Front Page Titles (by Subject) III: Economics and Public Policy - Literature of Liberty, July/September 1979, vol. 2, No. 3
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III: Economics and Public Policy - Leonard P. Liggio, Literature of Liberty, July/September 1979, vol. 2, No. 3 
Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.
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Economics and Public Policy
Economic theory and policies—whether sound or faulty—determine the health of a society and the chances of its material progress or decline. If sound economic insights fail to inform and “penetrate” political theory, a plague of social ills ensue. This is the recurrent and chilling lesson of economic history written in the suffering, frustrations, and catastrophes that characterize depressions, spiraling inflation, trade imbalances, energy shortages, and food or transportation disruptions. Economic science, far from being an abstract, ivory tower irrelevance, exercises a most practical influence—for good or evil—on our politics and individual lives. This vividly appears in the present set of summaries which investigate questions of inflation, depression, and monetary policy.
Since government economic intervention tends to create social, political, cultural, and financial dislocations, the second summary is of vital importance: why do citizens in democracies choose a policy of deficit financing with its calamitous inflationary consequences? The final summary sets forth, from such an unlikely source as Friedrich Engels, insights into the importance of competitive, free markets to allocate resources and guide production efficiently and humanely.
How Economics Influences Political Theory
“The Economic Penetration of Political Theory: Some Hypotheses.” Journal of the History of Ideas 39 (1978): 101–118.
Why do economic ideas penetrate political theories to varying extents at given historical times? Twentieth-century economics gives little support to political theories because it looks at man as an impersonal demander of utility rather than as does political theory (i.e., as a being involved in relations of dependence and control with other people). Attempts by political scientists to adapt the economic model of marginal utility equilibrium to an analysis of democracy has failed because it ignores the crucial power relations which any political theory must confront.
As a measure of how powerfully economics penetrates a political theory, we can ask whether the economic relations are viewed as settling the problem of the best possible political order. Put rather indirectly: “the economic penetration of political theory varies with the extent of the market.” That is, as markets come to dominate economic life, so economics impinges upon political theories. Because the rise of markets presents unsettling problems for societies, political theorists become concerned with these factors. Locke, Bentham, and James Mill display an increasing belief in the exploitation of the capital/wage-labor relation, and a corresponding belief in the extent to which government's role was thought to be established by economic relations. Strangely enough, J.S. Mill is pictured as marking a decline in awareness of the exploitative nature of capital, and a consequent decline in economic penetration of their political theories. In redefining utility in qualitative terms, Mill moved political theory away from political economy.
In addition, the economic penetration of political theory varies with the political strength of an exploited class; directly in socialist theory, and inversely in liberal theory. In liberal theory this relationship is borne out in twentieth-century political thought. As capitalism becomes less viable, liberals retreat from economic penetration to idealism. This movement should be countermanded by a political theory again becoming informed by economic insights.
Why Democracies Choose Deficits
“Deficits and Democracy.” Southern Economic Journal 44 (April 1978): 813–827.
Democracies have tended to resort to budget deficits to finance expenditures. We can use a model of political competition which explains deficit financing in democracies by recognizing that institutional arrangements and corresponding assignments of property rights significantly influence individual choice.
We can view politicians as political suppliers of deficits in a monopoly situation: politicians compete for the right to supply a monopoly product (governing) for a limited time which is renewable through reelection. This view implies that political parties will strive to give the voters what they want in order to get elected; hence voters seem in some sense to “want” deficits rather than taxes to finance expenditures. The “rational expectations” literature predicts that (since deficits imply future tax liabilities) rational voters will treat deficits and taxes as equivalent claims and exhibit no preference between the two forms of finance. However, even perfectly rational and foresightful voters will prefer deficits.
One reason politicians can get away with deficit financing without voter preference is the incentive structure. Voters may be conceived of as owners of public goods and politicians as “managers.” Then the politician-managers would have no personal liability for financial mismanagement, and would thus reduce the capital value of the public stock beyond their own pro rata share of future tax liabilities. Deficits are then seen as the least costly means of financing expenditures. Voters, on the other hand, would demand expenditure because they see the increased cost to any one voter as negligible while the potential benefit can be great.
Two factors explain why voters will prefer deficit financing in a democracy. The first is that individuals have positive discount rates (positive time preference), and the second is that they can shift some of the costs to the future. That is, voters desire deficits because they do not rate the utility of next generation's consumption as equal to their own. They can, in fact, shift the burden of the debt to the future by taxing human capital rather than non-human capital. If non-human capital alone were taxed, a budget deficit would place a liability on future income streams of capital goods. This would reduce the present value of the good sufficiently to offset increased future taxes. The present owner would bear the burden of the debt. If human capital is taxed, one cannot capitalize his own present value indefinitely into the future, so part of the future tax will be paid out of the human capital of the next generation. One test of this hypothesis would be if states which rely more on income taxes than property taxes have greater deficits. Testing has shown this to be the case. Governments which routinely tax human capital to finance at least part of their budgets are more likely to run deficits.
Inflation and the Welfare State
“Economic Growth and Social Welfare.” Scottish Journal of Political Economy 24 (November 1977): 193–206.
The relationship between economic growth and “social welfare” is complex since sometimes they complement and other times they counter one another.
Since World War II, 30 years of prosperity have ensued partly because of “full employment” policies. But these policies can lead to serious problems and even contain the seeds of their own destruction.
The acceleration of wage inflation toward the end of the 1960s was in part the delayed effect of the full employment policies. These government inflationary policies led employers to believe that they could not price themselves out of the market, and workers to believe that they could not price themselves out of a job because the government would always bail them out.
The welfare state was the main reason why public expenditure in Britain rose from 25%–30% of GNP during most of the inter-war years, to 40%–45% during most of the first two post-war decades. But the upsurge of government costs since the mid-1960s displays the irresponsibility of politicians who tried to act on the popular belief that government could provide goods and services like manna from heaven. It printed money and rationalized its actions in terms of the Keynesian acceptance of unbalanced budgets. It would be wrong to blame the founders of the welfare state for recent developments. What we are now witnessing, however, highlights the danger of absent-minded and unlimited enlargement of the state's role.
People in Britain are, however, becoming more aware of the enormous waste in the administration of public expenditure and the arbitrariness in spending public funds. They perceive how they are being forced to accept a pattern of consumption dictated by the state, whereas they would prefer more “private wage” and less “social wage.”
Above all, people are increasingly aware that public expenditure has to be paid for by higher taxation. Whereas during the first post-war decade a married man with two young children paid income tax only if his earnings were at or above the British national average, now he has to pay even if his earnings are under half the national average.
Monetarism and the Depression
“Money and the Great Depression: A Critique of Professor Temin's Thesis.” Explorations in Economic History 15 (1978): 127–145.
Peter Temin's essay on the “great contraction” of the 1930s, Did Monetary Forces Cause the Great Depression? (1976), has clarified the Keynesian interpretation of the Depression. Challenging the long prevalent monetarist explanation of Milton Friedman and Anna Jacobson Schwartz in their Monetary History of the United States, Temin claims that a major, autonomous decline in consumption occurred in the early 1930s and that this decline, by its repercussions on financial markets, caused the sharp and persistent recession. Thus, Temin argues that the declining money stock of the 1930s was a symptom of basic changes in the real sector. Consequently, even if bank failures had not reduced the money stock, declines in money would still have been near the actually observed levels. Temin interprets fluctuating interest rates as a sign that the demand for money fell faster than the supply of money contracted (for any given rate of interest).
If valid, these arguments would clearly weaken the monetarist claim that the “great contraction” resulted from inept and unnecessary money management. Several problems, however, weaken Temin's attack. For example, Temin emphasizes the year 1930 in his analysis of the monetarists' argument on the decline of the money stock. This emphasis is surprising inasmuch as Friedman and Schwartz deal with the period 1929 to 1933 and note that the major declines occurred after 1930. Then again, Temin's argument for an autonomous decline in consumption rests on only three observations, consumption in 1921, 1930, and 1938. This narrow focus precludes reliable conclusions: It is difficult to even identify the abnormal year in a selection as sparce as Temin's. Also, it is unclear that a major autonomous fall in exports reinforced the decline in consumption, as Temin argues. Furthermore, he fails to investigate whether declines in the incentive to spend and invest might be a cause of recession.
Temin may also be faulted for suggesting that the money stock would have fallen regardless of bank failures. The evidence indicates an excess supply of money preceding the wave of bank failures. Also, Temin lacks a defensible explanation for the behavior of real money balances. It is possible to explain the decline in short-term interest rates from either a Keynesian or a monetarist viewpoint. Thus, the evidence on real money balances fails to support Temin's explanation of declines in incomes.
Asian Monetary History: Gold & Silver
“Episodes from Asian Monetary History. The Fall of Silver: Part 1. China and the Silver Standards.” Asian Monetary Monitor 2 (July/August 1978): 33–43.
Under a bimetallic monetary standard of gold and silver, the silver standard countries had acted as automatic stabilizers, absorbing either gold or silver depending on their changing relative prices. But the government-induced shift from bimetallism to the predominant use of gold in the latter part of the nineteenth century, meant that the exchange rate between silver and gold standard countries was free to float for the first time. A combination of circumstances produced a longterm decline in silver prices which, in effect, was a continuous depreciation of this exchange rate. This chronic depreciation stimulated production and exports in the silver standard countries while rendering the exports of the gold standard countries relatively more expensive.
The government of India found fluctuations in the price of silver disquieting. These fluctuations were increased with the passage of the Sherman Act in the U.S. (1890) followed by a repeal of its silver purchase clause. The government acted to place India on a de facto gold exchange standard by intervening to maintain a fixed exchange rate between the India rupee and the British pound sterling.
The Chinese exchange rate would not be pegged and so it continued to fluctuate. These fluctuations meant that interest rates, prices, and output in China diverged from those in the gold standard countries. A floating exchange rate insulated China against an import of the trade cycle from the gold standard countries. Indeed, inflows and outflows of silver acted counter-cyclically in the world economy. The Chinese wholesale price index closely followed the Chinese exchange rate. The U.S. price of silver, and relative prices in the U.S. and in China, also closely followed each other. Chinese prices exhibited greater stability than did the price index in the gold standard countries. This monetary stability was shattered only in the 1930s, when the U.S. government's attempts to maintain the price of silver in effect imposed a massive deflation on the Chinese economy.
Specie Money vs. Antibullionists
“Winners and Losers: Some Paradoxes in Monetary History Resolved and Some Lessons Unlearned.” History of Political Economy (Winter 1977): 476–489.
Today's monetary issue is as old as economics itself, yet as modern as tomorrow: the question of the monetary standard, which, in modern terms, is the criterion of monetary policy. The “bullionists” are supposed to have won the nineteenth century monetary controversies, yet it is the “antibullionist” dogma that pervails today. We have the abstract (noncommodity) monetary unit desired by the antibullionists, but do not know how to manage it because we adopted it by default rather than by design.
Ricardo argued that nothing would prevent a costless currency from becoming worthless. No one has yet proved him wrong, and today we appear to be proving him right. The banking school became the stewards of the antibullionist doctrine, and relied on banking practice rather than politicians to maintain the value of the monetary unit. Forgotten were the fallacies at the root of banking school principles, such as the Real Bills doctrine. But these fallacies governed the operation of the banking system. The banking school dogma was tested and proved a failure in the thirties. Though the public believed the bullionists had won, public policy had, in effect, unknowingly enshrined the banking school doctrine. Hence, the disastrous consequences for the banking system—which was believed to be the product of the bullionist paradigm, but in fact operated according to the principles of antibullionism.
But the modern International Monetary Fund is simply a repetition of past errors. International reserves, intended to determine the international money supply, must instead function to protect an indeterminate supply. We are still left with the problem. Can a noncommodity money allow us to find a market-determined rule to guide monetary policy in the place of a real commodity money and the derived rules of the past? Monetarists think they have found such a rule, but neglect real factors (e.g., war) that are responsible for inflation-deflation cycles.
“It is no wonder that we do not know what to do. We know not what we have done or are doing.”
Inflation Effects on Capital
“Inflation and Taxes: Disincentives for Capital Formation.” Federal Reserve Bank of St. Louis Review 60 (1978): 2–8.
The tax laws levy on nominal returns and permit depreciation only on historical costs. For a firm to keep up (in real terms) with inflation, it ought to depreciate on replacement costs; and it ought not be taxed on the increase in nominal income that is necessary solely to maintain the firm's balance sheet as it was before inflation. Since these effects are ignored in our current tax laws, “taxes are being levied not only on the income generated by the capital, but also on the capital itself. This taxation reduces the incentives of firms to invest.”
Likewise, progressive taxation of personal income requires the investor to earn a higher pre-tax return if his after-tax return is to be the same as in a noninflationary environment. An economic environment of high taxes and inflation raises the firm's cost of acquiring capital at a time when their after-tax return is falling. These factors will profoundly distort future economic growth and well-being.
We cannot “learn to live with inflation” and maintain our standard of living. Either politicians must substantially revise the tax laws (which seems unlikely), or we must adopt monetary and fiscal policies to reduce or eliminate price inflation.
Consumption of Public Health Services
“The Distribution of Public Expenditure: The Case of Health Care,” Economica (UK) 45 (May 1978): 125–142.
Does the social position or class of individuals affect the amount of medical treatment they receive when they are ill? We can answer this by relating public expenditure on Health Services in England and Wales to the incidence of illness in socioeconomic groups.
Various measures of the distribution of ill-health (morbidity) among the social classes indicate that a greater proportion of people in the “lower” classes describe themselves as ill than in the “higher” classes. To some extent this may be explained by the different age and sex demographics of the social classes.
Estimates of public expenditure on health care reveal that relatively more is spent on those in the higher than in the lower classes. One estimate, in fact, suggests that people at the top of the social scale receive at least 40 percent more expenditure per person than do people at the bottom.
The estimated differences in expenditure per person may result from either or both of two factors: differences in the incidence of disease within each social class, and differences in the utilization of the Health Service by those describing themselves as ill within each class. The first alternative seems invalid because the available evidence suggests that “whatever other class differences there may be in Britain, differential incidence of self-reported illness is not one of them.” Therefore, accepting the second alternative leads to the question: why do the higher classes make relatively more use of the Health Services?
A sample utility-maximizing model of utilization would imply that individuals will “consume” National Health care up to the point where the marginal disutility of consuming further care exceeds its marginal utility. The marginal disutility of health care may be lower for the higher classes because they tend to spend less time travelling (as they can use their telephones to make appointments). The higher classes also use more health care because they live near better medical facilities and because they are likely to lose less income during the time they are consuming health care. Moreover, the higher classes may judge the marginal valuation of the benefits from health care as higher because they tend to perceive health services as real improvements in their health.
This suggests that cuts in public expenditure on public services would hurt the higher classes more than the lower classes. If such cuts were also accompanied by tax cuts, the lower classes might be better off and the higher classes worse off than they are now.
Factory Regulation and Vested Interests
“Factory Regulation: A Reinterpretation of Early English Experience.” The Journal of Law and Economics 20 (October 1977): 379–402.
Evidence suggests that Lord Althorp's Factory Act actual purpose was not industrial regulation to protect children, but rather an early example of industry leaders using the law to regulate their competitors.
As a legislative landmark in the history of industrial regulation, Lord Althorp's Factory Act of 1833 prohibited the employment of children younger than 12 years of age in Britain's textile mills. In current textbook literature, Althorp's Factory Act established government's right to intervene in industry to protect the economically and socially exploited. Historians have come to view the social welfare scope of the Factory Act as the beginning of modern economic regulation.
The Act was clearly a precedent for subsequent social and economic legislation, but its purpose is open to debate. Rather than intending it to protect young laborers, the authors of the Factory Act designed it to promote the interests of technologically superior cloth manufacturers by driving from business the more numerous but less sophisticated manufacturers who depended on the labor of children.
Before the Reform Act of 1832, a factory bill might well have embodied such humane reform proposals as those of Michael Sadler. However, the Reform Bill's extending of the franchise (and the reconstitution of Britain's electoral districts) hurt the reformers' political base and shifted the new power in Parliament to large manufacturing districts. Resulting factory legislation thus represented the interests of textile magnates rather than the socially-minded country gentry.
Traditionally dependent on water power for their mills, manufacturers had built rural factories away from major centers of population. The steam engine changed much of this. The urban steam mills with their greater power facilitated the greater use of labor-saving machines, which in turn diminished the need for child labor. By shifting political power to the cities, the Reform Bill allowed steam-using manufacturers to apply law to industry rivals.
In effect, the Act decreased the supply of cloth and increased price, and the additional revenues accrued to the plants controlling the largest measure of product unaffected by the Act. Moreover, the penalties for continued employment of children fell most heavily on the mills dependent on water. These penalties placed an additional burden on the competitors of steam-powered plants, thus enhancing the capacity of steam operators to control cloth manufacturing.
Poverty Programs and Government
“Statistical Poverty in Mississippi: A Profile of the Poor in the Nation's Poorest State.” Mid-South Quarterly Business Review 17 (April 1979): 11–15.
Mississippi has the greatest incidence of statistical poverty as defined by the official government indicator. However, the author contends, the higher-than-national incidence of statistical poverty in Mississippi does not of itself suggest a need for increased logistical support for programs of service delivery, consciousness raising, or an expanded government presence. In fact, “it might be worthwhile to consider what government is currently doing which it could cease doing if concern for the underprivileged population and expansion of opportunity for that category is the criterion of concern.”
We need to critically reappraise the automatic response of addressing appeals to government for help, solution, aids, and programs. Many of these appeals, regardless of the public interest vocabularies in which they may be couched, seem to work out as the efforts of special groups to profit at the expense of other groups through the political process. And there may be as much effort on the part of government to seek out clientele and beneficiaries as there are efforts to use the collective and coercive power of government. There appears to be considerable government-encouraged activity to mobilize community groups to seek increased government assistance.
Quite frequently it becomes clear after several decades of implementation of a messianic policy that it does not have the consequences enlightened spokesmen said it would have, but rather the consequences predicted by critics. This often leads to new ground wherein those enamored of government really intend to make it “work” in the public interest. The author suggests that we should evaluate the potential outcomes inherent in the process itself. We should also scrutinize schemes to mobilize resources in order to remove those hindrances to opportunity and productivity spawned by interest groups that manage to use the machinery of government in their own behalf (in the name of “the public interest”). We finally need to devise solutions to restrict government from prolonging poverty among persons, groups, or areas.
The Costs of Regulating Market Information
“An Appraisal of the Costs and Benefits of Government-Required Disclosure: SEC and FTC Requirements.” Law and Contemporary Problems 41 (Summer 1977): 30–62.
Expanded government-required disclosure of information by business is a legacy of the New Deal. More extensive mandatory disclosure gave the promise of less fraud on investors, better administration in the reporting corporations, more equitable and efficient capital markets, a more efficient allocation of resources, and greater governmental ability to manage the economy. While it is virtually an article of faith in many circles that government-required disclosure is a good thing, it could be that the costs of the SEC and FTC reporting requirements outweigh their benefits. Benston's investigations reveal not only that the cost of providing the required data is quite substantial, but also that the benefits to investors from the data are rather meager.
The Securities Act of 1933 and the Security Exchange Act of 1934 pioneered mandatory disclosure in the securities field. These and subsequent disclosure acts were intended to reduce fraud and inadvertent misrepresentation; reduce security price manipulation made possible through inadequate disclosure; enhance fairness to non-insiders; enhance public confidence in the securities market; increase the efficiency of making securities investments; and provide a greater flow and range of information to investors. Were mandated disclosures successful? “Little, if any, evidence supports the belief that these possible benefits have been achieved. Nor is there much, if any, evidence that is consistent with the claim that the Acts addressed a real problem. Furthermore, reason does not support the belief that the benefits claimed can be achieved or are indeed benefits.”
The FTC requires extensive reporting through its line-of-business report program. Under this program, certain businesses are required to collect and disclose detailed data on shipments, sales, advertising, profits, investments, and assets. The benefits claimed for the program range from improved anti-trust enforcement to enhancing labor's position in wage negotiations. Yet again, the promised benefits of disclosure turn out, upon investigation, to be little more than pious hopes. The FTC line-of-business categories for reporting do not represent a meaningful aggregation of data, and thus cannot realize the purported goals of FTC-required disclosure.
In light of this, why is government disclosure supported despite its cost and its failure to provide benefits? The answer, in part, lies in the public's apparent belief that government regulation of disclosure is beneficial and necessary. Another part of the answer is gained by asking who benefits from government mandated disclosure. The truth is that groups ranging from bureaucrats to financial analysts have a substantial interest in required disclosure. Nevertheless, if evidence can alter beliefs, there is hope for ending the counter-productive disclosure measures that are in large part a legacy of the New Deal.
“The 1974 Rent Act—Some Short Run Supply Effects.” The Economic Journal (UK) 88 (June 1978): 331–342.
The 1974 Rent Act (UK) on the furnished rental housing sector in Glasgow replaced the Rent Act of 1965. The latter distinguished between furnished and unfurnished lettings and provided security of tenure to unfurnished tenants. Rents of furnished accommodation were generally market determined and tenants had limited security of tenure.
The 1974 Act did not alter unfurnished lettings very much but made substantial changes in furnished lettings: they were regulated in the same manner as unfurnished lettings. Rents were to be “fair rents” assessed by rent officers and were defined as rents established in a free market without a scarcity premium. The fair rent criterion is theoretically imprecise and vague in its possible interpretations. The rent officers operate on an average cost pricing basis. This might seem unlikely to drive out landlords. But there are some difficulties. By giving tenants security of tenure, the 1974 Act increased the risks of letting and reduced the certainty of future returns, and reduced the landlords' ability to dispose of their property in their own way. Since landlords, who usually are small investors with two or three properties, often have a specific disposal date in mind (i.e., retirement from the labor force) this increased uncertainty might be expected to influence investment and letting decisions. In particular, landlords may adopt letting strategies which reduce the effective security of tenure provisions, for example, by letting only to transient tenants.
Surveys indicate that the 1974 Act did, in fact, reduce the supply of furnished properties. This reduction has not been counterbalanced by an expansion in municipal property available for letting. Consequently, those who wish to obtain furnished lettings are trapped between the effects of the Rent Acts and intransigent policies on municipal letting. Paradoxically, the attempt to reduce the power of the landlords results in a reduction in supply and an increase in excess demand. This may actually increase the power of landlords over their tenants. The current review of housing policy and the Rent Act will, perhaps, replace dogma with analysis in formulating housing policies that will be clearly defined.
Engels on Economics
“Friedrich Engels and Marxist Economic Theory.” Journal of Political Economy 86 (April 1978): 303–320.
Engels deserves a “more important and more interesting place in the history of economics, Marxist or otherwise, than leading authorities … have been prepared to ascribe to him.” W.O. Henderson's recent two volume Life of Friedrich Engels is no exception.
Engels' economic writings begin with his “Outlines of a Critique of Political Economy” written when he was only 23 years old. Remarkably, this work identified three themes central to Marxism before Marx wrote them. Engels emphasized periodic crises, a theme of great importance to Marxism even though he exaggerated their importance. Second, Engels predicted concentration of business before the joint stock company, and third, he argued that technological change would render Malthus's gloomy predictions obsolete. Significantly, Engels identified a third factor of production after land and labor—the mental element of thought or invention—which he differentiated from “sheer labor.” This idea, if followed up, would have undermined Marx's system from the start.
The theme of technological progress appears again in Engels' “The Principles of Communism,” a first draft of The Communist Manifesto. Engels' Principles, however, contains a description of the workings of the communist economy which was omitted from the Manifesto. (Marx never did tackle the problem of how a communist economy would function.) In this essay, Engels relies on technological progress to eliminate scarcity and the concomitant need for private property. However, he also calls for a period of transition. Hutchison comments “Never has there been a wider contrast or more extreme contradiction between short-term, ‘transitional’ aims and methods requiring the creation of vast bureaucratic vested interests and, on the other hand, what was professed to be the long-term objective of the ‘withering away’ of the state.”
In Poverty of Philosophy (Introduction of Marx's work), Engels attacks the Utopian Socialists, especially Rodbertus, who had proposed a system of labor money based on a labor theory of value. In his attack, Engels gave an excellent description of the role of a competitive market in resource allocation and guidance of production. “Mises and Hayek could hardly have made the point more forcefully.” However, in his and Marx own utopian schemes, he totally ignored the insight in his criticism of the other utopians. Hutchison concludes, “Surely no one in the whole of intellectual history can have looked a major, pressing intellectual and practical problem so clearly and piercingly in the face and then so blithely and confidently passed on without a word.”