Knowledge that Transforms

T HE recent report of the Economic Policy Commission of the American Bankers Association entitled A Plan for Member Bank Reserve Requirements is a remarkable document. The bankers are, in effect, asking Congress to hand them on a silver platter $9.8 billions of earning assets in place of an equivalent amount of unearning cash assets which they are now required to hold as reserves. The proposal is to count vault cash as part of the required reserves and to reduce the reserve requirements from the present levels (20 per cent for central reserve city banks in New York and Chicago, i8 per cent for reserve city banks in some 50 of the largest cities, and I2 per cent for smaller banks) to a uniform io per cent.' Of the $9.8 billion, $7.7 billion is accounted for by the reduction in reserve requirements and $2.I billion is accounted for by the inclusion of vault cash as part of required reserves. It is evident that only a very small part of the windfall would accrue to the smaller socalled country banks which hold about 38 per cent of the total assets of member banks. The proposal, if enacted into law, would conspicuously favor the large banks. American history is replete with government subsidies on a handsome scale. In many, possibly even in most cases, these subsidies from the railroad land grants to low-cost housing -can be justified from the standpoint of the general welfare. But no one will deny, I think, that there are few if any actions of government that demand a more conscientious assessment of general social benefits and costs. Subsidies, open or veiled, should continually be subjected to careful scrutiny. And this is especially true of subsidies which are veiled in mystery as is the case with the one here under consideration. The Commission says that a clear-cut understanding on the part of the public is highly important. Unfortunately, the report falls considerably short of this worthy aim. Still there is no need to feel alarmed. The Congress has evidenced in recent years a high degree of enlightenment with respect to monetary and banking matters and is not likely to act hastily on this proposal. World War II could have been financed entirely (apart from taxes and bond sales to the public) by the Federal Reserve Banks. This would have involved no subsidy to anybody. The war was indeed partly financed in this manner. The Federal Reserve Banks absorbed about $22 billion of new United States securities. The commercial banks, however, absorbed much more, about $69 billion. To enable them to acquire this huge volume of earning assets, they were supplied with the requisite reserves. This cost the banks not a cent. Some economists objected strongly to this procedure. They wanted the Federal Reserve to do all the bank financing in order to prevent the bestowal of a huge windfall of earning assets on the commercial banks. The policy pursued could, however, be justified. The volume of monetary transactions was rising by leaps and bounds under the rapidly growing war economy. This development involved huge increases in the cost of banking operations. War financing involved extensive banking services performed for the Treasury by the banks. Had the war bankfinancing been done exclusively by the Federal Reserve, the commercial banks would have had to be subsidized in some other manner, or else they would have been compelled to charge unbearably high service charges. The Economic Policy Commission deplores the fact that the Federal Reserve Banks had absorbed so high a proportion of the war issues. The commercial banks could have done the job with less use of Federal Reserve credit had the reserve requirements been reduced. Had this been done, nearly all of the asset windfalls would have fallen to the commercial banks and virtually none to the Federal Reserve Banks. The Commission now wishes to back The report suggests that this may be lowered or raised by the Federal Reserve Board within the range of 8 and I2 per cent.

T HE upheavals in Eastern Europe make it more than usually timely to examine some aspects of the postwar economic development of this area. This discussion is devoted to the mechanism of trade among the Eastern European countries and will attempt to give some evaluation of its efficiency. Section I provides some background on developments in the area since I945; section II discusses data on the volume and pattern of trade and on currentaccount balances; section III describes how the volume, composition, direction, and terms of trade are determined by the state planners; and section IV evaluates the efficiency of the system as presently operated.

Walter S. Salant, Beatrice N. Vaccara, Primary Effects on Employment of Shifts in Demand from Domestic to Foreign Products, The Review of Economics and Statistics, Vol. 40, No. 1, Part 2. Problems in International Economics (Feb., 1958), pp. 91-103

W HILE many economists have focused their descriptive and analytical energies on the size distribution of income, no wholly useful or empirically validable explanation for the inequality of individual income receipts has been developed. This article describes some empirical research intended to throw some new light on the factors which determine the size of individual incomes. The study involves a crosssection analysis bringing together data on the income and economic characteristics of a large number of individuals. We hypothesize that the amount of an individual's income is a consequence of the action of a number of discernible independent variables and of chance variation. In other words, we suggest that size of income can be explained on the basis of the following regression model: Y = ao + aIX1 + a2X2 . * + ctnXn + U where Y is the size of an individual's income; X1 . . . X,. are the independent variables; and u represents random variation. Such a statistical approach is frequently employed with regard to other social and economic phenomena, but it has never been explicitly applied in the study of the income distribution. While this methodological approach does not limit the nature and number of independent variables which may be introduced into the equation, in practice it becomes necessary to restrict the scope of the problem. We have postulated a particular hypothesis. Casual observation what may facetiously be termed armchair empiricism suggests a connection between the diverse nature of the productive services offered by individuals and the inequality of their incomes. We hypothesize that such heterogeneity, as illustrated by the differing socio-economic characteristics of the workerincome-recipients, plays a part in determining the size of incomes. In other words, we suggest that personal socio-economic characteristics are important independent variables in our regression model. We aim to ascertain whether such a notion has a place in a theory of income size distribution. In addition, we have investigated the variation of income which remains after the socioeconomic heterogeneity of its recipients has been allowed for. An exhaustive analysis of all other factors which may have a relationship to size of income was not possible, and no effort in this direction was made. However, our regression model does postulate the presence of random residual variation, and so the second part of the study was focused on this aspect of the distribution process. The analysis was limited to income from wages and salaries. In each case, we have dealt only with the earnings in one year of one individual employed full-time (as nearly as can be determined) for wages and salaries only. It is one of the complicating aspects of statistical work dealing with the size distribution that so much of the data concern total income receipts of spending units regardless of source, number of recipients, length of time worked, etc. Interesting as these data may be from a welfare point of view, they throw together a number of separate problems which cannot be handled properly when we are concerned with explaining the size of earnings. The statistical information upon which this research is based comes from the I950 to I953 Surveys of Consumer Finances of the Survey Research Center at the University of Michigan. These sample surveys, carried on annually under the sponsorship of the Federal Reserve Board, gather information on the financial status, spending and saving habits, etc. of a representative sample of approximately 3,000 American spending units. Among the varied information gathered are extensive data on in* This article embodies material from my unpublished doctoral dissertation, Some Aspects of the Income Size Distribution, University of Michigan, I956. I am particularly indebted to Dr. L. R. Klein and Professors James N. Morgan and Daniel B. Suits. Appreciation is expressed to the Survey Research Center at the University of Michigan who supplied the empirical data on which the study is based.

T HE growing complexity of managerial structures in the modern economy requires an increasing reliance on accounting as a tool of management. Effective management in such bureaucratic structures is achieved only by allocating responsibility unambiguously and then applying sanctions and conferring rewards in close accordance with the execution of responsibility. The effectiveness of control depends in large part on detailed reporting concerning the fulfillment of responsibility, and the crucial role of accounting in this process is determined by the simple circumstance that responsibility is often specified in terms of accounting magnitudes. In the Soviet Union, the consolidation of the entire economy under the direction of the state has confronted the Soviet economic administrators with the general problem of control in an acute form, and they have been strongly conscious of the necessity to strengthen accounting as one of the instruments of control. In particular they have placed great emphasis on cost performance as a general index of operating efficiency, and have elaborated a comprehensive system of cost accounting and reporting as an aid in controlling the manager-bureaucrats of their economic system. The purpose of the present article is to describe some of the problems of cost accounting in the setting of the Soviet economy and to make some evaluation of the effectiveness of Soviet cost accounting as an instrument of control.' Accounting supplies merely an ex-post record, and so cannot per se control anything. What it does, however, is to furnish information on performance so that performance can be checked against standards and appropriate action taken. Because of the oblique nature of this process its effectiveness depends on two important conditions. (i) There must be accurate and detailed standards against which performance can be measured. These standards must be objective, for if they are not, failure to comply with them means nothing; and they must be very detailed, so that over-all variances can be traced to the exact places where they arise. (2) The ex-post reports on performance must be truthful and accurate. This is an especially important problem in the Soviet Union, where there exist strong incentives to falsify cost reports. It is against the background of these prerequisites that we will discuss the effectiveness of Soviet accounting for cost control purposes. In the Soviet system the primary motivation of management at the level of the enterprise is to fulfill the assigned plan rather than to earn the greatest possible profit. For this reason management at the lower level has little incentive to minimize costs except to the extent that cost goals are embodied in the assigned plan, so the responsibility for controlling costs lies ultimately with the higher organs of administration such as the ministry or the glavk.2 It will be useful, therefore, to discuss separately two levels of cost control in the Soviet system: (i) the level at which the superior organ sets and enforces cost goals for the enterprise, and (2) the level at which the enterprise management uses internal cost controls to meet the assigned cost goals.

On the basis of this information we may make the flat statement: If the retirement distribution can be assumed to resemble the curve shown in Chart I, and the trend of installations over a past period of double the average service life of the assets can be roughly represented by a constant rate of growth, then, whatever that growth rate and whatever the life average, the gross survivor value computed by the crude method does not deviate by more than 6 per cent from what would be obtained by the correct method.5 In the case of a structurally similar retirement distribution with less relative dispersion the divergence for any given r n, hence also the maximum divergence, would be smaller.6 As far as they go, these findings indicate that the simple cumulation method does yield an acceptably close approximation to the correct result. To secure a fully generalized answer, covering most cases likely to occur in practice, it would be necessary (and probably sufficient) to add a similar analysis for the other f (x) and g (t) types listed above. If survival rates based on a skew retirement distribution curve were applied to the g (t)function underlying the preceding analysis, the divergence between the two S would have different values and different maxima, depending on the degree of skewness and dispersion of f (x). But a maximum divergence for some specifiable rnproduct may again be expected to exist for any assumed f (x). If the assumed g (t)-pattern is anything other than the simple exponential growth function we have used, the percentage deviation between the two gross stock values must be expected to depend also on the specific contour of the installation flow during the past period indicated by the range s, hence on the length of that range and thus, in general, on the life average n as well. 'The margin between 6 per cent and the 5.26 per cent we have derived is certainly sufficient to allow for any possible difference of our result from what would be obtained if annual rather than continuous functions were used. 8In our analysis we have purposely experimented with a retirement distribution curve having a fairly high coefficient of variation, which of course tends to increase the relative disparity between Si and S2. If retirements are completely concentrated at the average service life, the gross survivor values obtained by the two methods are always equal. In this as in any similar analysis, minor erratic oscillations of actual installations around a generally realistic g (t)-trend, or of actual retirements around a generally realistic f (x) -curve, will hardly affect the reliability of the results, except perhaps in the case of very short average service lHves.

M R. HICKMAN's article is a well balanced contribution, and I have only a few comments to make. When one speaks of autonomous shifts in consumption, one has to be careful to exclude shifts which are really induced. Certain shifts which can properly be classed as induced may not appear such at first thought. Thus there are clearly cyclically-induced shifts in the consumption function. These relate to changes in expectations caused by cyclical movements of investment and aggregate income. It may be possible eventually to establish a fairly standard pattern of this form of cyclical behavior, though doubtless the cyclically-induced shifts in the consumption function will vary more or less from cycle to cycle. Mr. Hickman himself implicitly refers to such cyclically-induced shifts in the first paragraph of his section II. Next it is important to weigh carefully contrived induced changes in consumption. These played an important part in the recovery of I954-55. They involved not only tax cuts, but also a deliberate program designed to push the expansionary role of consumer credit to the limit. Mr. Hickman also takes cognizance of this, but I believe not quite adequately. With respect to the relative importance of gross private investment and consumption in the downturn, I note that investment declined by $I0.4 billion from the second quarter of I953 to the fourth quarter of I953, while consumption declined by a mere $i.i billion all annual rates. Also with respect to the recovery, I note that from the second quarter of I954 to the fourth quarter of I954, gross private investment increased by $3.6 billion while consumption increased by only $4.4 billion. An increase in consumption of this magnitude in relation to the magnitude of the increase in investment is not at all out of line with typical cyclical behavior. And from the fourth quarter of I954 to the fourth quarter of I955 gross private investment increased by $I5.9 billion while consumption increased by only $22.0 billion -again quite in line with normal cycle behavior. A point is made of the fact that the of increase of consumption expenditures diminished during the first half of I953. This also is typical consumption behavior at the upper turning point, and in no way proves that consumption leads. In the I948-49 recession the declines in the rate of increase in the last three quarters of I948 were (in billions of dollars) 4.8, 2.8, and o.g. I am unable to find any peculiarly autonomous behavior of consumption in the I953-54 recession.