Behavioral science research; How behavior influences the economy

The following program is produced by the University of Michigan broadcasting service under a grant he made from the National Educational Television and Radio Center in cooperation with the National Association of educational broadcasters. How behavior influences the economy. A program from the series of human behavior social and medical research produced by the University of Michigan broadcasting service with special assistance from the Mental Health Research Institute of the University of Michigan. These programs have been developed from interviews with men and women who have the too often on glamorous job of basic research. Research in medicine the physical sciences social sciences and the behavioral sciences. Occasionally you will hear what may seem like strange or unfamiliar SOG these are the sounds of the participants office laboratory or clinic where the interviews were recorded. The people you will hear today are Max Milliken director of the Center for International Studies at the Massachusetts Institute of Technology. Jacob Marsh aka professor of

economics at Yale University and Kenneth Arrow a professor of economics at Stanford University and my name is Glenn Phillips. Sometimes economic process of spending and saving by consumers business investment government deficits and the like are studied as if they were independent of the decisions of human be the consumers the businessmen and government officials traditionally economic success sought to establish the laws of the Marketplace economics as a behavioral science studies decision making by consumers and business men. As it is influenced by people changing motives the attitudes and expectations. The crucial question is does such a study of economic behavior help toward a better understanding of the economy. We should ask this question with respect to two of the greatest economic problems of our time. Recession and unemployment on the one hand and inflation on the other.

First I asked Professor Marshak of Yale University how he felt economics fitted into behavioral study the economics of course is about behavior or behavior of people in them and in market behavior. Given that planned so if economics is a behavior it is a it's but it gives a particular twist to its study of behavior because it's interested in so-called rational behavior in how people solve their problems. They live their lives. Being sand consumption and money making and how can they sold them in the best possible way. Economics is about economizing and so economists usually start with their son should be able to do the best they can do this because their national behavior. We know that people actually do not behave rationally. It's perhaps not a very bad

first approximation. Once again Professor Marsh shark answered this way when asked if economists were concerned with the decisions that people make. We say that people decide about how best to reach certain goals how best for example to provide themselves with who would be best to what are the best decisions in the stock market and so on. Now they are going to mix has been used for very much not only to describe you're going to behave that way but also to advise people as to how to behave. What is the best decision. This question is very often I ask an economist for example their management consultant to companies asked by by manufacturing companies how to behave how to reorganize themselves or how to revise their policy on production or inventory and so on. Professor Mark Schock then continued by offering examples of decision making in economics.

But there are general principle of decision making which possibly apply to any kind of fulfilling goals where the goal is money making or feeding oneself or one's children or guaranteeing a victory in a possible war. So the front runner might say as someone said that economics is about economizing. I mean by this economics is about making the most economical which means simply the best decisions in a given situation. Going out to Doctor Millikin and the discussion I had with him at Cambridge he responded to this question. Does inflation as we have had it in America during the last 10 years have any new features different from those described in many countries over several years. Well there is a prevailing notion that a new element has been introduced into the analysis of inflation into the causes of inflation by changes in the organization of the American economy. Normally we have thought of

inflation in economics as being primarily the result of an expansion of demand at a greater rate than the capacity of the productive system to expand the supply of goods and with more money chasing the same or fewer goods. Prices tend to go up. Now we have had the concept of so-called cost push inflation introduced which is of a consequence alleged to be a consequence of the increasing degree of monopoly on both sides really of the labor market depending on whether you are a member of the employer class or a member of the labor class. You emphasize their monopoly on the labor side of the picture or monopoly on the employer side of the picture. But there is certainly a much to a much wider degree than was true in the 19th century in the United States and then has

been true in most other historical inflations. There is a tendency for wage bargains to be made by a VERY MUCH larger groups industry wide collective bargaining such as we recently saw an example of in the steel industry is a case in point. Now it's essential for this inflationary pressure cost push pressure to be effective for there to be a monopoly really on both sides not necessarily monopoly but heavy concentration of power on both sides of the labor market. Because if there is a monopoly amongst employees there is no tendency the union pushing for higher wages is freed of any fear that its employment position will be undercut by competing groups that will be willing to work for less. At the same time if there is monopoly

on the buying side of the labor market the person hiring labor is reasonably confident that he can pass on any increase in his wage costs that results from wage increases in the form of higher prices. Because all of his competitors are subject to exactly the same degree of the increase in wage costs. It is certainly true that in the recent history of the United States we have had continuing inflation in periods of fairly substantial unemployment. Our price level was constant in some areas and continued to rise throughout the fourth quarter of fifty seven and four out of fifty eight when unemployment got up as high as 6 or 7 percent of the labor force. This is most unusual. Normally the business cycle is associated with a price cycle. Prices fall off as business falls off as demand falls off and as

unemployment rises and then rise again as the labor force becomes fully employed and the pressures of demand tend to exceed supply the price of it hasn't been behaving that way in the last decade. There is greater institutional rigidity in prices as well as a greater degree of concentration of power on both sides of the labor market which leads to this notion of a cost push instead of demand pull inflation as possibly being a relatively new feature of the scene. Are there new features involved with the way people behave. For example businessmen trade union leaders and consumer. In so far as business insofar as a trade union leaders continue to believe that they can increase their own real incomes by pressing for the highest possible wages you tend to maximize the tendencies for cost

push inflation in so far as businessmen believe that their profit position is their only responsibility and that their profit position can be protected by passing wage increases along in price increases. Clearly the pressures for inflation are going to continue to be great. Many people however see some offsetting factors in the current scene. Labor is becoming increasingly aware of the fact that wage increases when they are across the board for a large fraction of the labor force and even in some cases simply for a whole industry are very likely to be followed by price increases which in turn are followed by increases in the cost of living. Now if an increase in the money wage isn't really going to bring you any increase in your real wage they're very much less incentive to press for an increase in the money wage. 50 years ago it's almost certain that what economists call the money

illusion was predominant amongst members of the working classes that is they believe that a dollar was a dollar was a dollar and if you could get a dollar more for a day's work that was a lot of good. Now increasingly partly through an increased understanding of the economic system partly just through the experience which we have been through in the last decade of substantial price increases following increases in wage rates. The labor force and unions generally are very much more aware. The real value of money and of the fact that wage increases but at the price of price increases don't really get them very far. This hasn't yet doesn't yet constitute a serious inhibition on the pressure of wages of labor for higher wages because it's still true that individual sectors of the labor force bargain separately for wage increases and that automobile workers

still hold preference to nce that if they can get an increase in the wages of automobile workers the costs of the cars they buy may go up but they'll be a lot of other prices that won't go up. Nonetheless there is a tendency for the labor union pressure for increased wages to be somewhat more rational and somewhat more limited in consequence of the increased recognition on the part of labor unions that. Wages are connected with prices in some sense and with the prices they themselves pay. The same point holds for business. There is an increasing recognition on the part of the business community that even though an individual firm or even an industry may be able to protect its profit position in the face of increased wages by simply passing on increased prices that nonetheless an environment an economic environment in which inflation is common is a relatively unhealthy

environment for business and that therefore there is some reason for the business community as a whole to resist the upward spiral of wages and prices even though their own individual profits might be protected by this. In other words to summarize the change in attitudes that I think is occurring both in the labor field among labor leaders and among business men. There is an increasing recognition in both groups of the consequences of their private behavior for the behavior of the economy as a whole. There are some who believe that we can rely on this sense of public responsibility in the part of both groups to prevent the wage push from leading us into undesirable inflation. I don't think we've quite reached that stage yet. I think there is still a fairly serious danger of the accumulated pressures for private interest leading to

a failure of the public welfare. And I think this has to be resisted by public policy relating to the overall availability of money. Has there been progress in our understanding of the economic motives. And can such progress help in fighting inflation. Yes I think there certainly has been as you say. An increase. It's not so much an increase in our understanding of economic motives it's an increase in our understanding of how the economic system works. And this is not just an increase in the understanding of economists and social scientists. I think there's been an enormous increase in the understanding of how the economy as a whole works on the part of those people whose decisions in fact are responsible for producing inflation. There's been an increase in the understanding of labor unions an enormous increase although they don't always behave as though this were true. There's been an enormous increase in their understanding of the

consequences of general wage increases for the economy as a whole and the same is true I think on the part of the business community and with this understanding it isn't correct to say the motives have changed but if you understand a phenomenon better then you're likely to behave in ways that are more likely to get the results from work. Have acts of government business leaders and of the consumers contributed in bringing about recessions during the last 10 years. This is a question on which there will be very very wide differences of opinion everybody will say that acts of one or another of these three groups have certainly played a part. The relative emphasis that would be put on the responsibility of each of the three groups would be different. Some would argue that the restrictive policies of the Federal Reserve System in raising interest rates quite sharply in the fall of 57

were of considerable importance in producing the decline in investment which brought on the depression of fifty eight others would argue that the buying spree in which consumers engage particularly with respect to automobiles and durable consumer goods in 56 and 57 was responsible for the recession that people overstocked private citizens overstocked endurable consumers goods in in fifty five and six and seven. And at this rate of purchase couldn't be continued because the inventories of consumers had just built up to a high level and had to be. Had to fall off the same kind of argument can be made with respect to business policy. Some would argue that business could do a great deal to even out the principal cause of relatively minor fluctuations in the national

income which is fluctuations in the inventory policies of businesses. On balance I think you have to say that in the absence of very effective governmental corrective action we are certainly likely to get bursts of activity followed by bursts of relative inactivity. This is much less true now than it was 25 or 30 years ago and government can be charged with some responsibility particularly in countering these inherent changes that have come about in the private sector. As a consultant for this program Professor George controlled I stated the post-war recessions were fairly short and mild. And that prompted the last question to Dr. Miller is this fact connected in any way with increased knowledge of economic behavior after Milliken said. Yes I think it's connected very much with increased knowledge of economic behavior on the part of both

government and and business. We have built into our economic system since the late 30s. A variety of measures which tend automatically to offset fluctuations in private incomes. We have a very much more progressive steeply progressive income tax than ever before this means that when. Private incomes for all the withdrawals from purchasing power are represented by taxes also fall very sharply and leave more money in the hands of consumers. In periods of otherwise slack demand on the other hand when incomes rise very rapidly the progressive income tax means that a very much larger share of this educational income is siphoned off into tax revenues and therefore the inflation doesn't go so far. Similarly we have much higher unemployment benefits now which

mean the purchasing power is pumped out in times of depression and this flow of payments is falls off and is reversed in the form of Social Security tax payments. In periods of of high employment the fact that we have these built in stabilizers these have been partly put in on purpose and consciously by government recognizing that they would have a stabilizing effect. Similarly business now understands that these stabilizers exist and business does much more long range planning in its capital expenditure policy than was the case 25 years ago. Business is much less likely at the first sign of a fall off in demand to cut back all of its major capital expansion program such as they did in the early thirties because business has confidence that this will be it will be temporary and B that it will not go to great depths because of government action. The final question today was asked of Professor Kenneth Arrow. Would an

unforced economy such as the wartime office of price administration bring about any economic stability or an economic model he said. It is probably true that if worst economy in the US in the sense that you mention. Is capable of greater stability than a free enterprise economy. By the way it is capable I want to stress the fact that it depends how our government manages the economy. It's perfectly conceivable that a government managed economy because of its. Lack of careful attention to its day by day needs for change may suddenly make great changes instead of making small ones continuously. It may therefore be quite unstable from a certain point of view. In general a planned

economy will avoid the kind of instability associated with the business cycle at least in a manifestation of unemployment. It is likely however to work on a different basis. One of priorities in crash programs which mean that if that any one branch of the economy may be crisis and for long periods of time and suddenly explode in a great fury of activity as the tension the government is directed there I understand for example that housing in the Soviet Union after having been at a very low level for a great many years has suddenly entered a boom phase with I may add the obvious effects on quality. But there are a number of questions that are raised by this and want to read it is it that we are trying to achieve. It is a familiar doctrine of economics that's under a number of conditions which should be carefully paid attention to the

price system is not merely a way of coordinating various decisions but a rate that in a certain sense makes in each individual as satisfied as he could hope to be compatible that is with the satisfactions of others. Perhaps one should clarify this in the first place. We start by assuming. That an individual's satisfaction or happiness or whatever you want is measured by his choices. If he says he prefers a better and less margarine less margarine a more butter we agreed that is what he should get. Other things being equal. So we're trying to make every individual as well off in the terms of his own choices as possible. Now what is this possible mean for us in the first place it means within the limitations imposed

by natural resources and technology. You can't get more than a certain amount of goods out of the natural resources available to us under any given state of technology that we may hope to change the state of technology in time. But of course in a world of a great many people. There is also the question of taking from one and given to the other. Economists like to separate the question of the distribution of income from the question of what they term economic efficiency are optimality. We tend to say whatever else we want to do with society. We don't want to have a situation in which everybody could be made better off by reshuffling the goods. If there's some I reorganize and production and consumption. So every individual could be made better off than he now is and a car is to be tempted to say the present state is inefficient.

It may still be true that once we've gotten everybody to a state with this reshuffling is impossible that we wanted this. Take away goods from A and give to B because individual A is very poor in example right away take away from the rich and give to the poor or vice versa if your ethics happen to run in that direction. Never really an argument of economists is that in fact the competitive prices to which I described earlier does at equilibrium and I stress that. Achieve precisely this goal. If the prices are really equilibrium prices and every individual is making his decisions in accordance with those prices then it is not possible to make everybody better off under another regime. Remember I have two things first place I've insisted the economy be an equilibrium and we already

seen there are dangers of instability so that it will not automatically get there. Secondly I have assumed that the criterion of individuals being better off is in terms of his own choices and thirdly this may not have been so clear. I was saying that the price ystem really governs every relationship between individuals. Now the last case is covers probably commas for me to call external economies a simple case would be that of the. Relation of parent and child in regard to compulsory education. It is the parent who decides whether or not the child goes to school. It is the child who in the long run benefits result is the the decision of the parent is not really matched up with the benefits.

In particular a firy across this cannot happen in reality. The parent in deciding just not send his child to school should recompense him with a sufficient amount of money to make up for the lack of schooling. Obviously pricing cannot be pushed to such absurd lengths and therefore it is necessary for the government to interfere with a pricing mechanism. In many ways zoning is a very famous example of this. Take one illustration of which economics textbooks you so much smoke from a factory is a cost to the neighbors and are ordinary less a property there is no effective way for the factory to be compelled to pay a price for this. Instead of this we it. Proceed by government regulation to prohibit smoking. Smoking factories in certain areas. I'm sitting here in Los

Angeles as I say this and the problem with smog. Of course as a wonderful illustration of these external economies. Now whether we call it an ethical problem or not just perhaps a little dubious. The ethics involves a judgement as to whether it is better to tell people what they want to have or to let them choose themselves and to agree that they ought to be the victims of their own bad choices. I say there are some situations in which there is no way to make the price system work. And there I don't think it is purely a question of ethics to say that the government has to intervene. This has been a discussion on how behavior influences the economy. The participants were Max Milliken director of the Center for International Studies at the

Massachusetts Institute of Technology. Professor Jacob Marsh aka professor of economics at Yale University and Professor Kenneth Arrow professor of economics at Stanford University. Next week you will hear Professor Marsh act and Professor arrow as they discuss decision making in economics on the next program from the series human behavior social and medical research consultant for this program was Dr. George of the University of Michigan. We extend our special thanks to the Mental Health Research Institute of the University of Michigan for their assistance. And Philip speaking asking that you join us next week and thanking you for being with us at this time. This program has been produced by the University of Michigan broadcasting service under a grant in aid from the National Educational Television and Radio Center in cooperation with the National Association of educational broadcasters. This is the end of E.B. Radio

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