Throughout our nation's history the American people have demonstrated resilience and a capacity to learn from experience. We are doing so again and that is my basic theme today.

Of late, the political leaders of both our major parties have finally recognized that inflation is the nation's Number One problem and that our public policies require significant modification. The new mood of conservatism has already left its imprint on federal finances. The efforts of trade unions to augment their market power through new legislation have proved unsuccessful. Both Congress and the administration have begun to deal with the cost-raising consequences of government regulation. And even the moves of the Federal Reserve to bring down the rate of growth of the money supply, which not long ago caused consternation in some government circles, are now being accepted with grace and even gentle approbation.

In surveying the condition of the American economy it is useful to go back a few years. The recession that began toward the end of 1973, following two years of hectic economic activity, was the longest and deepest economic decline since the 1930s. It brought hardship to many of our families. It disrupted the finances of the federal government as well as of many business firms and local governments. But that encounter with adversity also served to remind the American public that the business cycle was not yet dead. We learned once again that when inflation comes to dominate the behavior of markets, it will eventually lead to extensive unemployment of both capital and labor.

Since the spring of 1975 the American economy has again been moving upward. The recovery in physical production now fully matches the magnitude typical of earlier expansions. Employment has recovered briskly. During the past year alone, employment rose about 3.5 million. With women and teenagers entering the job market in ever-increasing numbers, the size of our nation's labor force grew sharply. Even so, the unemployment rate has declined from about 9 percent in early 1975 to less than 6 percent at present.

An unemployment rate of some 6 percent is still high by historical yardsticks, but that figure is misleading. Relative to the size of the population of working age, the volume of employment is running this year at the highest level in our history. The unemployment rate for married men is only 2.5 percent and for all household heads only 3.5 percent. Thus, as far as skilled or experienced labor is concerned, it may fairly said that our economy is close to full employment. The unemployment that remains is largely of a structural character, reflecting an archaic legislative approach to minimum wage, inadequate preparation of young people for jobs in industry, reluctance of some men and women to exchange generous governmental benefits for low-paying work, and inability or reluctance of others to take available jobs for family or personal reasons.

Although the federal government played a prominent part in the recent recovery by pursuing expansive monetary and fiscal policies, the growth of new jobs has occurred preponderantly in private industry. Consumer spending on goods and services, including the purchase of new homes, has been the main driving force of the expansion. Business fixed investment did not play its customary role. For a time, business investment was largely concentrated in relatively short-lived capital goods that promised quick returns--such as trucks, office equipment, and light machinery. Industrial construction did not turn up until the spring of last year--two years after the economy had begun recovering. But with profits gradually improving, slack in the economy diminishing, and credit generally available, business capital investment has gathered momentum and of late has been contributing materially to the cumulation of prosperity.

This brief review of recent developments suffices to indicate that our economy retains much of its historic resilience and vitality. Our recovery has not only fostered an abundance of new jobs and the formation of many new businesses; it has also proceeded further and faster than recovery in other industrial countries around the world. And yet, the return of prosperity has not brought a corresponding return of confidence. A mood of unease and anxiety about the future continues to haunt the state of business opinion. That is reflected in the doldrums of the stock exchanges, in opinion polls, and in the pessimistic tone of economic commentators.

As economists and businessmen survey the current scene, they see many trouble spots. First and foremost, the flow of money to markets is badly out of balance with the physical flow of goods and services; hence, the general price level keeps rising. The increase of wages is out of balance with the productivity of labor; hence, unit costs of production keep going up. The expenditures of the federal government are out of balance with its revenues; hence, there is a continuing impulse to further inflation. The overall demand for credit is out of balance with the supply of credit; hence, interest rates have recently been soaring. The upsurge of consumer and mortgage debt is out of balance with personal income; hence, the burden of debt repayment keeps mounting for consumers. Corporate profits are still out of balance with the growth of national income; hence, business investment is not imparting a sufficient lift to productivity. Exports of merchandise are out of balance with imports; hence, the dollar tends to suffer in foreign exchange markets. The unemployment of teenagers, especially among blacks, is out of balance with the general condition of the labor market; hence, we are storing up social trouble besides losing the contribution that these youngsters could make to our economy.

These and other imbalances on which economic observers have been dwelling offer ample reason for concern about the condition of the American economy. Our prosperity appears to be marred by numerous blemishes that threaten continuance of economic expansion in the short run or our economic prospects for the long run. Objectivity in interpreting economic developments is difficult and may be unattainable. Nevertheless, I shall try this evening to place in perspective several of the concerns that have lately loomed large in the minds of thoughtful Americans--first, the flattening out of the trend of national productivity; second, the proliferation of government regulations; third, the increasing cost of government and the growing burden of taxes; fourth, the accelerating pace of inflation; and fifth, the danger of an early recession.

Until very recently, America was perceived at home and abroad as an enterprising, innovative, and highly efficient nation that enjoyed the highest standard of living in the world. Our productivity--measured in terms of output per man-hour--practically doubled during the first two decades following World War II. As a result of this sturdy advance, we were not only able to achieve much better living conditions, but we also felt that we could afford extensive foreign aid besides more ambitious domestic programs for helping unemployed workers, the aged, and others left behind by the onrush of economic progress.

Unhappily, the trend of national productivity has faltered during the past decade. Whereas output per hour grew at an average annual rate of over 3 percent between 1947 and 1967, it has since then increased at only half that rate--a performance that compares quite unfavorably with productivity advances in other industrial countries. The costs of this recent stagnation have been enormous. If output per hour had continued to grow at the average rate of the preceding two decades, our nation's production of goods and services would have been some 17 percent higher last year than it was in fact. Besides this huge loss of income, the poor performance of productivity has had other unhappy consequences for our country: an accelerated pace of inflation, a weakened competitive position in international trade, greater social tensions, and--most troublesome of all--some loss of confidence in ourselves and in our institutions.

Fortunately, the stagnation of our productivity is now widely recognized in both government and business circles, and its causes are being actively explored. That the causes are many should be obvious from the size and diversity of our economy and the large number of distinct enterprises of which it is composed. Several factors seem especially important to me. First, the exceptionally rapid growth of our labor force has not been matched by a corresponding acceleration in capital formation; in other words, our workers are not being equipped with more and better tools of production at the same pace as earlier. Second, our research and development expenditures during the past decade have failed to grow in real terms. Third, the work ethic has declined in our country: paid vacations have become longer, holidays and sick leave have become more frequent, coffee breaks and other social rites on the job have become more widespread.

I emphasize these developments because we can do--and are already doing--something about them. Protracted national debate about the inadequacy of business capital investment has finally persuaded the Congress that it is short-sighted to keep favoring consumption at the expense of investment. This year's tax legislation departs sharply from the earlier practice of granting large reductions only to low-income groups. Moreover, taking note of the drastic decline of venture capital, the Congress has lowered the capital gains tax for most investors. Still other actions have been taken to improve the environment for new investment. Growth of expenditures on research and development appears to have resumed. And new congressional legislation seeks to improve attitudes toward work by establishing joint committees of labor and management at the plant, area, and industry levels.

If recognition of a problem is already half of the solution, we may soon be on the threshold of better productivity performance. It is well to remember that small firms have often, perhaps typically, pioneered in high-technology ventures. Just as our agricultural colleges have helped to improve the productivity of farming, so our business colleges may in time foster greater success among small businesses. And the recent tax legislation is only the beginning of what needs to be done to improve the climate for business investment. The double taxation of dividends, the high marginal tax rates on personal income from investment, the taxation of illusory profits that emerge through faulty accounting at a time of inflation--these are among the major tax issues that deserve, and I believe will receive, congressional attention as a long-range approach to the nation's productivity problem is developed.

Let me turn next to a related concern of thoughtful citizens--namely, the maze of regulations in which our business firms have become enmeshed. Over the past century, as our economy grew in size and complexity, social reformers turned increasingly to government for solutions of economic problems. As a consequence, Congress passed one bill after another relating to agriculture, transportation, banking, communications, income maintenance, and so on. During the past decade, as the American public has become more aware of the environmental, safety, and health risks to which our society is subject, Congress has devoted an enormous amount of attention to these areas.

For a time our government appeared to be in a regulatory frenzy, with members of the Congress and officials of the executive agencies vying with one another in devising new economic controls. State and local governments have provided supplementary legislation, and the agencies charged with carrying out all these laws have added mountains of regulations and interpretations. At the federal level alone, at least ninety agencies are now involved in this activity. The Federal Register, which records new regulations, ran to 3,400 pages in 1937, but swelled to about 10,000 pages in 1953 and to 65,000 pages in 1977. In this year's federal budget the amount allocated to regulation is about $5 billion--more than twice the expenditure in 1974. To this figure must be added not only the corresponding expenditures by state and local governments, but also the huge costs of compliance imposed on private industry. The Center for the Study of American Business at Washington University estimates that these compliance costs amounted to over $60 billion in 1976 and that they may come to over $90 billion this year. These costs, needless to say, are inevitably passed on to the general public.

Nor are financial costs the entire burden of government regulation. As things stand, many corporate executives find that so much of their finest energy is devoted to coping with regulatory problems that they cannot attend sufficiently to the creative part of their business--that is, planning new technology, developing new products, or exploring new marketing strategies. To proceed with a new project, whether it be a power plant or a cement mill, business managers need to deal with numerous agencies at several levels of government. They need to find their way through regulations that are usually complex and sometimes conflicting. The process is always time-consuming and the outcome is frequently uncertain. Months or years may pass before they discover whether they can go ahead, and even then they cannot tell what fresh obstacles may be put in their way. Such uncertainties and frustrations cannot be brought under a dollar sign; but they have a telling effect on a nation's business--as anyone connected with the electric power industry or the manufacture of nuclear equipment can testify to his sorrow.

A large part of our regulatory apparatus is obviously necessary and desirable--as in the case of a public utility that might abuse its monopoly power, or in the case of a food product that might contain elements injurious to health. But some government regulations severely restrain competition, and thus run up costs and prices for the public at large. And many of the newer regulations concerned with the environment, health, and safety take inadequate account of the importance of finding cost-effective methods of achieving the benefits that are rightly being sought.

Businessmen are no longer alone in being troubled by these and other difficulties that surround the regulatory process. As knowledge has accumulated of what the regulatory agencies are doing, uneasiness has developed in government circles. In the last session, Congress displayed heightened concern about the consequences of regulation, and seriously considered such innovations as "sunset" legislation and a regulatory budget. The report of the Council of Economic Advisers issued last January emphasized the need for correcting abuses that have crept into the regulatory area. In March the President directed all government departments and agencies to eliminate regulations that are needlessly burdensome, and since then some progress in that direction has been made. And in his address this October on the inflation problem, the President announced the formation of a Regulatory Council that will seek to eliminate overlapping regulations and to carry out cost-benefit analyses of proposed new regulations.

The recent outpouring of public criticism of the regulatory apparatus is a useful reminder that our democracy is still functioning vigorously and that the American public will not tolerate excesses indefinitely. Although the tide has not yet turned, we are now in a phase of crosscurrents--and that marks an advance. For example, regulation of the airline industry has been sharply curtailed, a start has been made in reducing regulation of the trucking industry, and the new energy law actually sets a date for deregulating natural gas. On the other hand, recently adopted banking legislation calls for a large number of new regulations, and so too does the energy law for the period before deregulation is to take place. Such crosscurrents may tax patience, but they must not obscure the new emphasis on removing regulations that impede competition and on insuring that both new and old regulations meet a reasonable cost-benefit test.

Let me turn now to the rising trend in overall government expenditures and the associated increase in taxes. While the subjects of productivity and regulation have been worrisome mainly to businessmen and public officials, the growing scope of governmental activity has stirred serious misgivings among people in all walks of life.

Americans are generous by nature. The deep and protracted depression of the 1930s awakened us to the economic hazards to which many individuals were exposed at a time of rapid industrialization and urbanization. With the imperatives of conscience reinforced by self-interest, our citizenry was in a mood to support extensive economic and social reforms. Demands on the government mounted--to insure bank deposits, to raise wages, to improve housing, to enlarge health services, to supplement low incomes, to broaden education, to subsidize agriculture, to improve the environment, and so on. The scope of governmental activities thus steadily expanded.

But so too did the cost. In addition to the spending on national defense, public works, and other traditional objects, government outlays became a vast engine for redistributing incomes. In 1929, total expenditures at the federal, state, and local levels amounted to 11 percent of the dollar value of our nation's entire production of goods and services. The corresponding figure rose to 20 percent in 1940, to 30 percent in 1960, and to 37 percent last year. To an important extent these increases resulted from federal expenditures on human resources. As recently as fiscal year 1965, federal outlays for education and manpower were only $2 billion, but in the fiscal year just ended they approximated $27 billion. Over the same period, federal expenditures for health rose from $2 billion to $44 billion; for income security, from $26 billion to $146 billion; for veterans benefits, from $6 billion to $19 billion. Taken altogether these outlays on human resources were still only three-fourths as large as the defense budget in 1965. Since then, the Great Society programs have ballooned; by 1970 the budget for human resources reached rough equality with defense and in the fiscal year just ended actually exceeded it by a ratio of more than two to one.

The proliferation and increasing cost of governmental activities in our country naturally resulted in a growing burden of taxation--in higher income taxes, higher sales taxes, higher property taxes, higher social security taxes, higher estate and gift taxes. As long as individuals and businesses experienced significant advances in their real incomes, higher taxes were tolerated with little protest. But with inflation eroding incomes and many housewives taking jobs to protect family living standards, dissatisfaction and outright resentment grew--particularly among members of the middle class. Responsible citizens recognized that government programs had contributed substantially to the virtual elimination of poverty in our country, that they had diminished human suffering, and that they had reduced discrimination in labor markets. But people also came to feel in increasing numbers that much of government spending was falling short of its objectives--that urban blight was spreading, that the quality of public schools was deteriorating, that crime and violence were increasing, that welfare cheating was widespread, and that collecting unemployment insurance was becoming a way of life for many--in short, that much of government spending was adding heavily to the taxes of hard-working people without alleviating social ills.

This feeling of resentment and frustration found dramatic expression in June when California citizens voted to reduce sharply their property taxes and to impose severe restraint on any new forms of taxation by their government. More recently, referenda in other states have demonstrated that people in many parts of the country share the desire to curb government spending and taxing. With these overtones of a tax revolt developing among the electorate, politicians in both major parties are now adding their voices to the chorus of protest. This year's federal tax legislation, on which I have already commented, is eloquent testimony to the new national mood. So too is the President's increasingly visible determination to bring the federal budget under reasonable control. As yet, the effects on the budget projected for this and the coming year may be unimpressive, but the gathering forces of fiscal conservatism are likely to elicit a stronger response from both the administration and the Congress. I believe, therefore, that the fraction of our national production directed to governmental use will diminish--at least in the years immediately ahead.

The importance of such a shift in the use of the nation's resources cannot be overestimated. For not only has the federal government placed an excessive burden on taxpayers; it has also been unwilling to limit the cost of its programs to the amount it was prepared to raise in taxes. For too many years we have engaged in a national fantasy, imagining that we could achieve desirable social goals at a bargain price. The hard reality, of course, is that we must pay in full--in the coin of inflation if we tender no other.

Since 1950 the federal budget has been in balance in only five years. Since 1970 a deficit has occurred in every year. Budget deficits have thus become a chronic condition of federal finance; they have been incurred in years when business conditions were poor and also when business was booming. Traditional rules for incurring deficits only when the economy was weak have been ignored. Not only that, the deficits have increased sharply in size in recent years. In the fiscal year just ended, the deficit reached almost $60 billion when off-budget outlays are included in the total--as they indeed should be. Instead of vanishing or diminishing as the economy expands, which had long been accepted practice, the deficit in fiscal year 1978 was slated this January to be almost $20 billion larger than in the preceding year. As events turned out, the deficit fell below the projected figure but still exceeded its predecessor by several billion dollars.

This persistence of substantial deficits in federal finances is mainly responsible for the serious inflation that got under way in our country in the mid-sixties. When the government runs a budget deficit, it pumps more money into the pocketbooks of people than it takes out of their pocketbooks. That is the way a serious inflation is typically started and later nourished. And when the deficit increases at a time of economic expansion, as it has done lately, we should not be surprised to find the rate of inflation quickening. The rise in the consumer price level was 5 percent in l976; it moved up to 7 percent in 1977, and it is running this year at a rate of about 9 percent. Of course, other factors besides the budget deficit--particularly, money creation by our central bank, the power wielded by trade unions, higher minimum wages, higher agricultural price supports, and fresh restrictions on various imports--have all played a part in this inflationary process.

The American people have by now had sufficient experience with inflation to appreciate its serious consequences. Inflation erodes the purchasing power of everyone's money income. It weakens the willingness to save. It drives up the level of interest rates. It affects adversely both stock prices and bond prices. It has capricious effects on the distribution of wealth and income. It hits many of the poor and elderly especially hard. It increases the risk premium that attaches to new business investment. It eventually leads to recession and extensive unemployment. More ominous still, by causing disillusionment and breeding discontent, inflation excites doubts among people about themselves, about the competence of their government, and about the free enterprise system itself.

The American people have been quicker in recognizing the consequences and dangers of inflation than the Congress or the executive branch. That is not to say that our government officials dwelt in ignorance or that they did not care. The truth is rather that they were preoccupied with the problem of unemployment and that they were misled by the popular theory that the existence of unutilized capacity would keep the inflation rate down. But as the clamor about rising prices intensified at home and as foreign governments complained with increasing bitterness about the troubles created for them by a depreciating dollar, our government finally recognized that inflation is the Number One economic problem of our country.

The radical change in our government's attitude toward inflation has been salutary. The President recently vetoed some costly legislation and he has been supported by the Congress. The President's new wage and price policy may compromise the developing trend toward reduced government regulation, but it at least indicates that the administration is no longer trying to combat inflation with mere rhetoric. More constructive is the administration's determination to bring in an austere budget next January. And there are other promising developments--especially, a stiffening of monetary policy by the Federal Reserve and an impressive mobilization of the government's financial resources with a view to curbing the dollar's depreciation in foreign exchange markets.

These developments signify that our government finally has a policy for bringing inflation under control. The policy is still evolving, and I hope that it will come to include bolder fiscal restraint as well as some relief from cost-raising structural policies--as in the case of minimum wages. In any event, it should be heartening to the American people that the Federal Reserve is no longer alone in carrying on the fight against inflation.

I have left for last the widespread concern that a recession may get under way next year. A heightened sensitivity to the possibility of an economic downturn is one legacy of the severe business decline of 1974 and 1975. Before that recession, businessmen had generally came to believe--as did the public at large--that our government nowadays had both the will and the knowledge to keep the economy on an even keel, that business depressions were a thing of the past, and that if a recession did occasionally occur the government would see to it that the setback was brief and mild. Being unexpected, the severity of the recession of 1974–1975 was therefore a shocking and humbling experience.

In the past few years, government officials have become more anxious monitors of every nuance in the business and financial world. The ability of economists to forecast the timing of recessions is still quite poor, but that has not always deterred well-meaning officials from prescribing quick cures for the troubles they imagined might soon overtake us. Such misdirected efforts at fine-tuning the economy have been partly responsible for our accelerated inflation. But if the heightened sensitivity to the business cycle has misled some governmental efforts, it has been on the whole a constructive force in the business world. Having been stung so severely by the recent recession, business executives have exercised caution in augmenting or replacing their plant and equipment. That caution has extended also to the management of inventories. Whatever its other effects, we can be sure that prudence in handling these vital activities will help to moderate any recession that might arise from excesses in the consumer area, real estate speculation, or other causes.

A more mature approach to the business cycle is beginning to emerge in our country, and that is a healthy development. More people now realize that our economy is not recession-proof, and that our government's ability to deal with recessions--to say nothing of its ability to anticipate or forestall them--is quite limited. More people also understand that however regrettable recessions may be, it is a mistake to view them as simply being pathological phenomena. In fact, a recession often performs an unavoidable function by forcing business managers to improve efficiency, by enabling interest rates to come down, and by wringing some of the inflation out of the economic system. Recessions are passing developments in the life of a nation, and a government that becomes obsessed with such phenomena cannot develop the sustained policies that are needed to assure a better economic future for its people. That too is better understood today than only a short time ago.

The learning process that has thus been going on in our country is to me a basic reason for viewing our economic future with optimism. Education may proceed slowly, but economic mistakes do not go unnoticed indefinitely in a vital democracy such as ours. Responsible citizens have gradually learned that our striving for a better society must be disciplined by prudence. They have learned that our productivity must increase faster if we are to remain a great nation, that governmental regulation can be overdone, that persistent federal deficits release forces of inflation, that inflation has been sapping our nation's strength, and that inflation cannot be brought to an end without making some economic sacrifices. They have learned also that confidence is still the main driving force of our economy and that business confidence in particular requires sustained governmental policies for encouraging initiative, enterprise, and investment.

Adversity has its uses in a nation's life. Just as the Great Depression of the 1930s awakened the American public to the neglect of the economic and social hazards that had been accumulating in our country, so the Great Inflation since the mid-sixties has been teaching the American people that their efforts to improve the quality of life are in large degree being frustrated by the corrosive effects of a persistently rising price level. The learning process never proceeds without confusion or pause, and that too has been part of our recent history. But more than any other factor, California's vote on Proposition 13 and later referenda in other states made dramatically clear the shift of economic thinking that for some time has been evolving in our country. Credit for changing the tone and trend of governmental policies thus belongs fundamentally to the American people.

All this marks a momentous change in the American political scene--a change that augurs well for controlling inflation, for renewing confidence in the dollar, and before long also for a stronger trend of business investment in fixed capital. The prospects for our long-run economic future have thus clearly improved, but they still must not be taken for granted. The visible shift in the political scene is such a recent development that no one can be sure how far it will go or how lasting it will prove. The proponents of larger government spending and easier credit are still a powerful political force. The federal budget deficit is still a powerful inflationary influence. The push by trade unions for sharp wage increases is still continuing. It is still not clear whether the money supply is staying within the Federal Reserve's targeted zone. And President Carter's new program for curbing inflation still remains to be tested.

The vigorous process of learning from experience that has been going on in our country and that has already brought improvement in our long-run economic prospects must therefore continue--in our universities, in our research institutions, in the press, and in our business and political organizations. In that way we will be reinforcing the most powerful of all economic forces--hope for a better future for ourselves and our children.

Arthur F. Burns is the recipient of the AEI Francis Boyer Award for 1978.