Knowledge that Transforms

Periodic feedback revision in policy plans to incorporate recent measurements of economic activity is perhaps the minimal strategy response to uncertainty. This paper illustrates an evolution of feedback revisions in monetary policy by an optimal control exercise with the MIT-PENNSSRC (MPS) quarterly model over the turbulent eight-quarter interval beginning in mid-1973. The purpose of the exercise is to trace the impact of measured historical dislocations of the economy on the ex ante expectations of a feedback strategy, and contrast the result with two alternative strategies: an open-loop strategy without feedbacking, and the optimal prescience strategy based on perfect foresight. The design of the feedback exercise is to revise ex ante monetary policy at sixmonth intervals: t= 1973-III, 1974-I, 1974-III, and 1975-I. At the beginning of each recontract quarter, the hypothesized planners select an eight-quarter path for nonborrowed reserves that minimizes the expected loss for the next eight quarters conditioned on their current information set EILt It-1 . Policy loss for this rolling horizon procedure was represented by an eight-quarter sum of asymmetric components

In the burgeoning literature on collective decision making, attention generally has been focused on the public provision of goods in equal quantities to all recipients. As a result, there has been little positive analysis of the effects of differential distribution of the benefits of public activities. This state of affairs contrasts with the more developed literature on the effects of differential distribution of the costs of public activities. By analogy to the tax share concept in the study of cost sharing, this paper examines the effects of differential benefit shares, or of changing benefit shares, on voting behavior at the individual and aggregate level in a majority voting model. Just as the early literature on cost sharing often assumed equal sharing by all and thus the same tax share for all, the assumption of equal quantities for all can be interpreted as equal benefit shares. This equal quantities assumption requires a distinction between production units (the units relevant for production and cost functions) and consumption units (the units relevant for individual preference relations).' This distinction immediately raises the issue of the distribution of public benefits, i.e., the transformation of production units into consuimption units. A benefit share measures the rate at which a production unit is transformed into an individual's consumption units.2 For example, in the case of a pure public good, without exclusion, the benefit shares would all equal unity. The problem this paper is concerned with can now be stated in its simplest form by the following example. Suppose that the state has made private trading in bread illegal. In lieu of market exchange, the government distributes the bread at a zero price, with the cost of the bread met through taxation. The total amount of the bread provided (units in production) is set by a majority vote, while the distribution of bread (units in consumption) is based on a fixed share arrangement. For example, if the total distribution is 100 loaves per week and Joe's benefit share is .02, then he receives 2 loaves per week. If the distribution scheme is changed-the fixed benefit shares are changed-how does this affect the total amount of bread (in production units) that voters will most prefer? On what factors does each voter's demand depend and how do these individual demands aggregate into market level results? Section IA examines the individual choice problem: how does an individual's most preferred public sector size change as his benefit share changes? Buchanan (1968, p. 54) conjectures that an individual with * Assistant professors, department of economics, and research associates, Center for Study of Public Choice, Virginia Polytechnic Institute and State University. We are indebted to the Ford Foundation for financial support of this research. We acknowledge the helpful comments of James Buchanan, Robert Parks and Theodore Bergstrom on earlier drafts of the paper. We are also deeply indebted to our late colleague Winston Bush who helped us launch our joint research. Earlier drafts of this paper were presented at the Southern Economic Association Meetings in Atlanta 1974, and in seminars at the University of Arizona and the University of Illinois. I This distinction is made in Buchanan (1966), further developed in Buchanan (1968, pp. 52-56), and is a major issue in the discussion between Albert Breton and Buchanan (1967). 2 Recent empirical work has explicitly utilized this distinction by assuming equal sharing in the consumption units. For examples of the use of the equal sharing assumption in the recent empirical literature, see Thomas Borcherding and Robert Deacon, Theodore Bergstrom and Robert Goodman, or Robert Spann.

In June and July of 1974, the influential Expenditure Committee of the House of Commons heard submissions from economists in the public and private sector on Public Expenditure, Inflation, and the Balance of Payments, House of Commons (1974). The hearings came just few months after the sharp rise in oil prices, and the demise of Conservative government whose incomes policy had made no special allowance for rise in coal miners' income despite the increase in energy prices. The witnesses called to give evidence included prominent British macroeconomists of both Keynesian and Monetarist persuasions; thus, for example, Lord Kahn and David Laidler both spoke before the Committee. The Committee reported, We are told that rise in the of imports was both inflationary and deflationary (para. 23), which they understood to mean price increasing and employment reducing. They also noted that the various witnesses were far from unanimous in what they thought the impact effects would be, and in what they recommended by way of policy. This paper will initially focus on how Keynesians and Monetarists expected the shift in the terms of trade to affect prices and output, and what policy conclusions were derived, using evidence given to the Committee. The main reason for concentrating on this aspect of recent inflation is evident from inspection of Figure 1 which shows how severe was the shock of the rise in import prices over the period 1973-74 (import unit values rose by over 60 percent from 1973-IT to 1974-IT). Later I discuss how the inflationary effects of such an external shock may be amplified by what Sir John Hicks (1975b) has dubbed wage resistance, so that bout of imported inflation may be followed by spell of home-grown inflation. Some witnesses (including those from the Treasury and the National Institute) had referred to the possibility of inflationary pressures from this source (House of Commons, paras. 49, 50, 136, 498). I will argue, however, that neither the Committee nor Hicks gave sufficient attention to the role of the incomes policy in operation when the of oil rose so dramatically. For this policy not only involved confrontation with the coal miners, it also led to the linking of the wages of about one-third of the work force to the retail index, at time when the latter rose sharply because of change in terms of trade. Thus the incomes policy helped to prevent real wages from falling when economic circumstances called for such change. Perhaps it is not surprising, therefore, that the report had very little positive to say about incomes policy, confining itself to expressing the view that a permanent, statutory prices and incomes policy is in modern Britain politically both imprac* London School of Economics and Graduate School of Business, University of Chicago. I would like to thank M. J. Artis, T. Burns, S. G. B. Henry, R. A. Jackman, D. Laidler, D. Sargan, and J. Wise for their comments, without implying that they would accept the views expressed here.

The renewed interest in Marxist economic theory during past few years brought with it a renewed interest in what Marx himself called the most important law of modern political economy, Law 'of Tendency of Rate of Profit to Fall. K. Marx's own analysis of laws of motion of capitalist development led him to following formulation of this law. course of capitalist development there exists a tendency for live labor to be continuously replaced by dead labor. Capitalists replace workers by using more machinery. At same time increased productivity of labor process lead to an increased amount of raw material and auxiliary material processed in any given hour of labor. Thus amount of dead labor incorporated in means of production (machinery, raw material, and auxiliary material) increases over time relative to amount of live labor directly employed in production process. Marx expresses this development in what he calls rising organic composition of capital, i.e., an increasing ratio of dead labor to live labor. This development, Marx argued, would lead to a tendency of rate of profit to fall over time. Thus, for him, this law is not a prediction at level of appearances. Rather he claims that despite existence of a number oi counteracting forces, tendency of rate of profit to fall would assert itself as a continuous structural threat to capitalist mode of production. On one hand Marx clearly saw this tendency as a longrun development of capitalist mode of production. It is, in this sense, directly related to inherent dynamics of process of capital accumulation. On other hand he put great emphasis on linking up this tendency with short-run crisis phenomena. Marx saw crises as temporary breakdowns in capitalist accumulation process. Yet at same time he considered them to be a mechanism that recreates preconditions for profitable capital accumulation. Crises are an inherent part of continued reproduction of capitalism. In totality of this disorderly movement is to be found its order (Marx 1933). One effect of crises is to reduce rate at which real wages rise or even to cause a decline in real wages. Furthermore crises result in devaluation of capital as well as its concentration and centralization. It is precisely these effects which allow accumulation process to continue by reestablishing profitable investment opportunities. Marx's own formulation of law * Stanford University. This paper is a byproduct of ongoing research with Bill Lunt which originated in Political Economy Seminar at Stanford. Furthermore, I greatly benefited from comments on an earlier draft by Sue Bessmer, Michael Carter, Duncan Foley, Don Harris, Bridget O'Laughlin, Anwar Shaikh, Sandy Thompson, and Robert Williams. Unfortunately, because of limitations in time and space, I was unable to incorporate all useful comments and suggestions.

Daniel Wisecarver and Richard Schmalensee in two recent papers on the social cost of input market distortions have committed a rather interesting error. They find a different measure of welfare loss due to an input price distortion depending upon whether the measure is in the output or input market. This is incorrect, as intuition surelv argues. and the source of the error lies in improper use of the Taylor's series expansion. Correcting the error suggests a worthwhile generalization.