Moral Suasion as an Instrument of Economic Policy

Author(s): J. T. Romans
Source: The American Economic Review , Dec., 1966, Vol. 56, No. 5 (Dec., 1966), pp. 1220-
1226
Published by: American Economic Association

Stable URL: https://www.jstor.org/stable/1815305

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1220 THE AMERICAN ECONOMIC REVIEW

be spent only on goods and services needed for these. The other is the develop-
ing countries' desperate need for development aid, which assures that such
grants-in-aid would become additional expenditure and not the alternative
financing of goods imported in any case.
It may be noted in closing that reserve creation as here outlined is designed
and suitable for the secular expansion of international reserves in keeping with
the needs of an expanding world economy. It would be too slow and cumber-
some to deal with payments problems created by crises of confidence, which
are best countered by bilateral (or multilateral) credit or swap arrangements.
TIBOR SCITOVSKY*

* The author is professor of economics at the University of California, Berkeley.

REFERENCES
1. R. N. COOPER, "Dollar Deficits and Post-War Economic Growth," Rev.
Econ. Stat., May 1964, 46, 155-59.
2. J. H. POWER, "Laborsaving in Economic Growth," Aw. Econ. Rev., Proc.,
May 1962, 52, 39-45.

Moral Suasion as an Instrunment of Economic Policy

Christopher Robin goes

Jioppity, hoppity
Hoppity, hoppity, hop
Whenever I tell him politely to stop it, he
Says he can't possibly stop
-A. A. MILNE

In the fourth century, Emperor Julian the Apostate exhorted the

of Antioch to hold down wheat prices-with a spectacular lack of succ
801]. Long lurking in the box of little-used policy tools, moral suasion ap-
pears to be undergoing a modern-day resurrection. In recent years one can ob-
serve both a marked increase in governmental (and particularly, presidential)
suasion as a policy instrument as well as (at least) a superficial increase in its
effectiveness. Recent examples of moral suasion are legion: the Kennedy-U.S.
Steel and Johnson-aluminum, -copper and -steel industry confrontations; im-
plementation of wage-price guideposts; top level mediation in labor-manage-
ment disputes; "voluntary" curbs on foreign investment and travel; "jaw-
bone" exhortations to business to pass the "savings" arising from excise tax
cuts on to consumers; and many, many more.
There is little evidence that moral suasion is being used wholly as a substi-
tute for other instruments of economic policy. The increasing number and
complexity of government policy objectives has led to increased use of all pol-
icy instruments, monetary, fiscal, etc. As Tinbergen has demonstrated, the in-
struments of policy must be at least as numerous as the number of policy ob-
jectives [5, pp. 1-4], and one way of viewing moral suasion is that govern-

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 COMMUNICATIONS 1221

ment has grasped it as an additional instrument to meet its increasingly nu-

merous economic objectives. But there are many objections that can be raised
concerning the use of moral suasion as a major policy instrument. Moral sua-
sion is inequitable in that it rewards noncompliance; it constitutes extra-legal
coercion by government without judicial review; it is in violation of the "rule
of law"; where promises, implicit or explicit, are involved, it entails the dan-
ger of an overly familiar relationship between regulator and regulatee; its ad
hoc character adds an additional and unnecessary element of uncertainty to
business decisions; and it may frequently be used in lieu of (i.e., as an excuse
for not implementing) more effective legislation.
Indicting as this list may be, it does not prove that moral suasion is inferior
to other types of policy instruments. All policies have opportunity costs both
in terms of their administrative and enforcement costs as well as their alloca-
tive effects on the economy. Whether moral suasion is inferior to other instru-
ments or whether a partially effective moral suasion policy is even superior to
a policy of doing nothing at all depends upon the relative costs and effective-
ness of alternative policies and the value system within which the relative
costs and benefits are weighed.
The purpose of this paper is not to examine the ethical or political or even
all the economic implications of this increasingly popular policy instrument.
Rather, the objective is to point out the necessary conditions for moral sua-
sion to be an effective policy instrument. It will be argued that (1) the neces-
sary conditions for a moral suasion policy to be successful in achieving any
desired goal constitute a special, not a general, case in the economy; and (2)
the presence of these necessary conditions may well be promoted by existing
trends in the economy so that over time we may expect to see a continued in-
crease in both the incidence and effectiveness of policies implemented through
moral suasion.
Since the concern of this paper is wiith moral suasion only in the economic
sphere, moral suasion will be defined here as the attempt to coerce private eco-
nomic activity via governmental exhortation in directions not already defined
or dictated by existing statute law. It is, in a sense, the extreme case of "rule
of men" as opposed to "rule of law."
The meaning of the appelative moral in the term moral suasion is not at all
clear. (Whoever heard of an economic policy of immoral suasion?) Possibly
the purpose of the appelative is to distinguish pure moral suasion, an appeal
for altruistic behavior, from other types of persuasion which are backed by
threats of punishment and/or promises of reward. However, as a practical
matter, pure moral suasion rarely has been used as serious economic policy.'
Also, it is not at all clear how altruism enters utility functions, if in fact it
ever does. Fortunately, the question of the degree to which altruistic consid-
erations influence economic behavior is not crucial, for the basic difference be-
tween moral suasion and direct suasion via the "rule of law" is not the threat

'An exception might be appeals to patriotism in times of national emergency. The "Buy
War Bonds" campaign of World War II, for example, was rather successful. To be sure, there
were other incentives provided via rationing policies and in the interest paid on the bonds.
But the interest rate was not raised.

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 1222 THE AMERICAN ECONOMIC REVIEW

of punishment or promise of reward. Rather, it is t

automatically and uniformly fall upon the (apprehended) noncomplier to
moral suasion as it does upon the violator of statute law. For where moral
suasion is buttressed by implicit or explicit threats, even if the policy fails, the
threats might not be carried out, and if only a minority does not comply the
moral suasion policy is likely to be deemed a success, and no follow-up action
is required or taken. (The immorality of moral suasion is quite clear here. It
rewards the noncomplier and punishes the socially cooperative and conscien-
tious.) Although, in some unworldy sense, moral suasion might carry with it
no threat of punishment or promise of reward, in a real sense, if the policy
constitutes anything more than innocuous pontification to the economy as a
whole, it carries at a minimum the implied threat of future legislation. In ad-
dition, the threat of fully utilizing existing regulatory powers; the danger of
incurring government displeasure and inspiring legal prosecution on complete-
ly unrelated grounds; the possibility of being pointed out for public ridicule
and abandonment or the promise of reciprocating favors may also play a role
in instances of moral suasion, both successful and unsuccessful.
Assuming intelligent government, moral suasion is exerted in the economic
sphere only in instances and directions which promote the national economic
welfare (as viewed from the government's objective function). Assuming ra-
tional, profit-oriented economic units, existing private economic activity is al-
ready maximizing each unit's own economic welfare. The sphere for moral
suasion, or any other economic policy, is where individual profit-seeking activ-
ity does not maximize the national welfare, i.e., where the particular and the
social interests diverge. Thus, moral suasion must encourage private economic
units to undertake actions which are unprofitable and which they would not
undertake otherwise.
It is worth noting that the strongest protagonists on the one hand and the
strongest opponents of moral suasion policies on the other, both in the ab-
stract and on particular issues, use the lack of one or the other of the above
assumptions as the main foundation of their position. Proponents of moral
suasion argue that it is to the long-run benefit of private units to comply with
the government persuasion ("What's good for the United States is good for
General Motors . . .") implying that private units are presently acting irra-
tionally and not maximizing (long-run) profits. On the other hand, opponents
of moral suasion argue that govelnment's position is misguided; that in fact
compliance with government wishes would not increase national welfare (". . .
and vice versa"). It is not in the national interest, they argue, to hold down
aluminum or steel prices to "subsistence levels" or to take firemen off trains,
etc. Neither side addresses itself to the only real dilemma: the situation where
both government and private units are acting rationally in the light of their
own objective functions. In what follows, intelligence and rationality are as-
sumed on the part of all parties.2 Eschewing from this discussion the cases

'To discuss moral suasion in any other context is in reality to discuss education, itself.
Although not of direct concern here, the educational aspect should not be ignored. Educa-
tion may be good even if it masquerades under the title of moral suasion, and educational
benefits are frequently used to justify-or rationalize-moral suasion policies. This is the

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 COMMUNICATIONS 1223

where government policy is in fact not promoting the national economic wel-
fare or where private activity is in fact not maximizing each individual unit's
welfare in no way defines away the problems involved in implementing eco-
nomic policy through moral suasion. On the contrary, it only disjoins those
dilemmas which can be potentially resolved through intelligent and rational
discourse from the dilemmas in which private and public objective functions,
rationally and intelligently arrived at, are still in conflict.
Within this frame of reference, it can be somewhat tautologically asserted
that moral suasion can be an effective economic policy whenever the expected
cost of noncompliance is made to exceed the cost of compliance. However,
there are conditions which must exist in order to so design a moral suasion
policy, and these conditions severely limit the size of the set of potentially
effective moral suasion policies. There are two necessary conditions for the
success of a moral suasion policy. The first is a long-run condition only; the
second is both short- and long-run.
1. The public must support the government's position. Strong involvement
with the public interest increases both the scope for altruism as well as the
probability that threats will be carried out. A glare of publicity can increase
the power of persuasion ex ante (by increasing the expected cost of noncom-
pliance) and the degree of censure on non-compliers ex post. However, this is
only a necessary condition for an effective moral suasion policy in the long
run, for fear of public displeasure is only one of the possible threats or prom-
ises with which government might back a moral suasion policy. In the short
run it may be possible to establish sufficient expectations of other costs for
noncompliers. But in the long run, given that economic policies are made in a
democratic framework, the public must support these policies politically. This
is particularly true when moral suasion is used recurrently against the same
group.
2. The populations to be persuaded must be small. Moral suasion appears
to be completely ineffective when exerted upon a large population. Fewness
makes noncompliers readily identifiable and places responsibility for the suc-
cess of the policy specifically and directly upon a small number of individual
units so that credit for success, or blame for failure, can be levied. The anal-
ogy with central banking practices in the United States and England is an ob-
vious one. Moral suasion is a cornerstone of English, but not U.S. monetary
policy, presumably because in England there are only five major banks which
need to be persuaded. A noncooperator can be immediately identified and held
up for censure. On the other hand, the Federal Reserve uses a superstructure
of legalistic controls to pursue the same ends. There are too many commercial
banks to identify culprits.

case with the wage-price guideposts, for example. The function of mediators in labor-
management disputes is usually explained on educational grounds as well. Similarly the re-
verse case, in which government is in some sense misguided, is not an irrelevant one. The
government is not tutelar nor infallible and its objective function is not necessarily equivalent
to the national welfare. It is not necessarily equivalent to anything even remotely approaching
it. Rather it is more equivalent to some such concept as the majority opinion or the com-
promise of the majority power.

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1224 THE AMERICAN ECONOMIC REVIEW

Furthermore, with only five banks, not only are the effe
any one bank readily visible, but any one bank itself may d
cess or failure of the policy. When there are many thousands of units, thou-
sands may refuse to cooperate and the policy may still be deemed a success,
and no retaliation is levied on noncooperators. In sum, as the size of the popu-
lation to be persuaded decreases, the probability that punishments will actual-
ly be levied on noncompliers inzcreases.
The necessity for a small population to be persuaded is particularly appar-
ent in cases of divergent firm and industry interests, for here the opportunity
cost of compliance for any one unit increases as the number of units which
comply increases. In essence, the greater the number of compliers, the greater
the cost of compliance. This is the composition problem familiar in agriculture
where it may be to the interest of all farmers to cut production in order to raise
price, but not to the interest of any one farmer to do so. If the short-run aver-
age cost curve is flat, then a small number of noncompliers can produce the
market share relinquished by a large number of compliers. Contrariwise, if the
average cost curve is U-shaped, then cutting output can raise costs to com-
pliers. In either case, compliers quite likely lose absolutely and always lose rela-
tively to noncompliers. For moral suasion to be effective here it must impose a
high probability of punishment on noncompliers and for this, as I have
argued, fewness is necessary.
Fewness also implies a closer and more direct correspondence between indi-
vidual action and public interest. If the cost of compliance is small and the
fewness condition is met, moral suasion backed by altruism alone might be
effective.
The failures of modern day programs for business to voluntarily restrict in-
vestment and banks to curtail credit abroad; for vacationers to restrict their
tourism abroad; or for business to pass on to consumers all "savings" from
excise tax cuts can be credited directly to the fact that the population which
the government was attempting to persuade was too large.3 (This was Emperor
Julian's problem also.) On the other hand, government's relative success in
imposing the wage-price guideposts in specific oligopolistic industries and in
high-level mediation of labor-management disputes can be credited to the fact
that the fewness condition was met.
The fewness condition imposes a severe limitation on the applicability of
moral suasion as an instrument of policy, and it cannot be artificially satisfied

One possible exception to the fewness rule, although again associated with a time of
national emergency, was the implementation of the Defense Production Act during the
Korean War [3, pp. 196-971 [31, [6], [7]. One aspect of this act, administered by the
Federal Reserve, was for voluntary restraint by lending institutions in extending credit for
nonwar and nonessential purposes. It is generally considered to have been a successful policy
reaching a pinnacle of success when investment banks refused to handle state bonds issued to
finance a veterans' bonus. The reasons for the relative success of this policy are probably:
(1) patriotism in time of war may be a temporary exception to the fewness rule; (2) there
was an attempt to achieve fewness by administering this program via regional Credit Re-
straint Committees consisting of representatives of local lending institutions; and (3) given
the existing demand for credit at this time, the cost of compliance may have been so small
that a negligible cost imposed on noncompliance could make the policy effective.

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 COMMUNICATIONS 1225

by arbitrarily delineating a small population to be persuaded. Generally, the

population to be persuaded must be as large as the population which policy-
makers desire to affect. One cannot, for example, successfully exert persuasion
on some of the firms in a given industry to cut prices. The exception of course
is where persuasion is exerted on only the price leader of an oligopolistic in-
dustry; and such industries meet the fewness condition by definition.
Fewness also implies the existence of sufficient market power to affect the
public interest. Given that some level of restraint is required on economic ac-
tivity, insofar as competition declines as concentration increases, substitute
restraints must come from either increased governmental controls or from
moral suasion. This offers a possible reason why we have observed and may
continue to observe increasing use of moral suasion as an economic policy.
Greater concentration in the economy increases both the effectiveness of moral
suasion as well as the need for restraining policies.4 In addition to concentra-
tion generally, the continuing growth of firms into national vis-a-vis regional
markets in response to transportation and other technological improvements
encourages the use and promotes the effectiveness of moral suasion. Concen-
tration in the national market meets the fewness condition far better than
does an equal degree of concentration in regional markets. In the latter, iden-
tification with the national interest is not close; a moral suasion policy is more
difficult to administer; the probability that implied punishments will actually
be levied is much less; and insofar as intermarket competition exists on at
least the regional boundaries, the need for restraining policy is less as well.
The geographic organization and regional bargaining practices of many labor
unions, for example, might explain why labor is (as many argue) less suscep-
tible to moral suasion than is business whose markets are more likely to be na-
tional in scope. Increasing concentration and rise of firms into national mar-
kets along with the increasing involvement of government in the economy, a
possibly more representative government in a more complex economy, and a
strong desire to maintain "free institutions" even where they may conflict
with other policy objectives, undoubtedly explains the rise in popularity of
policies implemented through moral suasion.
J. T. RoMANS*

'It is well known that the evidence in support of the view that concentration is increas-
ing in the economy is not overwhelming. The state of the art of measuring industrial con-
centration is such that the results depend upon the particular measure and time interval
adopted. In terms of the long run and in terms of expansion and concentration in the
national market, however, the evidence supports the view that concentration is increasing
[1] [4].

* The author is assistant professor of economics at the State University of New York at
Buffalo. He is indebted to his colleagues at this institution and also to Daniel Garnick and
Robert Spitze for critical comments.

REFERENCES

1. HENRY ADLER EINI-IORN, "Changes in Concentration of Domestic Manu-

facturing Establishment Output: 1939-1958," Jour. Arn. Stat. Assoc., Dec.
1962, 57, 797-812.

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 1226 THE AMERICAN ECONOMIC REVIEW

2. EDWARD GIBBON, The Decline and Fall of the Roman Empire, Vol. 1. New
York, Modern Library, 1932.
3. WALTER W. HAINES, Money, Prices and Policy. New York 1961.
4. SAUL S. SANDS, "Concentration in United States Manufacturing Industry,
1904-1947," Internat. Econ. Rev., Jan. 1962, 3, 79-93.
5. J. TINBERGEN AND H. C. Bos, Mathematical Models of Economic Growth.
New York 1962.
6. U.S. Congress, Senate Committee on Banking and Currency, Defense Pro-
duction Act, Amendments of 1951, Hearings, 82nd Cong., 1st sess., Wash-
ington 1951.
7. , Defense Production Act, Amendments of 1952, Hearings, 82nd
Cong., 2nd sess., Washington 1952.

The Supply of Storage Revisited

prices quoted at one time in a futures market, for two dates of

delivery, stand in a relation which in general does not reflect expectations
regarding events that may occur between the two delivery dates." So
stated Holbrook Working [12, p. 1255] in his fundamental article on the
price of storage.
Working illustrated his point in terms of the U.S. wheat market. It is
typical during a crop year following a relatively sparse harvest that the May
(pre-harvest) wheat futures contract will trade at a premium over the Sep-
tember (post-harvest) future. To Working, the magnitude of this premium
was in general not a function of either the expected size or the expected
timing of the forthcoming harvest: " . the price of May wheat (in April,
let us say) is above the price of wheat for September delivery because the
last crop was small (perhaps the carryover from still earlier crops was small
also, contributing to the effect). So far as suppliers are concerned, it is only
supplies already in existence which have any significant bearing on a current
inter-temporal price relation of this sort" [12, pp. 1255-56]. This observa-
tion was based at least in part on some of Working's earlier empirical find-
ings [10] [11].
Working's hypothesis is particularly useful because it places in proper
perspective the dominating role which stocks play in determining inter-
temporal price relationships (i.e. relationships between expected prices for
the delivery of a commodity at different points in time). On the other hand,
insofar as it reflects the consideration of a special case, the hypothesis is
incomplete and in part misleading. An investigation of this point not only
clarifies the theory of intertemporal price relationships, but what is of
greater interest, it also yields a theory explaining the dynamic behavior of
commodity spot prices.

I. The Supply of Storage

The fundamental relationship which gave rise to Working's hypothesis is
the "supply of storage" curve, illustrated in Figure 1. For very low current

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