staff of the Price Commission or Pay Board. The development of Phase III, a means of exiting from controls, took place under the auspices of the Cost of Living Council, but outside of the Council's ongoing activities. It began in August of 1972 with the formation of the C-8 group, headed by George Shultz. (See Policy Planning paper for a more complete discussion.) The group, working on a confidential basis, constructed five basic options for Phase III. The one chosen by the President was the move to self-administered controls over most of the economy, while retaining mandatory controls on food, health and construction. This plan was formulated with the expectation that as a result of declining growth in demand and the impact of mandatory controls on these three troublesome sectors, prices would remain fairly stable throughout 1973. Controls would be removed entirely as soon as practicable.

The flaw in this strategy was not in the concept, but in the economic predictions underlying the Phase III plan. The upsurge in food prices in the last quarter of 1972 and first quarter of 1973 was unexpected evidence that inflation was not subsiding. At that time, the Congress, labor and the general public favored the reimposition of comprehensive mandatory controls. In response to these conditions, on June 13, 1973, the President imposed a second price freeze, and directed the planning of Phase IV.

Phase IV Origins

Decontrol in Phase IV was to be accomplished by selectively exempting sectors of the economy. Selective decontrol was not a new idea to controllers. It was the method used by the Office of Price Administration to remove the World War II controls. During the discussions on how to remove Phase II controls, selective decontrol was advocated by John Dunlop, then Chairman of the Construction Industry Stabilization Committee (CISC) and soon to be named Director of the Cost of Living Council. Opposition to this method by senior administration economists, effectively ruled out its use at that time. In assuming the position of Director of the Cost of Living Council, Dunlop accepted the task of decontrolling the economy through the Phase III approach. However, the succession of economic and political events over the following six months afforded another opportunity to consider the selective decontrol approach.

A major cause of this change was the price explosion that occurred in the first six months of 1973, as shown in the following tables.

Economic Stabilization Quarterly Reports April 1, 1973-June 30, 1973.

The severe underestimation of the early 1973 inflation greatly complicated the task of decontrol. Many Congressmen (and much of the public) concluded that there was a correlation between the movement from Phase II to Phase III and the explosion in prices. In fact, the major causes of these price increases came from uncontrollable sources. It was judged that the perception of the public was such that any future moves toward decontrol would be associated with expectation of rapidly rising prices. In the last part of 1972 and the first half of 1973, two factors combined to account for the rapid increase in domestic and world prices: (1) disruptions in the world's supply of food and fuel commodities and (2) high levels of world demand caused by the unprecedented, simultaneous economic boom in the major, industrialized nations. This type of international, demand-pull, commodity inflation is nearly impossible to restrain through wage and price controls imposed on any one nation's economy, even an economy as important as the United States'.

It is acknowledged by many economists that not even the more stringent controls of Phase II would have significantly reduced the bulk of the early 1973 inflations. Despite continued controls in the food processing sector, food prices contributed more to the inflationary surge of the first six months of 1973 than any other area (58 percent). The price pressures originated with raw agricultural products, which were uncontrolled, and reflected world supply and demand conditions beyond the reach of domestic controls.

Nonetheless, public and Congressional pressure grew for a return to mandatory controls. During the Spring of 1973, Congress was debating not only the merits of imposing a price freeze, but also the possibility of ordering price rollbacks to January, 1973 levels.

In response to these pressures, President Nixon announced the second freeze, on prices only, and planning for Phase IV began.

GENESIS OF DECONTROL POLICY

President Nixon in his July 18, 1973 announcement of the Phase IV program outlined his basic decontrol position:

"There is no need for me to reiterate my desire to end controls and return to the free market. I believe that a large proportion of the American people, when faced with a rounded picture of the options, share that desire. Our experience with the Freeze has dramatized the essential difficulties of a controlled system-its

interference with production, its inequities, its distortions, its evasions, and the obstacles it places in the way of good international relations.

"And yet, I must urge a policy of patience. The move to freedom now would most likely turn into a detour, back into a swamp of even more lasting controls. We shall have to work our way and feel our way out of controls. That is, we shall have to create conditions in which the controls can be terminated without disrupting the economy, and we shall have to move in successive stages to withdraw the controls in part of the economy where that can be done or where the controls are most harmful.

"But while we are working our way to that ultimate condition in which controls are no longer useful, we must be alert to identify those parts of the economy that can be safely decontrolled. Removing the controls in those sectors will not only be a step towards efficiency and freedom there. It will also reduce the burden of administrative resources to be concentrated where most needed, and provide an incentive for other firms and industries to reach a similar condition." 3

This statement signalled the official Administration acceptance of the sectoral decontrol approach. The inclusion of this outline of the basic decontrol strategy in the official announcement of the Phase IV controls program indicated: (1) the seriousness with which the Administration viewed the extrication of the economy from wage and price controls; and (2) the Administration's recognition of the integral link between the success of the controls program and the success of the decontrol effort. Controls would have to help shape the proper political and economic conditions, before they could be successfully removed from the economy.

Underlying this policy, of course, was an economic prediction for the remainder of 1973 and 1974. Most economists predicted that the recent high levels of domestic and foreign demand would decline to levels more in accord with available supplies, as the major industrial economies, including the U.S., slowed from their boom status. With the application of proper monetary and fiscal policies along with an incomes policy, the U.S. economy was expected to make a smooth

3 Richard M. Nixon, July 18, 1973 Speech. (Available in Phase IV, Regulations, Questions and Answers [2nd Revision], p. 9.)

transition from this boom period to one of slower growth, without suffering a recession; this scenario was dubbed the "soft landing."

Phase IV's role in this environment was to manage an orderly pass-through of the cost and price pressures already built into the production process thereby helping the economy over this difficult transition period. If the cost and price pressures existing in the economy could be released slowly over several months, when controls ended business and labor would be faced with a much calmer economic environment in which to make their price and wage decisions. As demand pressures dissipated, it was expected that inflation would moderate to a point where a return to free markets could be achieved by early 1974.

However, the easing of demand predicted during late 1973 and early 1974 did not materialize. The Phase IV economic scenario had to be revised substantially to account for continued strong world demand and the impact of the oil embargo and resultant energy crisis.

As the Council moved toward implementation of its Phase IV decontrol plan, it became necessary to elaborate the elements of this strategy and create a set of tactics to implement it. In this task, the Council was basically on its own. The World War II selective decontrol experience had little relevance to decontrol in 1973 and 1974. Thus, Dunlop and the CLC staff, with few, if any, guidelines, were faced with the problem of developing a rational and defensible system for selecting industries to be decontrolled.

It is within this context of economic uncertainty and lack of experience that the decontrol effort began. Decontrol policy and process underwent continual evolution throughout Phase IV as each exemption provided invaluable knowledge and experience that was applied to the handling of remaining cases. Ongoing staff discussions of various decontrol strategies and their tactics led to further refinement of decontrol policy. Changes in the economic environment also provided input to the decontrol effort. By these and by other means, the Phase IV decontrol experience was shaped and reshaped within the broad strategy guidelines expressed in the President's announcement of July 18, 1973.

In retrospect, the period between July 18 and April 30, 1974, can be divided into four segments, based on major stages in the decontrol effort. The first encompasses Phase IV planning in the Summer of 1973 up to and including the exemption of the fertilizer industry on October 25, 1973. The second period covers the next two major excep