Economic Alternatives, Barry Bosworth, erstwhile director of COWPS, and Bruce K. MacLaury, president of the Brookings Institution, appealed for the implementation of comprehensive, mandatory wage-price controls. As always, the general public supported this proposal. Early in February, the Gallup poll found that 58 percent of those interviewed favored mandatory controls, only 34 percent opposed them. Most importantly, Senator Edward Kennedy, then vigorously campaigning against the President for the Democratic nomination, also called for mandatory controls.
The President, of course, had to “do something.” To his credit, he resisted the pleas for mandatory controls. Instead, he pressured a reluctant Federal Reserve Board into a new diversionary foray, a jerry-built program of controls over credit and investment institutions. And he resorted to jawboning, launching a series of meetings with industry delegations to urge greater price restraint.
COWPS and the President made good use of public hostility toward the oil industry. On February 25, 1980, the Council released a report accusing eleven oil companies of guideline violations. The Mobil Oil Corporation led the list of sinners. Late in March, Carter publicly accused Mobil, which he had earlier called “the most irresponsible company in America,” of refusing to refund more than $45 million in alleged overcharges to customers. “It’s difficult for me to understand Mobil’s position,” said the President, “at a time when compliance is so important.” Mobil responded that the charges were “patently and obviously political.” The whole dispute turned on a technicality related to whether compliance should be determined on an annual or a quarterly basis. It sprang originally from Mobil’s being caught between conflicting requirements of COWPS and the Department of Energy and was exacerbated by a retroactive change in the rules by COWPS.
In the midst of this furor, the Defense Logistics Agency announced on April I that it had awarded Mobil a $154 million contract for jet fuel. A Pentagon spokesman tried to account for this astonishing event by saying that the contract had actually been awarded on Friday, before Mobil was officially listed as a guidelines noncomplier on the following Wednesday. But George Marienthal, a deputy assistant secretary of defense, gave a more plausible explanation. “The Department of Defense is in the business of national security,” he said. “We needed the fuel, so we proceeded.” (It subsequently came to light that Mobil and other companies supplying the Department of Defense had been routinely obtaining waivers from COWPS’s standards for a long time.)
Still, this little tempest persisted. At a news conference on April 17, Carter again railed against the big oil firm and pledged to “continue to let the American people know about the irresponsibility of Mobil.” The company, now taking a more conciliatory tack, maintained that “an honest difference of opinion exists” and expressed the hope that “this difference can be resolved through good-faith negotiations.” Late in April a compromise was finally reached when Mobil agreed to forgo $30 million in permissible price increases to make amends for the $45 million of alleged overcharges. The government then removed Mobil from its enemies list. In retrospect, the whole affair appears as no more than another sorry episode of Presidential demagoguery.
Assessing the Program’s Effectiveness
From its beginning, the guidelines program rested on a fallacious economic theory. When one employs this theory in assessing the effectiveness of the program, one reaches false conclusions. The root of the problem is a persistent confusion of absolute and relative prices. Equivalently, one can say that the government’s theory embraces the layman’s untutored notion that any individual price increase, whether for bread, gasoline, or labor, signifies inflation. Defining inflation in this way, which is now commonplace in the news media—witness “energy inflation,” “wage inflation,” and similar terms—can only confuse and mislead. Proponents of this view quickly arrive at the conclusion that prices (in general) rise because prices (in particular) rise. This attempt to substitute arithmetical identity for economic theory is completely empty as an explanation of inflation.
In modern economic analysis, inflation is defined as an ongoing decline in the purchasing power of money. Inflation, properly defined, cannot occur unless total money expenditure increases relative to total real output. In recent years, inflation has occurred mainly because large increases in the money stock have fueled a rapid increase in money expenditure while total real output was expanding much more slowly—or sometimes not at all. The Federal Reserve System, under heavy pressure to monetize the enormous federal deficits—not OPEC and not acts of God—caused this excessive growth of money expenditure.
Yet the government continued to deny all responsibility and to attempt to shift the blame onto others—Big Business, Big Labor, Arabs, and Nature. In his economic report to the Congress in January, 1980, President Carter’s third sentence was: “Higher oil prices were the major reason for the worldwide speedup in inflation during 1979.” Inflation was “concentrated in a few areas,” he said, citing energy, home-ownership and finance, and food. This is nonsense. Inflation cannot be “concentrated” in certain product lines; it is not something that happens to the prices of particular products but rather applies only to the average price of all products (or, equivalently, to the single “price” of money).
The guidelines, according to the President, “served the Nation well. Although the price standards had only limited applicability to food, energy, and housing prices, in the remaining sectors of the economy, for which the standards were designed, prices accelerated little.” This assessment rested on the findings of studies by the Council of Economic Advisers as well as COWPS. The latter Council concluded from its statistical analyses that “had the standards not been in place during the year and a half ending in March 1980, the annual rate of increase of labor compensation would have been almost 2 percentage points higher . . . and the overall inflation rate almost 1/2 to 3/4 percentage points higher.”
This conclusion only reflected the idea that inflation occurs whenever an individual product price rises. During the year and a half studied, the GNP deflator, an index of the overall average price level, increased at an annual rate of about 9 percent. (The CPI, an unrepresentative index of the overall price level, increased during the same period at an annual rate of about 16 percent.) The Council claims that because some prices, those effectively restrained by the guidelines, rose less than they otherwise would have, the overall rate of inflation was restrained. This assertion implies, first, that the rate of increase of money expenditure diminished for one class of goods (those subject to the guidelines, which represent about 60 percent of the economy), which is by no means certain, inasmuch as enough additional units could have been bought to more than compensate for the restrained prices; and, second, that the rate of increase of money expenditure for all other goods remained the same as it would have been in the absence of the guidelines, which is implausible. Neither COWPS nor the CEA attempted to show that the guidelines reduced the rate of growth of overall money expenditure. Of course, they could not show this, because it did not happen.
To the extent that the guidelines succeeded in restraining some individual prices—and they certainly appear to have done so—they succeeded only in distorting the structure of relative prices, not in reducing inflation. Inflation, no matter which index is used as a measure, unquestionably accelerated after the guidelines program went into effect. The GNP deflator increased at an annual rate of 6.9 percent between the third quarter of 1976 and the third quarter of 1978. Between the latter quarter and the second quarter of 1980, under the guidelines, the annual rate of increase was 9.2 percent—exactly one-third higher. The guidelines clearly failed to prevent an acceleration of inflation. To show that they simultaneously dis-totted the relative price structure, as COWPS and the CEA proudly did without fully appreciating what they were doing, is only to add another item to the already lengthy indictment against this make-believe anti-inflation program. In reality, because distortion of the relative price structure leads to misallocation of resources, thereby increasing economic inefficiency, one can conclude that the guidelines must have raised the rate of inflation by lowering the economy’s total real output below what it otherwise would have been.
As the summer of 1980 merged into autumn, the coming elections preoccupied the Carter administration, and the guidelines program received little attention. The two advisory committees recommended that the existing standards be extended through December 31, and COWPS accepted this recommendation. The guidelines, said Kahn, were a “profoundly political” subject, and it would be best to defer consideration of further changes in the program until after the election. Most of the suggestions received from business and the general public called for either retaining the existing standards or scrapping the program altogether. In August the Business Roundtable, a group of some 200 executives of major corporations, which had earlier supported the program, called for its termination. Guidelines, said the Roundtable, “distort public understanding of the causes of inflation.” True enough, but un fortunately the program had done much greater damage. Most significantly, it had helped to delay the ultimate day of reckoning when the inflationary enemy must be faced squarely and fought with real weapons. It had therefore insured that the inevitable battle would be an even costlier and more socially wrenching affair.
With Jimmy Carter’s crushing defeat on November 4, 1980, the guidelines were doomed to pass away completely. But we would do well to remember that this kind of policy, like the phoenix, has a way of rising from the ashes. (Not so long ago, a Republican administration, on frightfully flimsy grounds, gave us mandatory wage-price controls.) Inflation is not about to disappear simply because Ronald Reagan has been elected. To bring it under control, heavy economic and social costs will have to be borne and difficult political decisions made. Not inconceivably, the Reagan administration may someday find itself tempted to impose controls. One can only hope that a full appreciation of the workings of the Carter program—and of the Nixon program before it—will discourage any future resort to such misguided and counterproductive policies. 
6. Council on Wage and Price Stability, “The Pay/Price Standards Program; Evaluation and Third-Year Issues,” Federal Register 45 (Friday, July 11, 1980):47067. See also the Annual Report of the Council of Economic Advisers (Washington, D. C., 1980), pp. 38, 84.