In conclusion I would say that we should have a policy of, don't just stand there, do something. And I am hoping that Mr. Simon's office will be doing that, and doing it decisively.

The people are again way ahead of the White House-this 71-21 ratio for rationing suggests that-just as they were way ahead in 1971 on the wage-price freeze. I think that they need and want rationing to tell them in an evenhanded way exactly what is expected of them to help thwart the Arabian oil blackmail and keep the U.S. economy running. Every additional day of unlimited gasoline use is stolen from our supplies in February, March, and April. And we are piling up energy I O U's that can only be paid in less jobs and less output when our present supplies, when our inadequate supplies run short. To protect our comforts and conveniences, we are sacrificing jobs and income. It is hard to imagine a worse economic tradeoff for the American people.

Thank you.

[The prepared statement of Mr. Heller follows:]

PREPARED STATEMENT OF WALTER W. HELLER

ENERGY, THE ECONOMY, AND POLICY

Once again, in today's energy crisis, the U.S. is learning the costly lesson that we can't manage economic policy as if there were no tomorrow. But we seem to be slow learners. Witness the economic crises of the 70's that have caught the country and the White House by surprise-and have been met by belated and reluctant, yet drastic, steps that the White House had stoutly maintained it had no intention of taking:

In 1970-71, as this Committee knows all too well (and, indeed, foretold), the hemorrhaging outflow of U.S. funds finally forced the White House to end dollar convertibility and devalue the dollar.

Also in 1970-71, stubborn, self-propelling inflation finally led to the shock therapy of wage-price freezes and phases.

In 1972-73, the startling shift from surplus to shortages in U.S. agriculture and the ensuing food price explosion finally led to removal of acreage limits and most import quotas and price supports.

And, now, the growing energy shortage, underscored by the Arab oil cutoff and the explosion in oil prices, has already led to oil allocations and will, perforce, lead to more drastic measures like rationing and/or stiff gasoline tax increases.

Since the energy crisis abounds in unknowns and unknowables, in economic uncertainties and political indecision, one cannot proceed to an understandable economic appraisal without specifying certain critical assumptions.

UNDERLYING ASSUMPTIONS

Let me start with one central proposition for the longer run. In spite of Mr. Nixon's complacent assurances that the energy crisis is only "a temporary problem," and that "we will once again have those plentiful supplies of inexpensive energy," the Arab oil problem is here to stay. It is having essentially irreversible effects on U.S. energy prices and supply strategy.

First, the era of cheap oil and gasoline is rapidly slipping into history, never to return. The debate over whether we should cut gasoline use by higher prices, by higher taxes, or by rationing may have obscured the fact that petroleum prices are exploding all around us. Look at the facts:

Foreign crude oil: Persian Gulf oil (medium grade) has jumped from $2.50 a barrel earlier this year to $4.90 today. Higher-grade Libyan oil is up from $3.78 to $8.93, Venezuelan from $3.25 to $5.20. Canada is charging a $1.90-per-baller exist tax. Iran got $17.40 yesterday.

Domestic crude: Protected by import quotas, U.S. crude drifted upward from $3.00 in 1970 to $3.40 a year ago to $4.17 today for "old" oil and uncontrolled prices on "new" oil (as much as $2 or $3 higher, more on tie-in sales).

Last week, White House sources characterized the decontrol of "old" oil prices as "not a matter of it, but when."

Wholesale prices of all fuels are 40% above a year ago, having risen 19% in November. Refined petroleum products are up 90%, with 35% of that jump occurring last month.

Meanwhile, down at the pump, the "low-test" gasoline I could buy in the Twin Cities last summer at prices ranging from 28¢ a gallon at the cutrates of 33¢ at the majors has jumped to 44¢ wherever I turn. In the same area, No. 2 heating oil is up from 19¢ last year to a range of 23¢ to 30¢ last week. Retail prices of all petroleum products seem headed for another 25% rise in the coming year.

In short, price changes that will have major effects on the rate of inflation and on patterns of both consumption and production are already in place or are in the pipeline.

Second, in spite of Sheik Yamani's assurances that, once Israel withdraws to its pre-1967 borders, Saudi Arabia and its Arab oil cohorts would never again have any reason to embargo oil exports to the United States, we would be well-advised never again to treat Arab oil exports to us as anything but "interruptible service" energy. Even if the oil valves are not turned on and off for political reasons, we should never forget that the OPEC oil-ogopoly will henceforth manipulate its oil outflow-both up and down-to suit its profit and portfolio objectives. When they want some more dollar assets, the valves will open. When oil in the ground looks relatively more attractive as a portfolio asset, the flow will be choked back or shut off.

It follows that our determination to develop alternative domestic sources of energy supply and cut wasteful uses and nonessential demand must not succumb to the euphoria of an eventual resumption of Arab oil flows. A credible and decisive commitment to develop our own fossil fuel capabilities and push ahead on more exotic energy sources will serve both our economic interests and those of our Arab-oil-dependent friends. Both our bargaining position on prices and our balance of payments will benefit-only yesterday, it seems, we were worried about meeting an annual import bill of $20 billion for Mideast oil a few years hence. And our efforts to cut energy use and expand supply will pay off for Europe, Japan, and others in the form of (a) a more assured flow of Arabian oil and (b) prices no longer supported by an unquenchable U.S. thirst for that same oil. So I start with the basic assumption that high prices of energy are here to stay and that we cannot afford to turn off the drive for potential self-sufficiency when OPEC turns on the valves again. In addition, any appraisal of the effective energy shortages on near-term economic outlook is highly sensitive to such unknown or uncertain factors as the following:

The true size of the oil and energy shortfall: My working assumption is that the shortfall will be about 34 million barrels a day in 1974, consisting of a supply cutback of 2 million barrels coupled with a normal growth of 14 million barrels. No significant ready reserves to narrow this gap are available in the form of either stockpiles or unutilized domestic gas and oil productive capacity. And significant obstacles appear to bar the path to early relief from either the potential output of 300,000 barrels a day from the Elk Hill Naval reserves or the quick expansion of coal production as fuel for power plants that was supposed to save 400,000 barrels of oil a day.

The duration of the Arab oil cutoff: For the sake of simplicity, I will assume (a) that the embargo will not be lifted in time to affetc the 1974 outlook very much and (b) that when it is lifted oil prices will remain high and we will not give up our energy-saving and supply-stimulating

measures.

The course of national energy policy: Under the whiplash of economic crisis and political necessity, I expect timid and vacillating White House policy to be galvanized into decisive action soon to curb wasteful and nonessential energy use as to protect and restore jobs and output.

The responsiveness of consumers and industry to government appeals and regulations on cutbacks of wasteful and nonessential energy uses: Here my assumption is one of reasonable optimism.

The capacity of industry to adapt to high costs and short supplies of oil by switching to coal, by more intensive labor use, by substituting one raw material or component for another, and by eliminating sheer waste (which E. I. duPont de Nemours and Company estimates at 15% of the power used in industrial processes, a potential saving of more than 1.5

million barrels of oil a day): After some hesitation and delay, I anticipate important savings on this front.

The short-run price elasticities of demand for gasoline and other petroleum products: Studies by Data Resources, Inc. and others place this at a little more than 0.2 for gasoline and a little less for other oil products. In other words, a boost in gasoline prices from 40¢ to 50¢ a gallon, or 25%, should cut gasoline consumption by 5% to 6%.

IMPACT ON THE ECONOMY

In examining the impact of the energy crunch on the level of economic activity, one can usefully distinguish among several categories of negative effects on GNP through:

cutbacks in consumer demand for things complementary to gasoline and other petroleum products (autos, tires, campers, motel services, meals away from home, and so on) not offset by shifts of consumer spending to other goods and services;

the direct loss of output growing out of reduced oil imports and the associated loss of value-added as a result of the slowdown in oil refining, distribution, and the like;

cutbacks in supply caused by bottlenecks in transportation, plant and office closings, and shortages of petroleum feedstocks for the petrochemical industry;

temporary cutbacks in plant and equipment investment decisions because of hesitation, uncertainty, and the process of shifting to less energy-intensive production.

By far the largest jolt to the economy will come from the demand side. A distinctly tentative assessment suggests a direct cut in consumer demand for things complementary to gasoline of nearly $15 billion at an annual rate during 1974. Some $7 to $8 billion of this drop would be in automobiles, brought about by a slump in unit sales to a range of 8 to 9 million (including 11⁄2 to 2 million imports) and a decided shift to small cars. Other demand complements associated with autos would account for much of the balance.

Although there would be sizable shifts in demand to other areas (one thinks of TV sets and other forms of home entertainment, coal, clothing, and the like), there will be a period of confusion, anxiety, and hesitation that will lead to a higher rate of saving. Substitution of other forms of consumption is likely for small-ticket items and services, but there is likely to be far less substitution in the case of big-ticket, credit-financed items like autos, trucks, and campers. Taking these factors into account, one can project a net cutback of consumer demand to the tune of $8 to $10 billion during 1974 as a reasonable first approximation.

Hesitation and readaptation of investment plans might cut $1 to $2 billion from business fixed investment in 1974. One could also visualize a loss of value-added in the petroleum industry of perhaps $3 billion.

What about the energy-related supply bottlenecks and output interruptions which loom so large in the news accounts of the economics of the energy crisis? During the period when policy is still floundering in its attempt to sort out essential from nonessential uses of energy, such supply interruptions and dislocations will indeed be disturbing. But the more we force the cutback in energy use onto nonessential automobile use, space heating, and industrial waste, the less will be the impact on supply. For 1974 as a whole, most qualified observers are beginning to conclude that supply disruptions induced by the oil shortage will have only a minor effect on GNP.

Adding up these direct negative effects and taking account of the induced effects through the dynamic multiplier process, one arrives at a cutback of $25 to $30 billion, or just over 2%, in 1974 GNP owing to the energy shortage. Since this mrakdown will be imposed on an economy that was previously expected to show a 2% to 22% rate of advance for the year, the energy-adjusted projection represents essentially a no-growth situation for 1974.

Although the size of GNP losses attributable to the oil shortage are difficult to pinpoint, the time pattern of GNP advances during 1974 seems reasonably clear. After a winter of severe economic discontent, any reasonable and rigorous set of energy and stabilization policy responses should lead to a summer and fall of rising spirits and rising GNP.

The first half of 1974 will look like-and perhaps by traditional standards will be a recession. We can expect a drop in real GNP at an annual rate of about

12% in the first quarter and 1% in the second, followed by a moderate rise in the third quarter and a more rapid recovery in the fourth.

During the next several months, the economy will suffer from temporary paralysis of business and consumer spending decisions in the face of extreme uncertainty, spot shortages, regional imbalances, and stock market and other anxieties. Perhaps half of the cutback in consumer spending on petroleum. complements will find its way into savings early in the year. Later on, as consumer (and producer) ingenuity expresses itself and confidence grows, the substitution of other spending will steadily rise from the initial 50% level. The processes of economic adaptation and of suppression of nonessential oil uses should be far enough along by mid-1974 to permit expansion to resume in the second half of 1974. As the readjustment of consumer spending continues and as investment grows in the process of redirecting production toward energyconserving production processes and buildings, compact cars, larger coal output, and so on, economic recovery should be moving strongly in 1975.

Given the foregoing projection of economic consequences of the oil shortages, one can expect a material worsening of inflation. As a function of the direct effects of petroleum price boosts and adverse effects on productivity-not to mention such ominous portents on the labor front as the reopening of the Teamsters contracts-one can expect an add-on of 1 to 2 percentage points to the advance in the cost of living for 1974.

In other words, a rise of 7% to 8% in the first half of the year and perhaps 6% in the second now seem in the cards. A rise of 5% to 6% in the GNP deflator during 1974 can also be expected.

Accompanying the drop in output will be a large and distressing jump in unemployment. It is likely to rise above 6% by the second half of the year.

POLICY IMPLICATIONS

Let me address myself first to the stabilization policy implications of the foregoing economic scenario, with particular emphasis on monetary policy. I anticipate that the prospective jump in the rate of inflation triggered by the energy shortage, coupled with a big spurt in money supply in November (at about a 10% annual rate), will lead some observers to call on the Federal Reserve to keep its foot firmly on the monetary brake, primarily by cutting back the growth in money supply. But under present circumstances, such counsel would be misguided:

The big spurt of money supply in November was mainly the result of a big jump in "precautionary demand" for money as a result of consumer and business indecision and anxiety-as such, it is distinctly a false signal for cutting back the growth in money supply.

Nor should the extra price jolt from the oil shortage in 1974 be taken as a signal-any more than the 25% jump in food prices in 1973-for monetary tightening. These shortages, to use the words of Arthur Burns in his recent defense of monetary policy, "hardly represent either the basic trend in prices or the response of prices to previous monetary or fiscal policies." To attempt to hammer down price increases in food and oil-two sectors with flexible prices and inelastic demands-by restrictive monetary policy would wreak havoc on the rest of the economy.

Since an easier money stance was already in order before the cutoff of Persian Gulf oil, and since the major impact of that cutoff on GNP will come through discouragement of consumer spending, the Federal Reserve should definitely move in the direction of ease.

In so moving, it should use interest rates as its guide under present círcumstances. The Board should stop worrying about the demand-oriented increase in the money supply and concentrate on bringing short-term interest rates down to soften the impact of the energy shortage superimposed on an economic slowdown that was already in process.

Following its initial move last week in cutting reserve requirements on Certificates of Deposit, the Federal Reserve should strive to bring the Federal Funds rate down from its unduly high level of 10%-plus.

In the field of fiscal policy, explicit steps are even more difficult to specify, but the general directions seem clear enough. The startling upsurge first in food and then in fuel prices (not to mention clothing) has been sharply regressive. Although food represents just above 20% of overage consumer spending, this rises to 40% and 50% in the very low income groups. For the poor family that

spends 40% of its disposable income on food, the 20% to 25% leap of food prices in 1973 represents a c ut of 8% to 10% in real income. If we add to that a 2% to 3% cut via surging energy prices, the implication is clear: anything we do on the fiscal front in 1974 must, as a matter of equity, transfer funds to the lower income groups.

The case for tilting fiscal policy in this direction is reinforced by a consideration of the pattern of energy demand across income groups. It seems fair to postulate a high income elasticity of demand for nonessential energy. To put it more simply, the larger the family income, the larger proportion that is likely to go for uses of energy that society would regard as nonessential or downright wasteful.

This does give us some clues to fiscal measures that might be appropriate. Especially to the extent that we increase excise taxes to curb gasoline use, we should make restitution to lower income groups via cutbacks in social security and income tax withholding and cash refunds to the poverty groups not covered by such withholding. Still within the framework of any energy tax, one should also consider providing free bus service or other commuter transportation for the lowest income groups.

But I do not mean to say that one has to stay within the framework to carry out the appropriate distributive objectives. In a period when events have cut deeply into the real incomes of poor families and when a great many unskilled and lower income persons will be thrown out of work as a result of the energy crunch, it would make good economic and humanitarian sense to restore some of the cuts in social service budgets, expand the public employment program, and eliminate payroll taxes on persons below the poverty line. Turning to the energy field itself, I do not mean to imply by the above that I would rely on the price mechanism, aided and abetted by tax hikes, to ration gasoline and effect the 25% to 30% cut that is vital to preserve the supply of petroleum required to sustain employment and output. Nor will the "do-ityourself" or "catch-as-catch-can" system of rationing implied by the present system of allocations combined with a squeezing down of refinery output of gasoline do an acceptable job. It can only lead to long queues and mad scrambles at the gasoline pumps, grey-market payola, corrosive favoritism, tie-in sales, and sweetheart deals at the service station not to mention unwarranted profits. For all its blemishes and administrative difficulties, an outright system of consumer rationing remains the fairest, quickest, and by a large margin (a 7172% margin in the Harris Poll as against a 78-17% vote against higher taxes), most acceptable way to go.

The choice of a particular form of rationing should be made on the basis of (a) equity in distributing reduced gasoline supplies, (b) minimizing black markets and counterfeiting, and (c) speed of putting the plan into effect. A system using negotiable ration coupons (distributed on a per-car or per-licensed driver basis) or a basic ration plus high-premium coupons sold by the government could be quickly and simply put into effect. Or one could use citizen rationing boards as in World War II, except that everyone granted a special ration would get non-transferable stamps, say, red stamps, while the negotiable ones could appropriately be green. Once the rationing system were in effect, people would be free to use their ration as they pleased-without a detailed set of curbs on speed, car mileage, Sunday use, and so on. Somewhat paradoxically then, rationing-especially if administered through the use of negotiable ration coupons can be thought of as a way of preserving freedom of consumer choice. To bulwark the rationing system, an increase of perhaps 10¢ a gallon in the gasoline tax would make good sense. Not only would it help cut consumption, but it would yield perhaps $8 billion a year that could be utilized in part for energy research and development, in part for mass transit, and in part for support of payments and programs for lower income groups.

Finally, in summary form, let me list some other policy considerations and recommendations that bear on the alleviation of the energy shortage and the minimizing of its adverse impacts on the economy:

Using the levers of price controls and the authority granted by the Export Administration Act of 1969, the Administration should act to break specific bottlenecks like that in drilling pipe and tubular casing required for domestic oil exploration.

The hitherto unquestioned right of the Pentagon to commandeer oil for military use should be subjected to intense questioning, and its plans for military conservation of energl should be subjected to rigorous review by the new Federal Energy Administration.