The Economic Consequences of Watergate

Author(s): James W. Knowles

Source: Business Economics, Vol. 9, No. 3 (May 1974), pp. 25-30
Published by: Palgrave Macmillan Journals
Stable URL: http://www.jstor.org/stable/23481409
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 The Economic Consequences
of Watergate
Many of the forces that led to Watergate
have also led to a combination of economic
■policies that have resulted in today's unsatis
factory unemployment/inflation situation. The
author reviews seven basic social, political,
economic or psychological factors that resulted
in Watergate and our current economic dif
ficulties. The alternatives available to us for
righting the economic situation, and bringing
us closer to the objectives of the Employment
Act, are listed and the results of each choice
suggested. The difficulties involved in our
making the correct choice are reviewed.
L cussions.
I AMagain
grateful for the forum
to a familiar privilege of returning
among old friendsonce
and
colleagues to analyze issues of economic policy,
public and private. My pleasure is somewhat
impaired, as you may easily imagine, by the
necessity of including Watergate in this discussion.
Two factors help to make this bearable. First, the
Watergate dirt has been so well publicized that
I can skip these details. Second, I feel no reluctance
This is an edited version of a talk given to the Downtown
Economists Club of New York.
May 1974
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James W. Knowles
Economic Consultant
Formerly, Joint Economic Committee
U.S. Congress
in dismissing out of hand the widely disseminated
cock-and-bull tale that Watergate has so paralyzed
and preoccupied the nation's policy-making ma
chinery as to bring about the self-evident failures
of economic policy-making and to explain com
pletely why these policy errors cannot be cured in
the immediate future.
Intriguing and deplorable as many may find
spying, employment of double agents, questionable
handling of funds, trading of favors, and attempts
to hide from public view knowledge of embarrassing
or even illegal activities, these are but transitory
and relatively insignificant symptoms of those
more basic social, political, economic, and psycho
logical factors whose nature and consequences
I hope to review with you today calmly and
reasonably, divorced from the highly emotional
tone that has so far marked the Watergate dis
Seven Gates to Watergate
Let us begin our discussion with a brief survey
of the Seven Gates to Watergate, by which I mean
those gateways to thought or patterns of working
out decisions that lead to such errors as Watergate
and the economic policy mess. There are obviously
other factors that could be considered on some
other occasion of which I call attention only to
one—namely the inordinate drive for increased
size of organization without due attention to the
relation of size to the effectiveness with which the
organization can function.
25
End Justifies the Means errors of fiscal and monetary policies in the last
decade, look to the decisions of the Congress rather
First, there is that perennial moral falsehood
than to the propositions of a largely powerless
variously expressed as anything goes or the end
White House entourage or the machinations of big
justifies the means or success is worthwhile at any
business or big labor. It is the Congress that has
price, only failure is despicable. The significance
the final authority over government taxes, ex
of this way of thinking to the political Watergate
penditures and monetary policies. These can
needs no elaboration but its greatest impact is
change only to the extent that Congress is prepared
undoubtedly in other directions. For example, in
to authorize. Inflation can only be created and
1965-66 achievement of the Great Society at home
continued by government actions under Congres
while financing such military operations in South
sional authority, hence it will not be cured by
east Asia as seen called for was of such over
admonitions against labor or business or agri
whelming importance that it was thought justifi
culture or bankers, but only by adoption of new
able to vastly increase Federal spending for both
economic policies by the Congress.
civil and military programs without an accom
panying tax increase to prevent inflationary con
sequences. It was feared, perhaps with some
reason, that a proposal of a tax rise wouldAssumption
give of the Right to
Determine Public Good
too much ammunition to the opponents of one or
more of the proposed programs or expenditures. Third, some officials—legislative, judicial an
Correspondingly, we have witnessed the justifica
executive, and particularly the latter two—yield
tion of full employment deficits in the budget on
altogether too frequently to the egocentric temp
the grounds that achievement of a low unemploytion to assume the right to decide various issue
ment rate was such an important objectivefor thatindividuals and for the nation without prop
substantial inflation could be accepted in order to
respect for the wishes or opinions of those affected
achieve this goal. Indeed, there is a tendency to believe that th
rest of us do not know what is good for us. Th
showed up very clearly in the Watergate episod
but has influenced other events too numerous and
Final Authority Rests With Congress
important to review. I am sure each of you can
Second, there is mankind's terrible tendency imagine
to the applications of this thought to such
worship strong centralized administration or leader matters as anti-pollution campaigns, automotive
ship or strong Presidents, etc. Indeed, it issafety, not welfare, or judicial invasion of politics,
excessive to point to 1600 Pennsylvania Avenue religion, biology and whatever other field attracts
in Washington as the holy shrine of thesetheir wor good intentions. In the economic field I call
shipers of central power. The latest version of your
this attention to the Penn-Central debacle con
fallacy is the proposition that Watergate hassequent been on a prolonged battle of the courts and
so damaging to the Administration that "Nixon the regulatory commission to see how thoroughly
can no longer govern." If there is any proposition they could strangle a profitable and necessary
taught by a study of history and political science, institution—granted that inept management didn't
it is that Presidents do not govern—though help. they Need we also review the long and sad record
may lead in some varying degree. The power heretoand abroad of foolish efforts by many well
govern is lodged in the people themselvesmeaning ulti people to establish and operate systems
mately and government officials forget this at their of direct controls over wages and prices? Phase III
peril in any country, especially the U.S.A.! If was
anydamned as a failure and now Phase IV is
part of the power to govern rests in officialdom, under attack, but what about Phases I & II?
it resides in the Congress as you can readily Given the long lags in results behind policies, if
determine by reading the Constitution—which in these first two stages were successful, why were
itself is a very educational exercise. The power of prices raging upward so fast this year?
Congress may be challenged from time to time by How many bruised egos are there these days,
the executive and judicial branches but when not merely among Washington policy makers, but
Congress is determined and has appropriate leader also among economists and econometricians who
ship it must ultimately prevail, providing that it were so confidently expounding the Phillips curve
is expressing the will of a majority of the population. trade-off between inflation and unemployment not
Thus, if you seek to assess responsibility for the long ago?

26 Business Economics

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Use of Substandard Evidence among intellectuals, students, and religious leaders.
Unfortunately, many economic policy debates
Fourth, people have a tendency, when emotionally
were similarly emotional rather than reasonable
aroused, to make use of substandard evidence in
in recent decades. Coldly logical analyses, like the
debates of a social, political, economic, religious
classical theories provided, give good predictions
or legal character. Indeed this tendency is so
as a basis for policy while the emotion ridden
prevalent that both science and law have adopted
contributions of the literary radicals of the left
rigid standards in an attempt to prevent this
and right reflect small knowledge of or use of
practice from producing errors of a serious type.
economic facts about the real world or of logical
Yet once more in Watergate we experience the
tools of analysis. The Watergate farce shows one
ready acceptance of evidence that any court would
kind of result from such deeply emotional com
exclude, and even court contests over the produc
mitment without the rule of reason but the adop
tion by court order of types of evidence that would
tion of wildly stimulative economic policy mixes
be questionable in more rigidly ethical circum
combined with either voluntary or compulsory
stances. But the consequences in the economic
direct controls over wages and prices is just as
policy field are far more serious. Almost everyone
emotional a commitment, just as devoid of founda
insists, for example, in debating policies under the
tion in fact and reason. A pure classical economist
Employment Act of 1946 in terms of the latest
would have predicted that these policies would
twitch in the BLS measures of unemployment and
result in both inflation and unemployment at the
prices even though it must be obvious that both same time as did in fact occur. Such an economist
of these lag far behind the times when policy
decisions must be made in the interests of economic
would have refused to accept the illogical theory
of the trade-off or the non-inflationary character of
stabilization. Need we embarrass anyone other
a deficit in the full employment budget simply
than the Federal Reserve by recalling the tighten because—as was said so often—there existed un
ing of the monetary screws in August 1957 in
employed resources.
response to rising prices and continued low un
employment even though almost all good fore
casters had long been expecting a recession—the Fallacy of Quick Results
only question was when. It turned out, of course, From Direct Action
that the peak of activity was August!
More recently, rising unemployment and con Sixth, this brings us to the widely beloved
tinued rising prices led to Phase I, but as history doctrine, so often leading to error: when general
vindicated classical economics against the attacks economic policies such as fiscal and monetary
of both the Keynesians and the followers of measures do not bring quick results, then direct
Galbraith, we found ourselves with not a trade action or regulation will bring economic villains
off but both unemployment and inflation worse into line to produce a happy result for all. This
than before. It is fair to say that the wrong naive belief has led mankind to trouble and even
evidence combined with bad logic to produce disaster many times; in the economic realm as
a predictable disaster. recently as the last three years. Yet it continues to
hold much of the human race enthralled. When will
we learn that one of the prices of human freedom is
Emotional Versus Reasoned Analysis limitation on the powers of government and private
organizations so framed as to leave important
Fifth, periodically we humans seem to lose our decisions to the individual along with some re
ability to reason coolly about issues of living sponsibility for wisely exercising that power of
together as social beings. To put it as simply as decision?
possible, we go on an emotional jag, so that we
rant or deplore or denounce or rage but not
reason. Sometimes, too often, we falsely label this The Crisis Rather Than
as some kind of application of value judgment.
Long-Run Approach
Sometimes, too, these binges are almost purely
economic in character as in a wildly speculative Seventh, perhaps the most devastating habit has
period such as the Florida land boom of the 1920's been the devotion of major efforts to immediate
or the South Sea episode. Much of the debates short-run crisis after crisis while leaving the longer
about our foreign issues of the past half century run problems to work themselves out in any way
seem heavily loaded with emotion, particularly that chance and short-run decisions may dictate.

27
May 1974

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What a difference would have been made in the in the economy had been faced courageously as
late as 1971 or preferably in 1965-66.
plans of the participants in Watergate if someone
had insisted on examining the longer-run con
siderations suggested by those plans! And what
Consequences and Choices
a change would have resulted in economic policies
As each of the Seven Gates to Watergate were
if public officials had taken into consideration the
long-run effects on our economy and on our cities
opened you were given a glimpse of its contribu
of tax and expenditure subsidies to stimulatetionthe to the Watergate of public fame as well as
automobile and aviation industries at the cost some hints of applications to other fields of our
of destroying public transportation—particularlynational life, particularly economic affairs. It
the movement of passengers by rail rapid transit!
would be interesting to follow up one line of such
application, namely the legal consequences, but
Having been staff advisor on an extensive study
of urban problems, I cannot resist asking whatthis
ouris not the appropriate occasion. Suffice it to
cities would look like today and what kind point of out that the legal system has been trans
places they would be to live in, if years ago city formed from a common set of generally under
planners had given more weight to consideration stood rules by which we live in safety, harmony
of the long-run effects on community life patterns, and justice with one another, into chaos. Indeed
mental health, or the economics of urban living the most important form of inflation today may
of their plans for separating the various types of sky-high cost of living legally, that is, if
be the
social capital and types of daily activity. Would anyone can be found who can live legally as a
they have moved the service facilities such as result of deliberate, knowing choice! One field
stores, schools, parks and playgrounds so far from alone, taxation, has been deemed so important
residential areas or separated work areas so much that we have been willing to set aside due process
from the places where the work forces could afford of law for all but the upper income groups, to
to live? disregard the constitutional injunction to observe
What would happen to our fiscal and monetary the equal application of the laws, and even to
policies if we just once admitted the limitations of regard the taxpayer as guilty until he proves
government powers in a free society, faced the himself innocent unless, again, he is wealthy
fact that changes in policy require long time enough to afford a legal fight with the IRS. For
periods to work their effects on the economy, ad those who can finance a fight the outcome is
mitted that it is probably beyond our capacity to unpredictable since the IRS itself does not know
forecast as far ahead as compensatory policy tech what our complex tax laws mean in application.
niques require for success and began to make policy The consequence of creating a fascinating and
on the basis of the possible achievements in the chaotic legal system is a drastic reduction in
long-run, say over five to ten years, frankly ad national productivity so that everyone's income
mitting that no administration or party can ac and level of living is lowered compared to that
complish much of any economic significance in which could be achieved with a legal system that
the course of a year or even four? What would every man or woman of good will could obey
be the rate of rise in prices and the unemployment because they knew what was required of them or
rate today if in 1971 Phase I had not included a could easily and cheaply find out.
strongly stimulative fiscal and monetary policy Though I would like to continue to follow out
mix but instead had accompanied price and wage the implications of these seven tendencies in
controls with a mix of fiscal and monetary policies various field of economics it is time now to face
consistent with full employment and stable prices the fact that bygones are bygones and the prob
in the long-run? I am convinced now, as I was blem before the nation is: what can we do now
then, that by now the results would have been an to bring us closer to the objectives of the Employ
absence of controls in a formal compulsory sense, ment Act. Failure to achieve those goals has been
a very slow rate of inflation and an unemployment perhaps the most crucial result of the factors that
rate that would be slowly approaching the 4% led also to Watergate. It is, of course, usual to
target. By concentrating on the short term results point to the stake of the poor and the working
so emotionally important to so many we have people in full employment; somewhat less to point
achieved the worst of all possible worlds, with little to the evils of inflation. But everyone has a high
hope that lost ground can be recovered except at stake in our success in simultaneously attaining
a cost far higher than would have been paid if both objectives. For example, over the decades it
the long-run consequences of inflationary biases looks as if the return on capital has been only 50

28 Business Economics

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to 80% of what would have been true if those out inflation in the long-run and put the
objectives had been realized continuously. What burden of short range adjustments on volun
then are our policy choices today, granted our past tary actions of the private economy.
failures?
These choices must be made in a situation8. Try alternative 7 but combined with some
form of compulsory controls over incomes
marked by a high and continuing inflation, excess
and prices.
unemployment, and slowing real output. Real after
tax wages are not rising and may be falling while
taxes on consumers are rising even without further
Choosing between these alternatives will be
more difficult than in the past. Unfortunately the
legislation due to progressive tax schedules and
social security tax increases programed forforces
1974 and tendencies that led to the political
Watergate
as well as last January. Housing faces increased also led to a long and disastrous com
difficulties as a result of rapid rises in interest rates
bination of inflationary and distorting policies in
and falling availability of funds for mortgages. the economic policy area. There will be a heavy
Government expenditures in real terms are pricenot
tag on any choice. Alternative 1 would
advancing as before due to inflation while the produce a quick acceleration of inflation, sky
budget becomes temporarily more restrictive due rocketing interest rates and within a few years,
to the quick response of taxes to inflation. On the
at best, a breakdown of the economy. It is not
other hand, inventories do not seem excessive, compatible with long-run stable economic health.
exports are strong relative to imports as a result Alternatives 2 and 3 might delay the disaster
of devaluation, and capital spending plans are but sooner or later—probably in present circum
pointing to rising levels over the foreseeable future, stances sooner—unemployment of labor and cap
particularly as inflation invites a shift from finan ital would rise and the policy break down.
cial assets to real capital. Alternatives 4 through 6 would demand excep
tional national agreement on the economic outlook
In these circumstances, given our past failures,
it would seem that the following alternatives face and a degree of success in the art of forecasting
us over the next year or more. that does not seem practical. In addition it would
require politicians to agree to restrictive policies
1. Adopt a policy mix that is strongly stim long before conditions in labor markets became
overfull and before price indexes showed signs of
ulative—expansive enough to reach full em
ployment and maintain it while accepting excessive rise. Policy would have to ignore the
any rate of inflation this produces, even an more popular indicators of unemployment and
accelerating rate, and abolishing all controls. prices—a very traumatic experience for many
people. This is due to the very long lags between
2. Combine a strongly expansive fiscal-monetary
policy decisions and their final or even initial
effects on the economy.
policy mix with a voluntary incomes or wage
price policy. Alternatives 7 and 8 require for success that we
recognize the severe limits on government's ability
3. Combine a strongly expansive fiscal-monetary to guarantee full employment without inflation
mix with a program of compulsory direct continously, adoption of a long-run planning
controls over incomes and prices. horizon in place of the present year-to-year
process, and a great educational program to in
4. Attempt to vary the fiscal-monetary mix form private individuals and organizations how
over time—first stimulating and then re they should make their decisions in order to con
straining activity as conditions change. tribute to the desired social result. Finally, they
would demand of all of us that we accept some
5. Try variable policies as under 4 above but short term failures and painful adjustments as
combine with a system of voluntary controls the price of long-run success. Programs to protect
over incomes and prices. the innocent against bearing too large a share of
the costs of the policy mix would be vital both to
6. Try variable policies as in 4 but with com acceptance and to justice.
pulsory controls over incomes and prices. What choice will we make and what choice
should we make? Over three decades' experience
7. Set the fiscal-monetary mix at a combination in the public and private sectors convinces me
that is consistent with full employment with that Alternative 7, perhaps with standby controls

May 1974 29

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in case of an inadvertent miscalculation, is the not be able to muster the courage and public
preferable choice. By this point it must be obvious support that a forthright decision would require.
that I have grave doubts that this will be the In that case the nation faces the prospect of con
choice. Some signs are favorable. Congress is tinuing excessive unemployment, moving up and
actively considering reform in the organization of down from time to time combined with an ir
the committee structure, and its procedures for regularly rising rate of inflation that will eat aw
handling the budget. There is some recognition at the political and social foundations of our
that the Phillips Curve choice is a mirage and freedoms.
that full employment and stable prices must be Since all sectors of society have an immense
attained at the same time or we shall not attain
stake in turning from these ways to disaster to
either for very long. But the temptation to try
wards a more just, efficient and effective society,
one or more of the Seven Gates to Watergatemay as I be so bold as to call all to the fight for a
I have called them is very strong. Congress may
non-Watergate world.

30 Business Economics

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