$3

ON ECONOMIC AND SOCIAL POLICY

Ludwig H. Mai

Recent controversies in regard to the effectiveness of economic policy caused these remarks on expectations and psychological influences.

Policy is normally and quite generally concerned with principles

governing actions to obtain specific ends. Individuals or groups,

as the case may be, f i r s t have to establish these ends. They must

know what they want, and then find means of achieving i t . Scient i f ic

methods may be readily helpful to show these means and ways. However,

to determine exactly what is wanted is in many cases complicated,

especially when a group of individuals is involved. But when we

try to determine what is possible or feasible, while observing

patterns of human behavior or ident i t ies in relationships, i t may l

become easier to discover the desired ends for a group or groups.

Economic or social policy is often described as a search for

an equilibrium point, which may be defined more easily theoret ical ly

than pract ical ly as ref lect ing dynamic l i f e . This is a truth which is

quite generally accepted and can also be related to the "Paretian

Optimum" (any change may be beneficial for somebody but would hurt

nobody).

I f the main objectives of economic and social policy are growth

and s t a b l i l i t y , we can say that substantial progress was made in

economic knowledge and applications during the past three decades.

However, with the highest in f la t ion rate since the post-WWII

reconversion occurring simultaneously with the highest unemployment

The author wishes to thank Dr. Thomas O. Nitsch, Professor of Economics, Creighton University for his c r i t i ca l remarks and advices.

54

r a te s ince recove ry from the Great Depress ion du r i ng the f i r s t h a l f

o f the p resen t decade, se r i ous new doubts have a r i s e n concern ing

our a b i l i t y to secure and m a i n t a i n the s t a b i l i t y o b j e c t i v e . Moreover ,

w i t h the c o n t i n u i n g concerns over issues o f s o c i a l j u s t i c e and

env io rnment p rob lems, e q u a l l y se r ious ques t i ons have a r i s e n as to

whether mere economic growth is d e s i r a b l e in i t s e l f and as to

whether i t i s capable o f moving us toward d e s i r a b l e ends.

I t t h e r e f o r e seems to be necessary to c l a r i f y the o b j e c t i v e s

of economic and s o c i a l p o l i c y more f u l l y , i f t h i s is p o s s i b l e .

The d e c i s i o n s of p o l i c y - m a k e r s are g r e a t l y i n f l u e n c e d by va r i ous

power groups~ The s t r e n g t h of t h i s i n f l u e n c e depends not on l y on

the s ize o f the membership or the number o f f o l l o w e r s but very much

a lso on the e f f i c i e n c y , aggress iveness and power o f the p e r s o n a l i t y

o f the l e a d e r s h i p . This human a b i l i t y , the c a p a c i t y and i t s e x e r t i o n

is an e s s e n t i a l f a c t o r in t h i s a c t i v i t y o f t r y i n g to o b t a i n s e l f -

se rv ing p o l i c y d e c i s i o n s which may be c o n t r a r y to the p u b l i c i n t e r e s t

or common good.

B a s i c a l l y the goal o f s o c i a l p o l i c y is human w e l l - b e i n g , a

v i t a l aspect of which is economic s e c u r i t y . The a t t a i n m e n t o f the

l a t t e r ~ and thus the promot ion o f the fo rmer , are s e r i o u s l y hampered

by i n f l a t i o n and unemployment and more so when they occur j o i n t l y .

Whi le both c o n d i t i e n s must t h e r e f o r e be removed from the economic proc-

ess, the re are at p resen t no persuas ive i n d i c a t i o n s t h a t we have the

necessary knowledge and e x p e r t i s e to do t h i s . N e i t h e r the m o n e t a r i s t s

nor the f i s c a l i s t s have come up w i t h a workab le compromise or

convincing solution. True, their theoretical analytics and econometri(

models have been, in some instances, helpful in acquiring a better

5S

understanding of the given problems but they did not produce t h e

solution which is sought. We know that the expectaitons of the policy

formulators and the mill ions of economic actors in the society

at large play a dominating part. But, this is nothing new. The

question is: How do we refinc our knowledge of these expectations

and behavioral effects so as to achieve desired policy objectives in

the most effective and least harmful manner?

The f i r s t formal attempt to incorporate expectations in a

general theory of economic behavior can be found in the master

work of J M. Keynes.2 Indeed, the mass psychology in the market-

place, was the fundamental phenomenon of his system. The "Marginal

Efficiency of Capital" as the expected net rate of return on now

business investment, the "psychological law of consumption" and

related "Marginal Propensity to Consume" and the "psychological timu

preferences" of individuals and "Liquidi ty preference function"

3 are basic to the General Theory. Ten years later Ludwig Erhard spoke

about the need for a textbook of systematic psychological guidance

for the eco~omy. Others have tr ied to write such a book.

The anti-Keynesian monetarists seem to have rejected or to have

forgotten, in theory and policy, these psychological considerations.

S t i l l , in real l i f e , we cannot overlook the f a c t t h a t our motivations

to act and work are based on expectations which are caused and

guided by imaginations, ideal is t ic hopes and desires, driving us

to attempt to trace and form them into rea l i ty and to find the

equilibrium point, which however often only wi l l be dSscovered

when i t is already lost. In this connection i t should be also

recalled that even i f we reach the fu l f i l lment of our expectations

56

a change of value takes place. In fact, omly the impact of the point

of fu l f i l lment offers the highest value and sat isfact ion, which

continually declines as we grow accustomed to i t and take i t for

granted. The achievements of the aff luent society created great new

problems and new expectations, which, looking back on what we wanted

and got, now appear quite normal and natural and lead us to

demanding something ent irely new.

4 In recent times some younger economists, who have been labeled

as "Rationalists" speak about "rational expectations" They

declare: the economic policy is impotent and can change l i t t l e . I t

can do l i t t l e to increase output and employment, because individuals

and institutioF~s act to 6ffset the planned changes. Of course, Milton

Friedman has already stated for some time that policy-makers are

unable to forecast the economy correctly and are unable to time

their policy to be an effect ive response to in f la t ion or recession.

He s~mply concluded that enterprises le f t alone can do much better

in establishing what is needed and desired.

The new "Rationalists" go much further. They say that no

systematic economic policy can be devised to affect anything, except

the rate of in f la t ion. Th is is so, they say, because individuals

form their expectations about the future and respond to the policies

of governments already ahead of the time at which the policies are

f ina l l y formulated and enacted.

Two theoretical findings are emphasized in regard to the

interaction between policy and economic behavior. F i rs t , any

policy move is widely expected and discussed long before the policy

is enacted and therefore has no great impact at the time of i ts

$7

enforcement. Second, only policies not expected before they are

announced wi l l cause a change in current behavior.

This is not a new discovery, but i t rece~,tly created quite

5 an excitement among the economic profession and much controversy.

The "Rationalists" have a good point. In the past, policy-makers

and economists have often done a poor job in forcasting the

effect of policies. They had not considered human behavior and

expectations and the public had already taken "protective steps" 6

before the policy was f ina l l y enacted. Glabraith's "countervailing"

forces and powers acted more quickly thanthe policy-makers.

Many very instructive examples could be given. In fact

countercyclical policies became sometimes procyclical pol icies, and

stabi l iz ing efforts became accelerators for economic downturms

and upturns.

The "Rationalists" suggest that a monetary policy has less

effect than a fixed money,growth rule. Only i f the move of the

government comes as a total surprise or the public continuously

makes serious mi:stakes in forecasting policies (which is improbable)

wi l l monetary policy have an impact on output and employment. These

observations may contradict Milton Friedman"s teaching but are worthy

of earnest consideration. They emphasize expectations and the time

element of adjustment, but do not yet offer a better solution to the

economic and social policy problems. S t i l l they may be a new beginning.

Compare also: Nev,: Perspectives in Stabil ization POlicies, Federal Reserve Bank of San Franscisco~ Econom'ic Review, Fall 1976.

$8

I . )

2.)

3.)

4.)

5.)

BIBLIOGRAPHY

Boulding, Kenneth E., Principles of Economic Policy (Prentice- Hall, Inc., Englewood C l i f f s , N.J.) Keynes, John Maynard, The General Theory of Employment, Interest and Money (Macmillian and Co. Ltd., London) Erhard, Ludwig, Prosperity Through Competition (Thanner and Hudson, London) e .g .E . Lucas, J r . , Chicago; T.Jo Sargent, Minnesota, Neil Wallace, Minnesota, R.E. Hall, M.I.T., Benjamin Friedman, Harvard. Galbraith, John Kenneth, American Capitalism (Houghton M i f f l i n , Boston, 1952)

ERHARD ON PSYCHOLOGY AND ECONOMICS

" I f we are successful in changing the economic att i tude of the population by psychological means, then these psychological changes themselves become an economic real i ty and so serve the same purpose as other measures of economic policy taken so far . "

"Economic events are not guided by mechanical laws. The economy does not lead a l i f e of i ts own l ike an automation, but is fashioned and applied by man. I f that is so then the whole structure of the economy wi l l have to change considerably according to our actions and att i tudes. So the consequences of the methods of psychogology must not be underestimated."

"Modern psychology demands precisely that the national economic process be not merely considered in the technical sense. I t is equally important that the human beings who animate this machinery be included in national economic calculations. How we ourselves act is of decisive importance for the trend of the economy."

" I t may well be too early to compile a text book of systematic psychological guidance of the economy. In the next ten years, when more experience has gained, economic science may well produce such a volume. "

Professor Ludwig Erhard in Prosperity Through Competition (London: Thames and Hudson, 1960)

Professor Ludwig Erhard has been called the architect of the "Wirtschaftswunder" was in 1945 the economic adviser of the American occupation forces in Germany, because Minister of Economic Affairs in Bonn and Chancellor of the German Federal Republic. He celebrated on February 4th 1977 his 80th birthday.