Knowledge that Transforms

The turmoil that has characterized macroeconomics for at least a decade originated with the inflation that emerged in the late 1960's and persisted stubbornly throughout the 1970's. The inability of the neoclassical synthesis to model inflation convincingly spawned the new classical models. Because they infer macroeconomic results more directly from principles of maximizing behavior, they appeal to some as more rigorous. Many others reject them as irrelevant because neither the microeconomic behavior that these models postulate nor their macroeconomic implications are realistic. The central postulates are that all agents are price takers and that all markets clear in the sense of Walrasian auction markets. In a dynamic, or multiperiod, context this means markets clear in rationally expected future prices. The most controversial implications are policy ineffectiveness and, in some versions, the proposition that inflation could be eliminated with little cost in real output. As one of those who was unimpressed with these more provocative postulates and implications, I was distressed that anyone took them seriously, and that the profession became so divided over important policy issues. But it is also true that some more interesting ideas, that were originally linked with the auction-market model by Robert Lucas and other authors, might not have been developed without the controversy. One is that the rational expectations methodology should be applied in a thorough way to macroeconomic relations. Another is that private agents' behavior will depend on the rules governing the conduct of policy, or the policy regime. I am optimistic that we are on the verge of generating more light and less heat than we have been recently. The interesting new ideas and methodology that have developed in the course of the past decade's debates will continue to be explored. But inevitably, I believe, these and other ideas will be examined within the framework of an economy that in crucial ways does not operate with auctionlike markets. Both the lack of empirical success with the classical postulates and the intellectual challenge of developing a more general micro foundation to supplant the auction model are pushing in this direction. With this development, the gap between rigor and reality should narrow as researchers differ less about the basic postulates underlying macro models.

I tackle a problem which I believe concerns all our disciplines; the problem of the legal processes involved in international trade regulation, and its various costs and benefits. Much of what I say could be applied to international processes, obligations, and institutions such as the GATT or OECD, but for reasons of time and space I will generally confine myself to the domestic U.S. laws and procedures concerning imports.' During the post-World War II period, there have been two parallel but clear trends in the system of United States regulation for imports. The first has been for the overall dramatic reduction in the level of tariffs since 1945, after the negotiation of the GATT, and the seven tariff and trade negotiating rounds under the auspices of GATT. The second trend has been a gradually accelerating recourse to measures for restraining imports other than normal tariffs, including measures entitled antidumping duties and This trend has particularly accelerated since 1962, and it is instructive to examine the major trade acts of 1962, 1974, and 1979 (the latter being the Trade Agreements Act of 1979, which implemented the results of the Tokyo Round Multilateral Trade Negotiations). The clear trend manifested in those statutes is towards a greater legalization or judicialization of the system. The 1974 act greatly reduced administrative discretion in the application of certain regulatory principles, particularly countervailing duties. It did this by imposing time limits, and in some cases embellishing the requirements for public hearings and other procedures to allow citizen access to the process. The 1979 act went even further in this regard, and also took some major steps in expanding the scope for judicial review of administrative actions. Consequently, as of this writing in 1983, the United States has a remarkably elaborate governmental system for the regulation of imports, including approximately a dozen different formal types of procedures or processes, many of which have explicit statutory procedural requirements calling for public hearings, judicial review, citizen complaint, and much reduced discretion for Executive Branch officials handling these matters. (See my 1977 book.) These include proceedings for escape clause, antidumping, countervailing duty, ? 337 unfair trade actions, ? 301 complaints against foreign government actions, etc. It is said that the U.S. legalistic system of regulating trade is costly, is itself a non-tariff barrier to trade, and lends itself to manipulative use by special domestic interests. Some of this may be true, but a systematic appraisal must examine at least three questions. 1) What are the real costs of the system? 2) What are the benefits of the system? 3) What alternatives to the system exist or are feasible, and what are their costs and benefits? I will therefore discuss those three questions, along with some policy and historical matters.

Ten years of floating exchange rates have not resulted in national policy autonomy. Indeed, in today's world, it seems scarcely conceivable that any exchange rate regime could enable countries to achieve their domestic objectives independently of what is going on elsewhere in the world; interdependence of national economies simply may not permit independence of national policies. Does this mean that policies directed in each country at getting the domestic situation right are to some extent hostage to the policy choice of others? If so, how do the constraints manifest themselves? Are these constraints made more or less onerous by the way the works? These questions are addressed by this paper; it would be too much to suggest that they are answered, or, indeed, are answerable in any definitive way. The early optimism that floating would free countries from balance of payments constraints and thereby enable them to direct policy, particularly monetary policy, to domestic objectives is perhaps understandable. The conditions over the period to the late 1960's had in many respects been particularly favorable to exchange rate stability. It would be natural if this led to the view that the few cases where exchange rate adjustment seemed called for would be better handled if exchange rates were left free to float, so that adjustment could take place relatively early and smoothly. But it would now seem that the typical applied economist or policymaker inherited from the period both a personal data base and a model that left him ill-equipped, in a number of ways, for what was to follow. First, few could have foreseen the extent to which countering inflation would need to become the overriding objective of policy. Second, supply-side shocks became bigger and more numerous. Third, the freedom and volume of financial flows has increased enormously. Fourth, the system that had been provided for much of the Bretton Woods period by the nth country role and anti-inflationary policies of the United States was lost, and no new anchor put in place. It could well be that the regime of floating rates that has been in operation over the last ten years has, at least in its broad features, been the only one that could have functioned in the prevailing conditions. If so, it may be that the regime has, at times, had an unwarrantedly bad press. The regime, and arguments put forward for its adoption a decade ago, should be judged not against some hypothetical ideal standard, but rather against what might otherwise have taken place. Ten years on, this judgement is not easy to make: what has not worked well is clearer than what is needed to make things work better.

With the growth of the literature on incentive compensation has come the belief by some that incentive pay may be less rigid than pay that is not designed to effect incentives. Some have gone so far as to argue that this may explain differences in unemployment rates across countries. it is shown that there is no direct link between incentives and wage rigidity. Many compensation schemes that provide incentives have the reverse effect: That is, they tend to make wages more rigid than would be the case were incentives not an issue atall. This paper explores the relationship between wage rigidity and the provision of incentives in a variety of circumstances.