Unemployment Japanese Style

By George P. Brockway, originally published May 9, 1994

I REPRODUCE above in its entirety a news article that appeared on page D4 of the Business Day section of the New York Times for Friday, April 29, 1994. Don’t feel badly if you can’t recall seeing the story in tile paper. It was easy to miss. It ran in the gutter at the very foot of the page and was surrounded at its top and left by an article from a stringer headlined “Denver Airport Date Firm” (on Sunday the date turned out for the nth time not to be firm). If you were the editor of what you proudly and properly referred to as a newspaper of record, and you had a story you wanted to kill yet had to print in order to complete the record, you would handle it in just this way.

I leave to others the task of speculating why the Japanese unemployment story was in fact buried; why, given its explosively dramatic contrast with American and European unemployment records, it was not run as the lead on the first page of the Business Day section, if not on the front page of the entire paper; why the bare numbers were not accompanied by a backgrounder explaining how the Japanese manage such a low unemployment rate even in the midst of a recession; why nothing about the story has appeared among the concerns of the editorial page or the Op- Ed page; why the Times economics columnists have found nothing to remark on in a report that renders suspect the barbaric but fashionable theory of a natural rate of  unemployment, a smattering of whose arcane details they dazzle us with now and then.

Although I will not speculate, I am interested in that last point. For as I have said often enough, I follow Keynes (and indeed everyone at all capable of empathy with a fellow human being) in holding that an outstanding fault of the economic society in which we live is its failure to provide full employment. The theory of a natural rate of unemployment, subscribed to by almost every conventional economist in the United States, argues that this outstanding fault cannot be corrected without igniting an inflation that would destroy the economy.

The news from Tokyo tells us that the current unemployment rate in Japan, while the highest in six years, is nevertheless lower than the lowest unemployment rate the United States has posted since World War II. I do not have at hand Japanese figures earlier than 1967, but after that date Japan’s unemployment has never been higher than 2.9 per cent and U.S. unemployment has never been lower than 3.4 per cent. The American low was registered during the Vietnam War. Our present rate (achieved during a sluggish peacetime recovery that has scared the Federal Reserve Board silly with nightmares of future inflation) is almost three times the present Japanese rate (achieved during a persistent recession).

These facts strongly suggest that the so-called natural rate need not be accepted as immutable. What the Japanese have done is surely within our capabilities; and given the freedom, not to say volatility, of American life, a 2.6 percent rate would be as near full employment as never was.

The natural rate theory has from the beginning allowed that the rate is not really natural but depends on “market characteristics” that are, as Milton Friedman has said, “man-made and policy-made.” What man and policy make they presumably can unmake. The chief market characteristic complained of by natural rate theorists is a minimum wage law. Emboldened by my recent adventure in investigative reporting (see “Ending Welfare As We Know It,” NL, March 14-28), I phoned six Japanese agencies (four of them official) and one American labor union to find out whether Japan has a minimum wage law. No one knew offhand, but the consulate called me back a couple of hours later to report that indeed Japan has such a law. It is a national law, and it specifies minimum wages for different trades and different localities. I doubt that natural rate theorists, who are firm believers in market discipline, would think it an improvement on the American law.

Let us therefore consider the reaction of conventional theory to a 2.6 per cent unemployment rate. Without doubt the prescription would be for a high-very high-interest rate to contain inflation. Has that been prescribed in Japan? Indeed it has not, nor has such a regimen been followed. Rather the contrary, the interest earned by a 1O-year government bond in Japan is now 4 per cent; with us, the corresponding rate is, as I write, 7.10 per cent and will go higher before you read this, if the present majority of the Federal Reserve’s Open Market Committee has its way.

Well, then, since Japan has comparatively low unemployment and comparatively low interest, it must, according to conventional theory, have comparatively high inflation. But Japan’s price index changed 0.0 per cent in April and, at least from 1967, has never climbed as fast as ours.

IT IS OF COURSE possible that other elements contribute to the differences between Japan and the United States. I can name three that may: import policy, productivity and saving.

We all know about Japanese import policy. It is difficult, devious, protectionist, and successful. Twelve years ago I wrote the first of several columns arguing for a protectionist policy for the United States (“America’s Setting Sun,” NL, June 14, 1982). I don’t propose to repeat myself now, except to remark that Japanese protectionism has obviously not prevented the success of Japanese policies directed toward low unemployment, and may well have been a factor in their success.

Productivity is another question I have addressed several times (first in “Productivity: The New Shell Game,” NL, February 8, 1982). In the present context all that need be said is that American productivity is now, and as far as I have been able to discover has always been, greater than Japanese. In fact, among the leading industrial nations, only British productivity has generally been outranked by the Japanese.

On the other hand, Japan’s GNP has, until the last couple of years, grown faster than ours.  Conventional economic theory, though, is possessed of the altogether unintelligible notion that productivity is more desirable than production. It may work out that way in a mathematical model, but it certainly doesn’t on the dinner table[1].

I have also written about saving and shall do so again, but the problem with respect to Japan is special. In the first place, a 1990 study by Fred Block in the Journal of Post Keynesian Economics demonstrated that the figures usually published overstate Japanese saving and understate American. In the second place, as Block showed, an extraordinary amount of Japanese saving, however defined, goes into speculation rather than production. The real estate (land and improvements) of Japan, a nation whose area is no greater than that of Montana, is, at today’s prices, more valuable than the real estate of our 48 contiguous states (a not inconsiderable amount of which is owned by Japanese). The Japanese stock exchange is notoriously volatile, with daily spikes (or spike holes) of 5 per cent or more not uncommon. Keynes thought Americans were addicted to gambling, but the Japanese seem to have it worse.

All of their speculation absorbs enormous amounts of money, but it does nothing for the economy. The money is saved in the sense that although it was earned in the producing economy, it is withheld from use in the producing economy. The withholding is achieved by underpaying large classes of workers, especially women, and by underfunding social services. Because of its hierarchical distribution of wealth and its systematic maldistribution of income, Japan cannot consume all it produces and must sell overseas; thus when foreign markets falter, Japan suffers recession.

In short, neither Japanese import policy, nor Japanese productivity, nor Japanese saving can account for Japan’s low unemployment coupled with low inflation. So is there nothing we can learn from the Japanese record? There are, I think, a couple of things. In the circumstances, the actual virtues (as opposed to the theoretical vices) of some sort of protectionism are very hard to deny, as are the virtues of a steadily low interest rate.

Regarding the latter point, we are told that we cannot afford a low rate because it would stimulate a flight of capital to the Bahamas or the Caymans or perhaps some more exotic land farther overseas. I don’t know about that. Even in the early ’80s, when the prime rate here hit 21.5 per cent, and the Japanese rate was as low as it is now, only a small proportion of the yen flew here. Why did most of it stay home? For the good and simple reason (as Tom Swift used to say) that with a low interest rate Japanese industry could be happily profitable, while the “strong” American dollar caused by high American interest made it easy to penetrate our unprotected market.

A high interest rate (and our recent supposedly low rate was exceedingly high by Japanese standards, as well as by our own pre-1960 standards) is a market characteristic that makes for a high “natural” rate of unemployment. A low rate, contrariwise. The news was barely fit to print. Still, we’d be wise to pay attention to it.

The New Leader

[1] Ed.:  I can’t help but wonder what the author would have thought of Clayton Christensen’s concerns with corporate focus on margins instead of profits as in the Innovator’s Dilemma, and his more recent thoughts on The Capitalist’s Dilemma.

Ending Welfare As We Know It

By George P. Brockway, originally published March 14, 1994

POLITICAL COMMENTATORS are practically unanimous in telling us that Candidate Bill Clinton’s most popular sound bite in his 1992 campaign was a pledge to “end welfare as we know it.” I don’t recall it that way. Welfare is certainly a part of the economy, stupid; but I doubt that many voters even know what “AFDC” stands for, let alone how it works. My suspicion is that the average middle-class citizen’s interest in the question is nothing more than a mean spirited irritation at anyone (especially anyone who is not a big-time operator) getting something for nothing.

There are three things that especially interest me about the present welfare problem, and I’m going to tell you about all three of them.

First, as near as I can determine, we ended welfare as we know it (or thought we ended what we thought we knew) in 1988, and I wrote about it in this space (“Reality and Welfare Reform,” NL, November 28, 1988). The Family Support Act of that year has a curious legislative history, and an even more curious media history. Senator Daniel Patrick Moynihan guided it to a 93-3 vote in the

Senate on June 16. (A “less stringent” version of the bill had passed the House by 230 to 194 the previous December.) The New York Times ran the story in the lead column on the front page the next day-and almost immediately dropped it. If you search business papers and magazines of that time, you will find little or no reference to the event. I can’t tell you about TV coverage because I’m not a close student of the medium.

I can, however, guess why the course of the bill through the Senate-House conference, the final passage by both houses, and its signature by President Reagan on October 7 attracted little attention. A tip-off is Reagan’s Budget Message of January 9, 1989, which includes funding for the Family Support Act but still reduces “welfare” by $800 million. A further tip-off is the fact that in the following two years 40 states froze or cut Aid to Families with Dependent Children, 11 cut emergency programs for the homeless, nine cut ordinary programs for the homeless, and 24 froze or cut programs for the elderly, blind or disabled. All this happened without causing any public uproar. No one gave a damn one way or the other.

I mention all this because, so far as I can make out, President Clinton’s end to welfare as we know it is the same as Senator Moynihan’s Family Support Act of 1988. Both make a fuss about tracking down “deadbeat dads”; both make a fuss about training welfare mothers for private sector jobs; and both propose to shove people off welfare and into workfare in two years, more or less. It therefore seemed to me it might be helpful to know how the 1988 Act has worked.

Well, I’m not paid to be an investigative reporter, but I tried. A full half hour on hold at the Department of Health and Human Services didn’t even console me with Muzak. Two letters to Senator Moynihan have gone unanswered. An appeal to his press secretary produced a sheaf of papers about the provisions of the 1988 Act, but nothing about its implementation or results. The Budget of the United States Government for Fiscal Year 1994 shows that in 1992 only about two-thirds of a $1 billion appropriation for payments to states with AFDC work programs was spent, and that the estimated outlays in 1993 and 1994 are about three fourths and five-sixths of the respective appropriations. Six years ago Senator Moynihan estimated that his plan would cost $3.34 billion over five years; so it would seem not to have been underfunded, at least on its own terms, but who knows whether it has done any good? Someone ought to answer that question before we end welfare as we know it all over again.

Which brings me to my second point of interest. There exists a fully worked out plan that actually would end welfare as we know it, that would practically administer itself, that would begin to heal the suppurating wound in our society between the haves and the have-nots, and that would start to restore the self-respect of fellow citizens who have become entangled and degraded in our safety nets. Not only does the plan exist, it was for one shining moment a major plank in the platform of a leading candidate for the Presidency of the United States.

The plan is the creation of Leonard Greene, an inventor who bubbles with three new ideas while he’s chatting with you. He’s president of Safe Flight Instrument Corporation, founder of the Institute for Socio-Economic Studies, leader in a fistful of social welfare activities, and author of a book I’m proud to have published titled Free Enterprise Without Poverty. Greene devised his plan in answer to a problem he ran into in his business.

In the course of his civic work he had met and hired a bright and eager young black. The young man was a fast learner and seemed to have a rosy future, when one day, without warning or explanation, he quit. Greene sought him out at home and discovered that his wages, together with his mother’s Social Security and some AFDC payments for younger siblings, would make them too rich for their public housing and Medicaid and AFDC money, but would be far from enough to make up for what they would lose. “Welfare as we know it” would make it smart for him to leave home or not to work. Greene found it easy to collect scores of similar cases.

Greene’s reaction was to figure out how the law could be changed. His solution was beautiful in its simplicity, its comprehensiveness, its practicality, and its fairness. First, each person would take all his or her existing entitlements or transfer payments and put them in one pot. Those that were “in kind” (food stamps,Medicaid, public housing, and so on) would each be assigned a standard cash value that would be added to the cash received from Social Security and other transfer payments.

Second, every citizen, from Ross Perot to the bag lady on the comer, would receive what Greene gave the unfortunate name of a “Demogrant,” which is a sort of guaranteed income similar to what Milton Friedman calls a negative income tax. In most cases this would be a bookkeeping transaction; no money would actually change hands.

Third, all of the foregoing would be added together and taxed at progressive rates, starting, of course, very much higher than the rates do today. In general, none of the poor not now subject to Federal Income Tax would be taxed under Greene’s plan. But Greene’s excellent young man could accept a good job, paying the applicable income tax, without compromising his family’s public housing.

Most important, the hurdles now erected between underclass poverty and full membership in the commonwealth would be removed. The course would still be far from the level playing field demanded by the Wall Street Journal for speculators; but it would at least be a smooth upward path, and reasonably diligent young people could hope to do reasonably well on it.

I REMEMBER (more clearly than I remember talk about welfare reform) that hope was a steady theme in Clinton’s campaign message. As long as the inhabitants of the inner cities and the rural slums are without hope, we have no hope of solving the problems they make for society as a whole as well as for themselves. Conrad had it right: “Woe unto him who has not learned while young to love, to hope, and to put his trust in life.” The same woe threatens a nation.

Obviously, there would be complications in the Greene plan, especially as old plans were phased out and the new one was phased in. Yet work would not be discouraged, families would not be broken up, and everyone would be on the same scale as everyone else. Needless to say, the plan would not be without costs. Greene would cover them with a value added tax-but that’s another question.

As I’ve said, the plan once seemed a political possibility. Leonard Greene had George McGovern‘s ear. They were so close that Greene flew McGovern in his private plane to file for entry in the New Hampshire primary of 1972. McGovern carried the Greene plan into the primaries, where he had trouble getting it across.

The press made fun of “Demogrants,” which sounded like the grunting of Democratic candidates. Hubert Humphrey, I’m sorry to say, charged that the negative income tax was a gift to the rich. By the time of the California primary the Greene plan had come to seem a handicap. McGovern renounced it and never mentioned it again.

On reflection, I have concluded that the plan was too sensible, too simple, too practical. We Americans pride ourselves on our down-to-earth pragmatism, just as the French pride themselves on their rationality and the Indians on their spirituality. We are the most theory-driven people on earth, however, constantly prattling about market discipline and other such nonsense. And there is what the literary critics call a dark side to the issue: Everyone knows that blacks are disproportionately represented among recipients of the present welfare benefits. For a shamefully large number of us, welfare as we know it can be improved only by slashing it to ribbons.

Finally, there is the third thing I mentioned at the beginning. This is the notion that welfare recipients are to be given two years of job training and then pushed out into the labor market, where they will help us compete in the new global village.

Six years ago, when the Family Support Act was passed, I thought that was a nutty idea, and I still do. It is impracticable and it is vindictive. Moreover, it conflicts with the theory of a natural rate of unemployment (see “Are You Naturally Unemployed?” NL, August lO-24, 1992). Although accepted by every mainstream economist in the land, the theory is a nutty idea too. If you believe in it, you must believe it would be a disastrous mistake to get everyone off welfare and into regular employment, because the natural rate of unemployment would be violated and inflation would rage without limit.

Indeed, the trouble is that if President Clinton actually begins to end welfare as we know it, the Federal Reserve Board will be theory-bound to raise the interest rate high enough to restart the recession and move those welfare mothers back among the naturally unemployed. I would like to see this conflict brought out into the open.

The New Leader

Making a Mess of Russia

By George P. Brockway, originally published January 17, 1994

THE NEWS FROM RUSSIA these days reduces one very quickly to hysterical laughter or hysterical tears. We sometimes seem to be well on the way toward Cold War II or World War III; and if we achieve one or the other (or both), we’ll have the economists of the world, with our economists in the vanguard, to thank.

Of course, the economists won’t be entitled to all the glory. They couldn’t do it alone. They’ll need the help or at least the acquiescence of the statesmen and bankers of all countries, particularly the United States. Crucial will be the austere devotion to austerity of the International Monetary Fund. No less important will be the casual mistranslation, miscomprehension, or misrepresentation of the news by the daily press and television. If, as economists never tire of repeating, we consumers are sovereign and get what we demand, it will in the end be our fault, and the world will suffer for our stupidity, our ignorance and our laziness.

The foregoing diatribe could have been prompted by almost any day’s news, but was in fact inspired by the lead story in the New York Times a couple of days after Vladimir V. Zhirinovsky‘s surprising showing in the election. The Times correspondent wrote: “In what may be a sign of a weakening of economic resolve after his electoral rebuff on Sunday, President Boris N. Yeltsin today granted new heavily subsidized loans that could aggravate the budget deficit and inflation …. The loans were for farm machinery enterprises at 25 per cent interest a year, far below the Central Bank’s discount rate of 21O per cent, the Interfax news agency said.”

Let’s start with the end. It may be that the Interfax news agency, or someone representing the agency, actually said something like what the Times attributed to it. It may also be that “discount rate” is an accurate translation from the Russian. But maybe not. With us, the term has a precise meaning and requires a developed banking system, which Russia is having difficulty organizing.

According to the Federal Reserve Board, “Discount rates are the cost to member banks of reserve funds obtained by borrowing from Reserve Banks …. discounts for member banks are usually of short maturity-up to 15 days.” A discount rate of 210 per cent is not so outrageous as the GI loan shark‘s “six for five” (a loan of $5 today to be settled with $6 on payday, next week), but it is bad enough to stop all business except gambling and thievery dead in its tracks.

With us the prime rate is usually about double the discount rate. It is inconceivable that the best-run medium-size businesses (who are given the prime rate) should be expected to survive paying 420 per cent for their money. They would do better to sell their assets for whatever they could get for them and lend the proceeds to the suckers still trying to earn a living by working for it.

It makes me sick to think of it, because it was not very long ago, when Paul A. Volcker was chairman of the Federal Reserve, that many thitherto profitable American companies found themselves saddled with such an array of “finder’s fees,” “lawyer’s fees,” “compensating balances” and so on (not to mention a 21.5 per cent prime) that they were paying what was effectively more than 40 per cent interest for their money.  Those who survived the shock treatment did so by firing people, cutting production and raising prices.  Otherwise they couldn’t have paid their bankers’ bills.

President Coolidge observed that “when many people are out of work, unemployment results.” I myself have observed that when many people raise prices, inflation results. In Volcker’s day we got it both ways: the highest unemployment rate since the Great Depression, and the highest inflation rate since World War I. The Russians are getting it both ways now and, oddly enough, they don’t seem to like it.

But let’s not forget about those lucky (or well-connected) farm machinery manufacturers who got the “subsidized” loans at “only” 25 percent, thus somehow throwing the budget out of whack and lighting a fire under inflation. I’ll agree that a loan at 25 per cent is inflationary (not so inflationary as 210 or 420 per cent, but sufficient unto the day). After all, interest is an expense, just as rent and wages are expenses; all expenses increase the cost of doing business; and all costs have to be covered by prices charged. I do not, however, believe that is what the Times story meant.

No, the Times (like the Wall Street Journal and all lesser media) is possessed of the curious fancy that interest expense has the mysterious property of lowering prices, whereas all other expenses raise prices. How this magic works is never explained. In contrast, the Times never mentions the prime rate without  pedantically telling its financial section readers what it is, and always makes sure business people understand that when the bond market rises, the interest rate falls. (For more on the mysteries of interest, I refer you to “Why a Low Interest Rate Is the Proper Preventive of Inflation“ in a forthcoming issue of the Journal of Post Keynesian Economics.)

Let’s put those farm machinery manufacturers in a larger context. We are told that Russian agriculture is in a bad way, and that Russia needs billions of dollars in foreign aid in order to feed its people. It certainly would be better for everyone (except, perhaps, American, Canadian and Australian wheat farmers) if Russia boosted its own wheat production. And it is, I suppose, no secret that the purpose of farm machinery is the more expeditious production of food. So it should be obvious even to an economist that it would be a smart idea, as well as less inflationary, to get cracking on the production of farm machinery.

But economists know, if they know anything, that international trade is good because it is good, as they have recently taught us in regard to NAFTA and GATT. So even if Russian firms make the best farm machinery (for all I know, they do: Poland is said to make the best golf carts), economists would advise Moscow to import farm machinery on a shock program (shock programs are good because they are good), rather than “subsidize” Russian manufacturers with loans at usurious rates. The alleged subsidy is, they say, inflationary. But assuming the inflation were due to the supposed subsidy, it still could not hold a candle to the inflation caused by unnecessary importing.

There are two sorts of inflation. The sort we’re familiar with is what happens to our Consumer Price Index. The other sort is what is happening to the Russian ruble on the international money market. The two are not closely related, for when all is said and done, even in the brave new global village, domestic markets are many times larger than the import-export business. In the early 1980s, for instance, when our CPI kept on setting new double digit records, our dollar was far “stronger” against foreign currencies than it is today.

The Russian CPI, whatever it is, is undoubtedly very bad because of the usurious interest rates. But it is nothing compared with the free fall of the ruble, which is tumbling because Russia has lost its export markets in Eastern Europe and consequently is unable to import in the style it was accustomed to. When it is said Russian inflation is in excess of 20 per cent a month, that does not mean today’s $2 loaf of bread will be $2.40 next month and $5.97 in six months. It merely means that if you want to show your neighbor what a wheeler and dealer you are, you had better buy your Mercedes today, because it will cost you three times as much if you wait six months.

It is this second kind of inflation that exercises the International Monetary Fund, since it is the Fund’s purpose to make all the world’s currencies interchangeable. It is also this kind of inflation that attracts the attention of Western reporters, who exchange Western for Russian currency to pay for their food and shelter and entertainment. More important, it is this kind of inflation that can get out of hand and pass over into hyperinflation, as it did in the Weimar Republic and then several other places.

Hyperinflation comes about when a nation has debts it can’t repay that are denominated in foreign currencies. Our contribution to Russia’s troubles is a clutch of economic advisers, mostly from Harvard, who seem determined that Russia must destroy the industry it has and borrow to import state-of-the-art factories from us. How else will the Russians be able to compete in the global village (where they were, only yesterday, sufficiently competitive to scare us silly)?

Now, THERE IS in the world a good example of what can happen if you tell the IMF to go peddle its papers. All of a sudden China is being hailed as an economic miracle, more miraculous than Taiwan. I am an authentic old China hand, having spent three weeks there in 1976, when Chairman Mao was still alive. Mao tried shock treatment long before Harvard thought of it. He called it “The Great Leap Forward,“ and had befuddled peasants trying to make steel in their backyards. It proved a disaster. He tried another shocker – “The Great Proletarian Cultural Revolution” – and that, too, passed away, but not before thousands of people were killed and thousands more ruined. After Mao’s death and the defeat of the “Gang of Four,” Deng Xiaoping, who had twice been disgraced by Mao, took over.

Deng is an eclectic gradualist. He followed Mao in scorning foreign loans, in not breaking up the less-than-state-of-the-art factories, in plowing with oxen when tractors were not available, in encouraging (or requiring) teams of workers to plan their year’s work. The plans were subject to veto, but they had the virtue of getting some people to think about what they were doing. It was a form of privatization more meaningful than selling shares of stock on a trumped-up exchange.

Recently Deng has accepted substantial investments by “round-eyes” and has relaxed some controls, especially those on retail trade. Now he is regularizing the currency. Yes, I remember Tiananmen Square; and no, I do not favor the extension of China’s most-favored-nation status. I cite China as an example of what can be done if you take a little time and eschew international finance.

As an example of what is likely to happen after shock treatment, I would cite almost any country in sub-Saharan Africa or South America. All of them are crushed by debts denominated in foreign currencies.

Most of them, bowing to the advice of their IMF masters, have tried to balance their budgets by destroying their civil service, whose officers then supplement their starvation wages with extortion.

The enthusiasts for shock treatment cite Germany’s successful ending of hyperinflation in 1924. They forget that the inflation ran for more than three years, and that those who really got shocked were the bankers and investors who lent Germany money to “pay” the War debts, which were ultimately forgotten. Yeltsin wouldn’t mind that sort of shock.

The New Leader

Health, Wealth and Taxes

By George P. Brockway, originally published October 4, 1993

IT SAYS LITTLE for the presumed intelligence of American citizens that the opening dispute over President Clinton’s health care plan turned on whether it will be mainly financed by a payroll tax or a compulsory insurance premium paid by corporations. The fact of the matter was not at issue – only the name.

By any name, the probable method of financing will impede business enterprise, discourage hiring entry-level workers, encourage hiring part-time workers, put a damper on pay raises for full-time workers kept on the payroll, deepen the stagnation of our economy, and reduce our longed- for ability to compete in the new global village with Mexico and South Korea. Since these unpleasant consequences will be debated ad nauseam, it is almost certain that the tax (as House Minority Whip Newt Gingrich of Georgia is right-a first!-in calling it) will be kept low, that the system will be inadequately funded, and that therefore it will be better than what we have now only in details, many of which might have been managed with less uproar.

You will note that the troubles mentioned will flow from the system of taxation, not from the way medical “suppliers” are paid or from the way medical care is “delivered.” It may be that these elements will be faulty, too, but those are separate questions.

We Americans talk endlessly about taxes, yet all we understand about them is that they are an expense. They cost money. Other things being equal, we are better off the fewer expenses we have to pay. In the case of taxes, of course, things are seldom equal. Not even Jack Kemp, who is opposed to all taxes in principle, could get along in a world without police and courts and armed forces and paved roads and the myriad other necessities taxes provide. It would be nice if we could enjoy these services without paying for them, and a few of us do manage to avoid some taxes. On the whole, though, the folk saying is correct, and taxes are as certain as death.

Since it does no good to sulk and stamp our feet and sob that we don’t like taxes, it would be the better part of wisdom to inquire what kinds of taxes are best for what purposes. One of President Bush‘s most irresponsible acts was his promise of no new taxes, and one of the electorate’s most irresponsible acts was the single-issue voting against him for breaking that promise. Some level of taxation is unavoidable, and we will surely need more funds to pay our medical bills. Still, some new taxes would be preferable to others.

In general, there are three kinds of taxes: (l) taxes on what exists, such as property taxes, estate taxes and poll taxes; (2) taxes on what is done, such as sales taxes, payroll taxes, excise taxes, franchises, and tariffs; and (3) taxes on income, such as personal income taxes and corporate profits taxes.

The Clinton medical plan will be paid for by taxes of the second sort-payroll taxes and excise taxes (a.k.a. sin taxes). All taxes on doing something can be avoided by doing nothing. But if you have a job, or hire someone to do a job, or buy something, then you pay a tax.

Such taxes have the virtue of being relatively easy to collect, but that’s about their only virtue. They are plainly and inescapably costs of doing business. The fewer people you employ, the lower your payroll taxes, so you are slow to hire additional employees. The less you buy, the less you have to pay in excise taxes that are invariably passed on to the consumer. It is a sad fact that most economists think it’s good and, indeed, “natural” to reduce employment (it improves “productivity”), and that it’s good to discourage consumption (it encourages “saving”). We have examined these professional delusions before and shall no doubt do so again; here let’s merely observe that payroll taxes will not constitute an improvement on, or even much of a change from, our current system of financing health care.

At present, medical insurance is a fringe benefit in most medium and large businesses. Because of skyrocketing costs, benefits are generally being reduced. Rising insurance premiums are also a factor in businesses deciding to rely as much as possible on part-time employees who don’t get the fringe benefits. There is no question that medical insurance is a tremendous load for businesses to carry, and that it operates like the Social Security tax as a cost of employing people. American automobile company executives claim medical insurance adds $2,000 or more to the cost of a new car, making it hard for them to compete in the global economy everyone talks about. Substituting some form of payroll tax for the insurance premiums will merely guarantee that every American enterprise is carrying the same burden; it will not reduce the weight.

Moreover, payroll taxes are passed back to the employee – not literally, perhaps, but effectively in the form of an argument against pay raises. And that’s not all. Businesses usually try to set prices to cover costs (including payroll taxes), plus a planned or “normal” profit (figured as a percentage of costs). If costs go up 10 per cent, and if “normal” profit is I0 per cent, prices must go up 11 per cent. Granted, no one can calculate that closely, because no one can tell what the future will bring; nevertheless, both profits and prices tend to move up faster than costs.

Now, you might think that spokesmen for industry would be 100 per cent opposed to taxes that make them raise prices and become less competitive. As it happens, they are about 50 per cent opposed – and it is this ambivalence in their opposition that gives the Clinton plan a chance to be enacted. What industry spokesmen are 100 per cent opposed to is the third kind of tax: a tax on personal income or corporate profits.

At first glance, the corporate tax seems ideal. You don’t have to pay it unless you have a profit.  It won’t interfere with your plan to start a new enterprise or expand an old one. It won’t bankrupt you. It is the next-to-the-last payout you make-and there’s the hitch. For the last payout you make is profits. It is a simple arithmetical fact that your after-tax profits will be lower than your before-tax profits.

THIS IS WHERE the morale of our system often breaks down, because the interests of the owners of an enterprise diverge from the interests of the enterprise itself and of most of its employees. The enterprise and its employees want to stay in business. The owners – the vast majority of them don’t even have a clear idea of what the enterprise does. They simply got touted onto it by their stockbroker and added it to their portfolio. Their connection may be more abstract than that: A mutual fund they own a few shares of, or a pension plan they participate in, may have a position in the enterprise.

The situation calls to mind John Kenneth Galbraith‘s observation in Economics and the Public Purpose. Especially in big business, he pointed out, the corporate objective had changed from profit maximization to protection of “the planning system and its technicians.” In the 20 years since Galbraith’s groundbreaking book was published, another shift has occurred, largely as a result of the takeover and buyout frenzy of the 1980s.

Control of both the directors and management of many a big corporation now rests with investment bankers or their representatives, who, knowing little about the day-to-day operation of the business they have acquired, rely on a handful of executives to see that their cash cow is properly milked or, it may be, bilked. To ensure the devotion of the executives, the bankers generously reward them with absurd salaries, fantastic stock options, and even the last word in medical insurance, making them multimillionaires too.

There is one thing that is hated by multimillionaires like these: the personal income tax. They are rich, they congratulate themselves on their richness, and they think it unfair that they should be soaked for it. This sense of unfairness or isolation from the rest of us further alienates investors and their executives from the companies they control and helps account for the puzzling acquiescence of many of them in payroll taxes that can only hurt American business.

That they clearly understand how payroll taxes hurt is apparent from their vehement arguments against raising the minimum wage, which also affects prices, though to a lesser degree. But they have supported increases in the regressive Social Security tax, because it doesn’t much bother them personally. For the same reason they will support a payroll-based health care tax in preference to using the income tax, which might force them to pay their share of the load.

The final irony is that the true-blue believers in laissez-faire will attack President Clinton’s plan as the proposal of a liberal. Actually, it is the middle-of-the road proposal of a middle-of-the-roader. The President’s program is certainly better than what his opponents have proposed, but my mother always warned me that it wouldn’t greatly improve my health to play in the middle of the road.

The New Leader

The Reserve Takes Flight Again

By George P. Brockway, originally published September 23, 1993

On July 20, Federal Reserve Board Chairman Alan Greenspan announced a fundamental change in the way the august body he heads looks upon the economy. This is not merely a tactical shift, as from easy money to tight money – although the Board’s volatility on the tactical level is bad enough – but a basic rethinking of how the economy works and what the Board should therefore do. It is the second such revision in Greenspan’s six and a half years as chairman, and the fourth in something under 14 years. So many radical rethinkings in so few years suggest an unseemly flightiness in an institution whose primary excuse for existence is to provide financial stability beyond the turmoil of partisan politics.

Let’s look at the record. On October 6, 1979, Paul A. Volcker, the then new chairman, revealed that thereafter the Reserve would “be placing greater emphasis on day-to-day operations of the supply of bank reserves, and less emphasis on confining short-term fluctuation in the Federal rate” (the rate at which banks borrow reserves from each other overnight or for a day or two). Monetarism had taken charge.

For the next six or seven years we heard a great deal about M1 and its velocity. (In case you’ve forgotten, M1 is cash and traveler’s checks and checking deposits; M2 is all that plus most savings accounts, money market funds, and other odds and ends.) Milton Friedman, the leading monetarist, wanted M1 to grow annually between 3 and 5 per cent. Expansion beyond 5 per cent, he claimed, would cause inflation – instantaneously if the expansion was anticipated, or with a lag of a year if it was not. Not only that, but the inflation would accelerate without limit. By 1986, expansion beyond 5 per cent was surely anticipated by all rational economic agents, because it had not been below 5 per cent for 10 years. Yet in 1986, when M1 jumped 16.8 per cent (and M2 jumped 9.4 per cent), the Consumer Price Index (CPI) rose only 1.9 per cent – its smallest rise in 22 years. Monetarism clearly missed the call, and missed badly.

The Federal Reserve Board was left without a theory – that is, without a coherent idea of what it was doing or why. For the rest of Volcker’s term, the nation was forced to rely on seat-of-the-pants judgments of officials whose cerebral judgments had proved sensationally wrongheaded.

In the spring of 1987, Alan Greenspan succeeded to the chairmanship and at once set three economists to work on an equation intended to use M2 to prophesy the price level two or more years ahead. Also, true to the teachings of Ayn Rand, he cut expansion of M1 and M2 back below the 5 per cent target. And what did the CPI do? It surged ahead 4.4 per cent in both 1987 and 1988.

Nevertheless, on June 13, 1989, the Reserve went to extraordinary lengths to publicize what two years of labor by those three economists had produced. If you yearn to know more about P-star (as their equation was called by insiders), I refer you to “The Reserve’s Silly New Equation” (NL, June 12-26, 1989), in whose last sentence I wailed, “How long must we allow ourselves to be deluded by silly equations?” Well, the Reserve seems at last to have abandoned this equation, or the theory behind it, which, Greenspan said last month, “has been downgraded as a reliable indicator.”

Of course, the money supply never was a reliable indicator, for the simple reason that no one can say what it is. The Federal Reserve owlishly publishes aggregates it calls M1, M2, M3, and L. L is about six times M1. Friedman once said the number used did not matter, so long as one stayed with it. Since the tracks of the different aggregates have been substantially different, it would appear to have made some difference.

You would think that by this time we might all agree to stop fretting over the money supply. Yet the Reserve, perhaps for ritualistic reasons, has adopted a new target for M2 growth (1-5 percent), even though it acknowledges that hitting (or missing) the target won’t indicate anything special.

The downgrading of M2 does not mean the Chairman is without any indicator. He has mentioned only one aspect of his new one (and that I will discuss presently), but he has used it with results that can hardly be called encouraging. In his July 20 testimony before Congress, he forecast a second quarter growth rate of 2.5-3.0 per cent. Nine days later, the official number proved to be 1.6 per cent.

I think I can promise you that the new indicator will continue to get things wrong. According to Greenspan, “one important guidepost” of the new indicator win be the so-called “real” interest rate: the actual rate minus the rate of inflation. When, as now, the Federal funds rate is about 3 per cent and the CPI rate is about 3.5 per cent, the “real” Federal funds rate is negative 0.5 per cent. Anyone lending $1,000 at 3 per cent gets back $1,030 at the end of a year, but his purchasing power will have shrunk to $993.95. So why should he lend? Because if he buries his money like the slothful servant in the Parable of the Talents, he will still have his $1,000 but his purchasing power will shrink to $965.

Greenspan thinks that’s unfair and hints about raising the Federal rate one-half a percentage point or more to make things even. Naturally, if he raises the Federal rate, he effectively raises others, including those that are far from negative.

What Greenspan is threatening is a Cost of Living Adjustment (cola) for bankers. It is well understood by bankers and economists that colas on workers’ wages are inflationary and should be resisted. How are bankers’ cola different? In a word, they aren’t, and they cost the economy (that is, you and me) about $500 billion a year (see “Bankers Have the Classic COLA,” NL, January 9, 1989).

Although bankers do most of the talking about the interest rate, their role in lending is comparatively passive. If no one wants to produce a better mousetrap or buy a better automobile or take a flyer in the stock market, bankers must sit on their cash. Putting consumers and speculators aside for the moment, consider a company with plans for a better mousetrap, requiring investment in a factory, equipping it with machinery, buying supplies, hiring workers. The company figures all that to cost $10 million. For convenience, let’s say it can borrow at prime, currently 6 per cent, for an annual interest expense of $600,000. It feels it can just about swing it.

Now suppose Greenspan gives bankers a one-half percentage point cola. At 6.5 per cent, the interest expense is up to $650,000 – an increase of 8.3 per cent in cost, and a decrease of 8.3 per cent in the amount of money the mousetrap company can afford to borrow.

The company then has three options: (1) Abandon or scale down the expansion and the jobs it would have created. (2) Raise prices to cover the added cost. (3) Make do with lower profits, which would make future borrowing still more expensive. These options are faced every day by every company, large or small. Even rich companies that do not need to borrow must consider the opportunity cost of using their own money instead of lending it out.

If investment is as important as everyone says it is, and if stable prices are as important as the Reserve says they are, Greenspan’s half point adjustment would be bad for every company and for the whole economy in one of the ways I’ve noted, and quite possibly in all three ways. Not only that, but the bond market would fall, as it necessarily does when interest rates rise. The stock market would surely follow later, for the same reason – and, considering its present fragile highs, could very well crash.

The interest rate, not the money supply, is what the Federal Reserve Board can control directly and assuredly. It sets the Federal funds rate and the discount rate, and it controls them by buying or selling Treasury bonds on the open market. In order to buy, it offers a high price, which is the same as a low interest rate. The banks that sell bonds thus increase their cash reserves, putting additional downward pressure on the interest rate.

If all this activity increases borrowing, as it is likely to do, it will increase the money supply, because money is negotiable debt. But who cares? It is the interest rate that matters to the economy, and it is through stabilizing the rate at a low level (about half what it is today) that the Reserve could (if it would) do its bit to stabilize the economy.

Milton Friedman has long contended that the Federal Reserve Board has used its great powers so erratically in the past that it should be put under strict statutory regulation. He may be right. But he would regulate the growth of the money supply within a narrow range, even though he doesn’t know what the money supply is, and the Board has shown it doesn’t know how to control it, whatever it is.

That there is a determinate money supply, and that its size determines the price level, is an old mercantilist idea. It was valid enough when money was something rare and tangible and not readily reproducible, like gold or silver. The capitalist system turns on borrowing, however, and borrowing depends on the interest rate, and the lower the rate the greater the economy. How long must we allow ourselves to be deluded by archaic ideas?

The New Leader

In Pursuit of a Fiscal Fantasy

By George P. Brockway, originally published June 14, 1993

PRESIDENT CLINTON’S $31 billion “stimulus package” was defeated by a filibuster that was organized, not on the reasonable ground that the package was woefully inadequate, but on the fanciful ground that by increasing the deficit it would hurt the recovery now supposed to be under way. I want to talk about the alleged recovery, but first let’s pay our respects to the deficit.

Suppose we had an adequate stimulus – something on the order of $200 billion, rather than the proposed $31 billion. That kind of money could knock 5 points off the official unemployment figure, bringing it down to an arguably tolerable level of 2-per cent, and could start to do a job as well on those who are working part time or are too discouraged to look for work.

But could we afford it? Of course we could. The late Arthur Okun, a universally respected economist and the chairman of the President’s Council of Economic Advisors under LBJ, maintained that a 1 per cent rise in unemployment causes a 3 per cent fall in real national product. If Okun’s Law works backward and becomes a multiplier (not guaranteed), the 5 per cent fall in unemployment we’re after should result in a 15 per cent rise in output. That would be about $850 billion and should, in turn, yield about $210 billion in taxes at present rates – not to mention the gains for state and local governments, or the savings in reduced welfare outlays. So our massive stimulus could produce a modest reduction in the deficit. As Mr. Micawber would say, result happiness.

The result would still be far from misery even if Okun’s Law didn’t quite work backward, and even if the government proved incompetent in all the ways the naysayers say it is. If we had to borrow the entire $200 billion, the deficit would be increased by the interest, or by $13 billion–and if the Federal Reserve Board should miraculously decide to be on the same team as the rest of us, the interest could be as low as $6 billion.

Are you worried silly about the $16,750 that rabble-rousers say is your share of the national debt? Grow up. I have a $75,000 mortgage that I’ll not pay off if I live till I’m 105. The bank isn’t worried. My estate will pay it off, of course, and whoever buys the house will mortgage it again and will no doubt later refinance the mortgage to pay for some improvements or repairs. And so on. It’s a well-built house and should last (and be mortgageable) for another hundred years or more. All that’s necessary is for the successive owners to be able to pay the interest. The same is true of the United States of America and its national debt.

What is the alternative? It is proposed that we get government out of the way or off business’ back or whatever metaphor appeals to you, and let the present “recovery” rip. The good old free enterprise system, we are told, the very system our economists are teaching with such smashing success to Russia and Eastern Europe, would soon show that a man knows what to do with his money a lot better than some bureaucrat in Washington. You bet.

The big trouble with this prescription for prosperity, worked out by the classical economists, is that it is based on unrealizable assumptions. One assumption we’ve mentioned previously: full employment. A second is that a level playing field, of the kind the Wall Street Journal pines for, isn’t enough. The players must have at least fairly equivalent equipment. Adam Smith put it this way: “The whole of the advantages and disadvantages of the different employments of labor and stock must, in the same neighborhood, be either perfectly equal or continually tending toward equality.”

In addition, there’s an assumption that economists pretend doesn’t matter. All the buyers and all the sellers are assumed to know all about all the products available and the demand for them. Whoever believes this assumption should have followed me around last week as I shopped for a new automobile. I don’t even know how to kick the tires. A contemporary school of economists gets rid of this assumption with another, namely that everyone acts rationally and rationally expects everyone else to act rationally, too.

If you accept each of the assumptions, you probably can see some sense in the notion that an invisible hand will guide us to the recovery of our dreams. Don’t be too sure. If I really knew what I was doing when I shopped for a car, I’d make the best buy possible–and so would you and everyone else. One dealer would start to get all the business. Then the competitors would lower their prices, and pretty quickly there would be one big price war.

Short of collapse, there could be no end to such wars. All competitors can lower their prices by cutting their costs. Their costs are someone else’s prices, which likewise can be lowered by cutting costs. And so on ad infinitum. David Ricardo and his followers argued that this regress would be stopped by the costs of food and other basic things (called “wage goods”) that workers need to survive.

But the costs of wage goods are not immune to cutting, so the regress would continue. Very likely some people would lose their jobs as prices tumbled, although the classical theory merely calls for wages to fall. Either way, if the free market were left to its own devices, the price-cutting, cost-cutting, payroll-cutting, demand-cutting sequence would continue unabated until prices, payrolls, production, and profits all approached zero. The free market could not stop the process – nor, if they played the game by the rules, could any of the participants. The invisible hand pushes everyone and everything inexorably down.

The drama has a different ending in the scenario of Leon Walras, the patron theorist of free market analysis. He wrote that “production in free competition, after being engaged in a great number of small enterprises, tends to distribute itself among a number less great of medium enterprises, to end finally, first in a monopoly at cost price, then in a monopoly at the price of maximum gain.”

So take your pick. The Walrasian theory has free competition ending in monopoly. The more conventional theory, though it says nothing about an end, offers no reason why general disaster should not result.

There is, of course, a third outcome – what actually happens. For we take steps to prevent disaster, either by accident or by design, and those steps reveal that we are, by turns, do-gooders, pragmatists, and sponsors of crime.

In our role as do-gooders we enact child labor laws, minimum wage laws, worker-safety laws, social welfare laws, and many other laws to mitigate the horrors of free competition. It is not bad to do good – except in the eyes of conventional economics. In his speech launching the idea of a natural rate of unemployment, Milton Friedman condemned all altruistic measures. They would, he said, increase the natural rate of unemployment. Pre-Depression America, which knew very little of such things, is touted as a time of low unemployment. It was also a time of child labor, the 12-hour work day, labor injunctions, and similar amenities.

It must be confessed that we are more comfortable thinking of ourselves as pragmatists than as altruists. In any event, whereas businesspeople applaud the pronouncements of conventional economics, very few act in accordance with them. They may compete vigorously, but very few compete primarily on price, having learned (as a book of business advice once had it), “Don’t sell the steak. Sell the sizzle.” With less pressure on prices, there is less pressure on costs.

Finally, we are sponsors of the crimes we deplore. A character in the funnies used to say, crime don’t pay well. For most practitioners that may be true, but it pays enough above the bottom of the current legitimate pay scale to entice hundreds of thousands into making a career of it. If these people were to renounce housebreaking and carjacking and mugging, and were to look for decent work, their competition for jobs would push the legitimate pay scale even lower.

AND THAT’S not all. As John E. Schwarz and Thomas J. Volgy show in grim detail in The Forgotten Americans, there are 30 million working poor in America – people who are desperately trying to live the work ethic yet still cannot afford the basic necessities at the lowest realistic cost. Heartbreaking thousands of these people take a flier at drug running or prostitution just to survive.

We are, as I say, sponsors of all this crime and squalor. It serves to retard the free fall of the economy, and with our altruistic and pragmatic practices it will eventually help us to settle at a stopping point somewhere between here and the pits. Economics, however, takes time, and it will be years before we reach that point. When we do reach it, we will find ourselves in what economists call an equilibrium, with upwards of a quarter of our productive capacity unused, with 20 million of our people unemployed or underemployed, and with probably 50 million men, women and children living lives that are far from solitary but are nevertheless (in the rest of Hobbes’ phrase) poor, nasty, brutish, and short.

I don’t suppose that, aside from a few fanatics for the apocalypse, there is anyone who is eager for such an equilibrium. But there are many millions who are capable of denying its possibility, and (as with other diseases) the denial makes its actuality the more deadly – especially since conventional economics can think of no way to upset the equilibrium, except by doing more of the same.

In the past, similar equilibria have been upset by wars. The Civil War made us a nation; World War I industrialized us; World War II got us out of the Great Depression. Professor Joseph A. Schumpeter celebrated the creative destructiveness of great new industries, like the railroads, which rendered canals obsolete, and the automobile, which doomed the horse-and-wagon. (Some expect the computer to play a similar role, but the information revolution is responsible for much of the payroll-cutting currently in progress, including its own.)

The thing about these equilibrium upsetters – these wars and these creative destroyers – is that they’ve all required ever bigger expenditures by ever bigger government. The expenditures for war are obvious; but often forgotten are the grants of public land to build the railroads, together with the postal contracts to keep them running, and the paving of streets and building of highways for the automobile. Is it conceivable that we can summon the wit and the will to make the expenditures that need to be made today?

I cannot conceive it. What is all too probable is that the welfare of the nation and of increasing millions of our fellow citizens will continue to be sacrificed to an accounting fantasy called a balanced budget.

The New Leader

Why Productivity Will Undo Clintonomics

By George P. Brockway, originally published May 19, 1993

THE FIRST COLUMN in this series, almost 12 years ago, was titled “Why Speculation Will Undo Reaganomics” (NL, September 7, 1981). Well, I was wrong. I was right enough in my analysis – that speculation would enrich the rich and impoverish the poor and bring on what we now call a credit crunch – but I naively could not imagine anyone being pleased with such an outcome. By last November, of course, a considerable majority of the voters did become displeased, if not with the enrichment of the rich and the impoverishment of the poor, at least with the stagnation that followed from the polarization of the economy.

I now feel possessed of another prophecy. And I hope I’m wrong again.

When I say productivity will undo Clintonomics, I mean just that. I don’t mean lack of productivity. I mean what the New York Times and the Wall Street Journal and the Economist are always writing about, what Nobel laureates in economics from MIT are always talking about, what Labor Secretary Robert Reich is now planning to try to increase. I mean that to the extent that Clintonomics is successful in improving our productivity, it will fail to improve our standard of living.

If our aim is what all these worthies say it should be, we can achieve it by decreasing production, profits, employment and wages. In fact, this is what General Motors and IBM and other giants of our economy are doing today. The fashionable word for their activity is downsizing, and the purpose is to step up productivity. Given a modicum of managerial skill and luck, half of the downsized corporations may actually improve their rating on the productivity scale. But their production and profits and employment and wages will mostly be lower. And the national product and profits and employment and labor income will certainly be lower.

Productivity is not a new idea. It was an old idea when President Reagan, in his first year in office, created a 33-member National Productivity Advisory Committee headed by former Treasury Secretary William E. Simon. You never heard of that committee? Who ever did? A year or so after its appointment I spent some time trying to find out what it had accomplished. Although I wrote as CEO of an American corporation, Simon did not answer my inquiries, nor did the White House. Finally, Senator Daniel Patrick Moynihan was able to dig up for me three or four slim pamphlets published by a second productivity committee that had been created some months after the initial one. I still have the pamphlets somewhere in this mess I call my study. As I recall them, they were paeans to efficiency and might well have been written by Frederick Winslow Taylor a hundred years earlier.

When economists started playing with productivity they changed it radically. They defined it clearly enough as output per unit of input. In keeping with their passion for mathematics, though, they devised an equation to determine it and an index to rank performance. Since labor is by far the largest factor of input, they thought to simplify the equation by letting labor stand for all inputs. This had the further attraction of allowing them to quantify input in “real” rather than dollars-and-cents terms, as they would have had to do in order to add the input of labor to the inputs of land, capital, technology, and whatever other factors one might name. Mathematical economists tend to believe that money is not real and don’t like to talk about it in public, but their simplification, as I’ve shown in greater detail elsewhere (see The End of Economic Man, Revised–Adv.), causes a serious distortion.

The productivity equation relates two quantities. It is a ratio, an ordinary fraction. In the United States it is computed by the Bureau of Labor Statistics of the Department of Labor, which divides the gross domestic product of a period by the number of hours worked in the period. “Hours worked” includes those of proprietors, unpaid family members and others “engaged” in any business.

Like all simple fractions, this one can be increased in the two ways we learned in grade school: by increasing the numerator (2/3 is greater than 1/3), or by decreasing the denominator (1/2 is also greater than 1/3)[1]. Given this property of fractions, a moment’s reflection will satisfy you that the productivity index is constitutionally incapable of providing an unequivocal answer to any question you may reasonably want to ask. It tells nothing of the size or nature of the domestic product, and nothing of the size, composition or compensation of the labor force.

The index goes up when production fails, provided “hours worked” falls faster; that is what the downsizing movement aims for. The other name for this result is recession, or depression. On the other hand, the index declines when production rises, provided “hours worked” rises faster. The other name for this result is nonsense. The economy is not less prosperous, nor is the nation weaker, because more people are working. (Otherwise, why are we so eager to get welfare mothers to work?)

The foregoing is obvious, and the mathematics is indefeasible. How is it, then, that so many intelligent, experienced, well-intentioned men and women –practically the entire membership of the American Economic Association, not to mention the with-it managements of our corporations great and small – are bemused by the productivity delusion? Psychology aside, I can make a stab at explanation.

Let’s begin with a quotation from a back issue of the Times: “A worker who produces 100 widgets an hour is clearly more productive than a worker who produces only 50 widgets an hour.” That is certainly true. And generalizing the observation, a nation of 100-widget-an-hour workers should be twice as prosperous as a nation of equal size composed of 50-widget-an-hour workers. True again – with one proviso, namely that both nations have full employment[2]. Should the first nation have only a third of its workers employed, while the second has full employment, the second will produce 50 per cent more widgets than the first and therefore will be more prosperous.

The assumption of full employment is one that economists are so comfortable with that they make it routinely, without thinking about it. Indeed, classical economics was based on this assumption, and so is neoclassical, or the economics currently practiced by most of the profession.

The beauty of full employment is that if you have it, almost anything you try will work. David Ricardo thought that England should stop making wine and concentrate on wool cloth, that Portugal should do the opposite, and that the two countries should exchange surpluses. The English vintners would become weavers, and so on. Given some rather special assumptions, this was a dandy idea in 1817 (and today it underlies the North American Free Trade Agreement). A better idea, because the British Isles were plagued by roving bands of homeless unemployed, would have been to employ the unemployed as vintners (or brewers or barley-water bottlers) and let the Portuguese keep their port, along with the wool they were perfectly capable of weaving.

If you have full employment, you can (and should) invest almost without limit to upgrade your product and upgrade the workers and capital plant that produce it. If you have millions of men and women who are unemployed or underemployed, you need to increase the number of hours worked. It doesn’t make much sense for the nation to train these people for jobs in industries that don’t exist, or that we can only imagine, to satisfy the presumed demands of a hypothetical global economy.

The new global economy is a hot ticket today. In the sense that we have one, however, there has almost always been one. Archaeologists now claim that the fabled Silk Route is two or three millennia older than Marco Polo thought. But the economic impact of the route was slight in prehistoric times, and at present the economic impact on us of Bombay and Cairo and Mexico City does not extend much beyond our corporations exploiting their labor in order to undercut our wage rates.

Unemployment is our problem. Adding up those who are officially called unemployed, those too discouraged to look for work, those too turned-off to think of working, and those able to find only occasional part-time work, recent testimony before a Congressional committee reached the appalling total of 17.3 million men and women. If we followed Mexican practice and counted as employed everyone who as much as cadged a tip for opening a car door last week, our unemployment total would be as low as the 2 per cent Mexico reports. Or if we followed mainstream economic practice and did not count at all the “naturally” unemployed, we could squinch our eyes shut and pretend that the problem didn’t exist (see “Are You Naturally Unemployed?” NL, August 10-24, 1992).

It exists, nevertheless. It really and truly exists, and as long as our best brains are trying desperately to reduce “hours worked,” it will not go away. Clintonomics may cauterize a few hundred malignant polyps at the top of our income distribution, and that will be all to the good. It may find suitable work for a few thousand middle managers rendered redundant by corporate or governmental downsizing, and that will be to the good. But unemployment will not be substantially reduced (except by the withdrawal of people from the official labor force), aggregate consumption will not be substantially increased, and whatever brave new hi-tech industries are created will stagnate for lack of consumers, here or abroad, able to buy their products.

These dismal outcomes will no doubt be exacerbated by the eagerness of Congress, whipped to a frenzy by Citizen Ross Perot, to cut government expenditures, and by the complementary unwillingness to fund the President’s already inadequate stimulus program. But all that aside, a mad drive for “productivity” in the face of long-lasting unemployment is fully sufficient to undo Clintonomics.

I hope I’m wrong, for I joined in the grateful cheering during the State of the Union address.

The New Leader

[1] Ed: Reminds me of seeing a colleague trying to explain some numerical analysis in a peer review session, a Friday Afternoon Seminar, and failing. Finally our founder stood up and said, “Well, that’s the trouble with ratios… They have a numerator and a denominator.”  He then walked off…

[2] Ed: Loyal readers will recall that the author does not believe in NAIRU, the natural rate of unemployment.

Social Security is on the Table

By George P. Brockway, originally published February 8, 1993

THEY SAY THAT Social Security is on the table. I hope the table is spacious and sturdy, for Social Security is like the proverbial horse designed by a committee. It is part employment tax, part endowment, part life insurance, part social welfare. It doesn’t fulfill any of these functions well, especially since it embodies a scheme of family values that would ordinarily be thought archaic even by members of the 1992 Republican Platform Committee.

The best thing to do with Social Security is start over again. All citizens should without question be entitled (that’s right, “entitled”) to decent protection of their dependents and a decent retirement. Since everyone should be covered and the claims can be closely anticipated, it is foolish to try to build up trust funds of one kind or another. The benefits or entitlements should be treated as ordinary expenses of government and paid for out of current income taxes, not out of taxes on employment.

Actually, of course, that is already the case. In 1992 the Social Security tax brought in $126 billion more than had to be paid out. The 1993 surplus is estimated to be $131 billion, and the surplus is expected to continue to increase for another decade or more. These billions of dollars make up the Social Security Trust Fund, but they aren’t stuffed in a bank vault somewhere, as our gold reserves used to be at Fort Knox. Instead, the Fund buys U.S. Treasury bonds, and the money thus lent to the government is used to pay bills.

Twenty or 30 years from now[1], when the baby boomers are enjoying their golden years, the smaller succeeding generation, though paying the same Social Security tax rate, will not pay in enough to cover their parents’ entitlements. So the Trust Fund will annually redeem some of its Treasury bonds. And where will the Treasury get the money to meet its obligation? Out of current taxes. Where else?

As the detective stories say, follow the money. When you do, you will see that under the present system the Federal government collects 38 per cent of its revenues by a grossly regressive tax that takes 15.3 per cent of her pay from the mite of a widow housekeeper but only 0.6 per cent (or less) of the pay of the millionaire executive who employs her, and nothing at all from those whose sole quasi-economic function is to clip coupons and cash dividend checks. Furthermore, you will see that the surpluses generated by this regressive tax will not in the slightest lighten the burden of future generations.

What can be done about this? Probably nothing. A couple of years ago New York’s Senator Pat Moynihan tried to get the Social Security tax lowered to a rate that would simply cover the outlays. He said, in what still seems to me a measured observation, that if the Democratically controlled Congress failed to adopt the proposal, it would be difficult to see what the party stood for. He got nowhere (although the publicity he generated probably derailed President Bush’s drive for a reduced capital gains tax). Indeed, the Senator was accused of planning the rape of generations yet unborn, of financial ignorance, and of much else.

Moynihan is now chairman of the Senate Finance Committee, the third or fourth most powerful man in the country when it comes to taxes, but I doubt that he will have more success with his proposal than he did earlier. And I’m sadly certain that he would have no success whatever, even if he was of a mind to, in persuading the good citizens of the Republic of the virtues of my proposal. So I retreat to a prepared position with suggestions for treating the sores exposed by Nannygate, bearing in mind the fact that we’re talking about provisions of the law that ‘are violated at least three-quarters of the time by otherwise law-abiding citizens-provisions, moreover, that everyone who thinks about them for even a minute recognizes as unjust.

Consider first the case of a nanny (I thought the word went out when Peter Pan grew up) or a cleaning lady (as the job description used to have it) who is a married woman, perhaps a widow, perhaps a senior citizen. The odds are that she will be or is entitled to Social Security benefits as her husband’s spouse. In addition to her regular income tax, 15.3 per cent of her earnings will be collected by the Internal Revenue Service simply to swell the Social Security Trust Fund. She will almost certainly receive no retirement benefit or social welfare or anything except what she would have received if she hadn’t done a lick of work in her life.

That’s where the family values I mentioned at the outset come in. A man and his wife are not individuals but a couple in the eyes of the Social Security system. After the principal bread winner retires, the couple gets one and a half times his benefit. In the statistically unlikely case that the wife is the principal breadwinner, the couple’s entitlement will be based on her earnings. Because the Social Security tax is levied only on the first $57,600 of a person’s income, it may happen that both husband and wife have paid the maximum tax. If so, the benefits will be paid on the husband’s tax even where the wife’s total earnings are many times greater. That, I imagine, will one day be the case of corporate lawyer Zoe Baird and her academic husband.

For the Bairds the situation is merely ridiculous. They will not have to rely on Social Security in their retirement; and given the lack of much progressivity in the present income tax, they are taxed little enough as it is. The cases of the cleaning lady and the nanny are of a different order. There are undoubtedly many who love babies and even some who like housework and enjoy the gossip that often goes with it. But the great majority of women who do this sort of work do it because they need the money. For them the Social Security tax is a cruel hoax. It would be surprising if most did not pressure their employers to join them in breaking the law. Once Social Security is on the operating table, it shouldn’t be too difficult to remove this diverticulum, preferably by increasing the benefits payable to a second wage earner in a family.

Now consider the kid next door who mows your lawn or baby-sits for you. While we’re at it, let’s consider all part time workers under the age of, say, 21. Suppose that instead of filling out forms and withholding taxes and all that, you gave such claimants, along with their pay, a voucher worth approximately 15 per cent of the money due. You’d buy the vouchers at the local post office, where they would be available in several convenient denominations. Banks and even grocery stores might want to sell the vouchers as a public service. The vouchers would earn interest in the same way and at the same rate as series E bonds, with these provisos: They would have to be used to finance some approved form of education, and they would have to be cashed before the holder’s 26th birthday. The vouchers would be required for all paid work by youths that is, no records would have to be kept to see whether the present $50 minimum was reached.

I MENTION VOUCHERS because that is a popular word today in educational circles, but stamps would be better. You are probably too young to remember the Postal Savings stamps one used to be able to buy at the post office or the Defense Stamps of World War-II, but I’m sure you can imagine how easy stamps would be to handle. Each worker would be given a little booklet with spaces to stick them on and instructions on their use.

Not only would this scheme free employers of annoying paperwork, it would free the government of expensive record keeping. Moreover, it would be largely self-enforcing. The present system is widely evaded because the supposed beneficiaries are unlikely to get any benefit from the Social Security taxes they pay as teenagers. Upon retirement, their benefits will be calculated on their highest 35 years of earnings. Under my proposal, young workers would get the benefits almost immediately, and those benefits would go for a purpose most employers strongly approve of. The nation would give up the relatively small taxes it now collects and will get in return a much larger contribution toward a cause its future depends on. Last but not least, good citizens who hire teenagers will both feel a public pressure to pay the tax and be relieved of the guilty conscience and anger that go with breaking a bad law.

Finally, let’s look at the COLA problem that at this writing is still teetering on the edge of the table. Cost-of-living adjustments, or COLAS, seem to derange the minds of many worriers about the deficit. Bankers are peculiarly susceptible, perhaps, because they enjoy the most refreshing COLA of them all. They don’t call theirs a COLA, of course. They call it an inflation premium. The interest they charge you for a loan is, they figure, made up of two parts-the real interest and a premium to offset inflation. Well, my Social Security benefit is also made up of two parts-the base benefit and the cost-of-living adjustment. Same thing exactly, except for the amount of money involved.

The Social Security COLA last year came to about $12 billion, while the Banker’s COLA came to about $800 billion. The Banker’s COLA was, in fact, more than double the budget deficit that upsets bankers so. And mark this: Inflation last year ran at a rate of 3.1 per cent, costing the economy about $186 billion. The Banker’s COLA that theoretically makes up for inflation happens to have cost the economy 4.2 times as much. If there had been no Banker’s COLA, there would have been no inflation.

On the other hand, if there were to be no Social Security COLA next year, some 500,000 senior citizens would be pushed down below the poverty line. The same fate would await hundreds of thousands more in every subsequent year that the Social Security COLAS were frozen. Very few retired people can survive on Social Security alone, yet for many millions it is the difference between modest comfort and penury.

In the past 10 years (as the Federal Reserve Board was being congratulated for inducing two recessions in fear of inflation), the cost of living has increased 47.2 per cent. Without the COLAS, a 1O-year retirement (the present expectancy) inexorably becomes very bleak indeed.

Well, it’s fine to have Social Security on the table. But if your problem is reducing the deficit, the way to do something about it is by increasing the taxes of those who benefited from the ’81 and ’86 tax breaks. Or, as Jeff Faux, president of the Economic Policy Institute, put it: “Send the bill to those who went to the party.”

The New Leader

[1] This article is being loaded into the blog 21 years after it was originally published

Clinton’s Supply Side

By George P. Brockway, originally published January 1, 1993

THE LITTLE ROCK “economic summit” was one of the most moving and inspiring and uplifting events in recent public life.  Earnest men and women dedicated to serving their fellows, some of them obscure, were able to explain their goals and difficulties to a President-elect who plainly shared their goals and had a sympathetic understanding of their difficulties.  Nothing like this has occurred before in our history.  Few of our Presidents would have been capable of it.  (Face to face with an ordinary citizen during the campaign, President Bush was puzzled.  “I don’t get your question,” he said.)

At the same time, and from the point of view of this column, the economic summit was one of the most depressing and disheartening – and dismal – events in recent public life.  There was remarkable agreement among the business executives, bankers and economists present.  I wasn’t able to watch the complete proceedings, but while I watched I heard only two bankers and three economists interpose objections to the mainstream that was rushing by.  To be sure, there were ripples in the mainstream – quibbles about details – yet the fundamental message was clear.

In fact, if you closed your eyes, there were times you could easily have imagined you were listening in on a planning session of Ronald Reagan’s early advisors, or perhaps a meeting of the Business Roundtable. One after another, the bankers wailed about regulation and boasted cheerily of what they could do if government could be gotten off their backs. One after another, the business executives and economists hailed the glories of investment (especially in the interest of “productivity”) and excoriated the seductions of consumption.  With a few exceptions, all the business and economic people fretted over the perceived necessity to stimulate the economy and the corresponding horror of failing to reduce the deficit.  Saving was soberly praised, and a word or two was said in favor of reduced capital gains taxes.

It was, as I say, a dismal performance.  For it was the supply side all over again.  The words “supply side” could not be read on anyone’s lips; no one traced a laughable curve on a cocktail napkin; and the ideas were restated less breathlessly than Jack Kemp does.  Nevertheless, it was the same old story.  A few spoke scornfully of trickle-down economics, and several spoke approvingly of the middle class.  I imagine most of the speakers would be shocked to be called supply-siders.  They should listen to the tapes.  The rhetoric was different, but the theory was substantially the same.

So where is the change that Candidate Clinton promised us so tirelessly?  Well, unpaid compassionate leave will be available to corporate employees; there will be less overt or covert endorsement of racial, sexual and ethnic cleansing; in close calls, the decision will usually go to the otherwise disadvantaged; the environment will not be a dirty word; family planning will again be a virtue; and something will be done about medical insurance.  In issues like these (except, perhaps, for the last named[1]), we can expect common sense and common decency to prevail. Common sense and common decency are no small things; we have lived without them far too long.  Their recovery will make the Clinton Presidency worthy of being remembered.  But I fear that the economic rebirth we long for will continue to elude us.

The rebirth will be aborted because the new supply-siders have, so to say, a monetarist side.  Speaker after speaker warned against over stimulating the economy.  It was explained that, whether by stepping up spending or reducing taxes, stimulation would increase the deficit, which would scare the “market” into increasing long-term rates, which would spur short-term rates, which would renew or deepen the recession.

Either way the deficit had to be reduced; and any way the deficit was reduced, the economy could not be stimulated.  That’s a dilemma for you. The proposed solution was twofold: First, the economy should be stimulated, but cautiously.  Second, a long-term, foolproof deficit-reducing program should be enacted to convince the market that the deficit is on the road to reduction; so renewed inflation will not be a danger, and interest rates need not be raised.

Let’s look at the stimulation, to be produced by expanded public works (I don’t believe in the second part of the solution any more than I did in Gramm-Rudman.) The largest sum I heard mentioned was $50 billion, with most of it going to state and local governments to restore services and repair infrastructure neglected under Reagan-Bush.

I can’t say that’s a bad idea because a little over a year ago in this space (“Taxing our Credulity,” NL, December 2-16, 1991) I wrote, “If Federal grants to state and local governments were restored merely to the same proportion of Federal expenditures as in 1980, a sum of $63.1 billion would be available to break the back of the recession.”  You will note that I proposed spending at least 26 per cent more than did the most spendthrift speaker at Little Rock.  Even so, I would not have been satisfied, as I made clear in subsequent columns, for $63.1 billion may seem like a lot of money, but it is only about 1 per cent of our gross domestic product (GDP).

As our economy is now organized, wages and salaries are about 80 per cent of GDP.  The median income for full-year male workers over 15 years old is about $30,000; the corresponding figure for females is about $20,000.  Beneficiaries of an economy-stimulating program might be paid less than the median – say, $20,000 as the average for both sexes.  And of course much of the stimulus would go to people who are employed.  Putting all these guesstimates together, I conclude that a $50 billion stimulus would directly create about 2 million jobs, while $63.1 billion would directly create about 2.5 million jobs.  Factoring in the “multiplier,” these totals might double, although not at once.

That’s not bad – provided you’re not one of the 6 or 7 million who would still be unemployed.  Please read and reread the previous sentence until its meaning in human suffering starts to become real to you.  I fear that it is not real to most mainstream economists, especially those who believe in the “natural rate of unemployment.” (See “Are You Naturally Unemployed?”  NL, August 10-24, 1992.[2])

A couple of the Little Rock economists pointed out – as I have done here many times (thus showing how obvious the point is) – that the debt and deficit ratios to our gross national product (GNP) were about twice as high in 1947 as they are at present, yet we proceeded to save Europe with the Marshall Plan and enjoyed a quarter-century that never saw the unemployment rate come close to what it is today.  The interest rate also was lower than today’s in every year except 1968, ’69 and ’70, and the inflation rate was lower in every year except 1948, ’51 and ’70.  One of the mainstreamers o9bserved that the postwar prosperity was driven by the demand for consumer goods pent up during World War II.  He did not seem impressed by the counter-observation that a lot of demand for consumer goods would be released now if the unemployed had jobs.

A CURIOUS FACT about the conference was the virtual absence of any reference to the Federal Reserve Board.  It was almost a case of the dog that didn’t bark.  There was a good deal of talk about the interest rate, but I heard only two participants refer to the agency that sets it.  One of the references suggested that things would change when we got “our” Board (unhappily, not an immediate possibility).

The other reference was a brief but remarkably comprehensive paper by a former governor of the Board.  He made two main points:  First, the long-term rate remains high because the Board keeps hinting the short-term rate will be pushed up to meet it (although there is plenty of room for the short rate to come down further). Second, the long-term market is effectively merely the market for 30-year Treasury bonds.  If there were no 30-year Treasuries, there would be scarcely a long market at all.  The Treasury raises only about 7.5 per cent of its funds long term and would save money if it gave them up.  Why not do so?  I regret to report that Secretary of the Treasury-designate Lloyd Bentsen did not respond, nor did President-elect Clinton.

Taking one thing with another, my sorrowful conclusion is that the Clinton economy is not going to be sensationally better than the Bush economy.  The National Bureau of Economic Research (not an “official” body, regardless of what the New York Times says) thinks you can have a recovery with both wages and profits falling and 10 million unemployed.  The awesomeness of this organization and the power of the Federal Reserve Board practically guarantee that the economy will get only a minimal stimulus, and that for only a minimal length of time.

Practitioners of economic science have dismally short memories.  In 1937 the GNP jumped up 7 per cent, where-upon the New Deal rushed to mollify Wall Street by cutting relief programs.  The budget deficit, which had reached the vertiginous height of $3.1 billion in 1936, was converted to a surplus (yes, surplus) of $300 million in 1937.  The result was a sharp recession within the Depression.  I fear that we’re getting ready to do it all again, and with far less excuse.

But one sound proposal, calling for full funding of Head Start, was generally endorsed at the economic summit.  Some of the economists saw Head Start as an “investment” in future productivity.  Their supply-side bias blinded them to its certain contribution to economic recovery.  Nonetheless, most of the money – and it will not be a trivial amount – that goes into Head Start will immediately go out to teachers’ or leaders’ salaries, to snacks and lunches, to consumable supplies like finger paint and soap, and to low-tech and expendable furniture and decorations.  At the end of a year there will be little or nothing tangible to show for these expenditures.  In the eye of an accountant the whole thing will seem like consumption of the most profligate sort.

Yet such profligate consumption (if it actually happens) will do more to stimulate the economy this year, and every year of the program’s existence, than the schemes to restore the investment tax credit, to rehabilitate IRA’s, and to cut taxes for the middle class.  All of those are bum Reaganesque ideas that we have already tried and found wanting.

The Clinton-Gore book title had it right:  We should be Putting People First.

The New Leader

[1] True enough, no action until the Affordable Care Act, aka ObamaCare

Ed: [2] We do not have a copy of this.  If you have one, PDF or in print, please share

Are You Naturally Unemployed?

By George P. Brockway, originally published August 10, 1992

AT THE END Of my piece on “The Last Chapter in Keynes” (NL, June 29), I referred to the currently received doctrine of the natural rate of unemployment. The implications of the doctrine are such that they don’t, as the saying goes, bear thinking about. Nevertheless, I propose to try to think about them here and now.

The expression “the natural rate of unemployment” was apparently coined by Milton Friedman in his presidential address to the American Economic Association on December 29, 1967. Friedman was clear that what he called the natural rate was not a natural law (like, say, S= 1/2[gt^2]). “On the contrary,” he said, “many of the market characteristics that determine its level [such as minimum wage laws] are man-made and policy-made.” Yet he saw and, I believe, still sees something inexorable in the idea.

Friedman said he used the word “natural” because the idea was comparable to “the natural rate of interest,” a notion advanced by the Swedish economist Knut Wicksell in 1898. Wicksell is worth reading (though perhaps not on this issue), but for the moment we need note only that he is thought by many to have anticipated Keynes in some ways. And as to Keynes, we need remember particularly that his initial quarrel with the classic economists was that they believed involuntary unemployment was impossible. Since whatever is “natural” is ipso facto involuntary, Friedman, too, broke with the classics on this point. I hasten to insist that Friedman is not now and never has been a Keynesian or a neo-Keynesian, and certainly not a Post Keynesian (which, if you must know, is more or less what I am).

The natural rate of unemployment is thus an idea that resonated unexpectedly in many corners of modern economic thought. In its pure form it goes like this: Given the civil laws, customs and institutions of the economy (though Friedman is not now and never has been an institutionalist follower of Thorstein Veblen or John R. Commons), beyond a certain point any increase in the rate of unemployment will result in deflation and a recession that will continue until wages fall to a level to encourage entrepreneurs to start hiring again; on the other hand, any decrease in unemployment will result in inflation and a recession that will continue until employment returns to its natural rate.

The idea was not immediately embraced by the profession. Very likely thin-skinned economists were timid about saying that joblessness could be your patriotic duty. This difficulty was overcome when somebody (I’m sorry I don’t know who[1]) came up with a name that obscures the implications of the idea and has, moreover, an acronym that soothingly sounds like the name of a languorous South Sea isle. The new name is Non Accelerating Inflationary Rate of Unemployment, or NAIRU. The modifier “nonaccelerating” is a modifier of Friedman’s original notion and recognizes the fact that, as we know from our experience of the past half century, it is not too difficult to live with inflation if the rate is fairly low and steady.

The NAIRU was 3 or 4 per cent at the end of World War II. It reached 5 or 6 per cent in 1975, after the Federal Reserve Board raised interest rates in its quixotic response to the first OPEC embargo. And it appears to be around 5 or 6 per cent today (the current 7.7 per cent rate of unemployment is dismal from any point of view).

Let us be sure we understand what a NAIRU of 5 or 6 per cent means. It means that, given our present labor force of some 127 million men and women, about 7 million of them must be unemployed through no fault of their own. Forgive me for raising my voice, but we must see clearly that NAIRU won’t work if unemployment is the result of stupidity, poor training, laziness, lawlessness, or unreasonably high wage demands – if unemployment is, as the classical economists said, voluntary. The NAIRU people are not the people of Reaganesque anecdotes (if such people there ever were) who flit from job to unemployment insurance to job as spirit moves them. Stupid, incompetent, lazy, lawless, or grasping people do not compete for existing jobs; it is the function of NAIRU people to make holders of existing jobs fear for their positions and so acquiesce in low pay, unsafe or Quayle-approved working conditions, frayed fringe benefits, and nonunion shops.

Perhaps you will now sense another resonance of the natural rate of unemployment. It is the stern, impassioned tread of Karl Marx’ industrial reserve army. “The industrial reserve army,” Marx wrote, “during periods of stagnation and average prosperity, weighs down the active labor-army; during periods of overproduction and paroxysm, it holds its pretensions in check.” Friedman might have put it somewhat more gracefully, but he couldn’t agree with it more.

How did the soldiers of the industrial reserve army get recruited? They weren’t rounded up by press gangs like those that helped Britannia rule the waves, but their fate has not been dissimilar. They did not volunteer, and they were not drafted; they were in the wrong place at the wrong time, and many of them were simply born wrong, just as Rockefellers and such happened to be born right. They are victims of crashingly bad luck.

From time to time, demographers publish studies averring that only a percentage (say 10 per cent or 5 per cent or perhaps 1 per cent) are what we used to call lifers and spend their entire lives in the industrial reserve army, or that only some other percentage (say 12 per cent) serves more than 27 weeks at a time, while Horatio Alger and his like are discharged in a matter of days. We may accept these studies, or most of them, at their face value and still observe that those in the industrial reserve army serve as a consequence of crashingly bad luck, and that they serve in our interest and indeed in our stead. This being the case, it cannot be denied that our economic system – a system said to depend on the natural rate of unemployment – would self-destruct if it were not fundamentally unjust. It is clever to say that life is unfair; it is corrupt to raise unfairness to a principle of control.

As we noted here a short while ago (“Where Schumpeter Went [Astray],” NL, April 6[2]), Joseph Schumpeter celebrated capitalism as “the civilization of inequality and the family fortune.” I cannot do that. I cannot understand doing that. I cannot settle for NAIRU in any of its forms. I can accept the military draft and have in fact been drafted. It is possible in time of war to show citizens, chosen by lot, their duty to risk their lives in defense of the nation that nurtured them. It is not possible to show anyone a duty to lead a life of squalor in order that others may be free to choose among moderately priced commodities.

If there really is a natural rate of unemployment for our system, the system is immoral. If it is immoral, we should change it. Some will say that even with NAIRU, ours is the best system seen so far, and others will say that NAIRU applies to all systems. Despite these answers, improvements are possible.

To share the burden of NAIRU fairly, we might take Marx’ metaphor literally and institute a draft for the industrial reserve army[3]. It is unlikely that there would be volunteers, and there should be no exemptions of any kind (except for the unemployable). Membership in the army probably would be by nuclear families, unless children were put out for adoption while their parents served. There would no doubt be problems with the definition of a family, but I’m sure that, given good will, solutions could be found.

Every able-bodied family in the nation would pull at least one hitch in the army. Service would consist of living without personal assets or income (including imputed income, as for example, decent food, clothing, and shelter) for a period. I imagine two or three years would suffice at the present natural rate of unemployment. For ease of administration, it might be convenient in some cases for families to exchange homes. Certainly the houses of wealthy draftees could not be left vacant without inflating the general cost of housing.

Private charity also would have to be rigorously controlled to prevent favoritism and corruption. Food Stamps, Aid to Families with Dependent Children, Medicaid, and the like (including Workfare if finally enacted) would be available. Of course, for the army to serve its purpose, recruits must be able to work, but their availability would have to be in accordance with length of service. It wouldn’t be fair for me to be enlisted one day and hired by a friend the next.

Perhaps all that strikes you as preposterous. I hope so. It certainly seems preposterous to me. But the whole idea of placidly accepting a natural rate of unemployment strikes me as far more preposterous.

Now, looking back at the theory of NAIRU, we note that the general price level is to be controlled by holding down only one of the factors of production (labor). Why shouldn’t we also hold down the rate of interest? Since inflation of the costs of production is the issue, why shouldn’t we have NAIRI as well as NAIRU?

“But,” cry the governors of the Federal Reserve Board, “we already control inflation by raising the interest rate.” They know not what they do. In the 40 years since 1951, when the Reserve freed itself from its wartime agreement with the Treasury to hold rates down, the percentage of GNP that goes to pay interest on debt of the nonfinancial sector has gone from 4.59 per cent to 20.51 per cent. Let me put it another way: In 1951 the interest bill of American corporations was about one-twelfth of their wage bill, whereas today it is more than a third. If the 1951 ratio still applied, today’s costs would be roughly $845 billion less than they actually are, and the price level would be lower by a considerably greater amount.

By raising the interest rate (even now it is more than double what it was in 1951), the Federal Reserve Board has contributed to (if not mainly caused) inflation. It has then restrained the inflation it caused by bringing on recession, which keeps the industrial reserve army in being.

So NAIRU not only serves reactionary interests in keeping wages in check; it is a convenient reactionary ploy in other situations. Public works cannot be used to reinvigorate the economy because the increase in employment would violate NAIRU. Likewise, although doctrinaire free traders may admit that selective protection might protect or restore as many as 2 million jobs, NAIRU forbids it. And so on.

In short, the nasty theory of a natural rate of unemployment is counterproductive as well as immoral.

The New Leader

[1] Ed:  According to Wikipedia It was first introduced as NIRU (non-inflationary rate of unemployment) in Modigliani – Papademos (1975) – Wikipedia offers three references:  ^[3][4][5]

[2] Ed:  The actual title is “Where Schumpeter Went Astray” but when this article was written it was cited, with a lack of the author’s normal poetry, as “Where Schumpeter Went Wrong.”

[3] Ed:  In case you’re not paying attention, the next 3 paragraphs are at once both analytically correct but intended to demonstrate to the reader how insufferably wrong-headed NAIRU is… These paragraphs are, in current parlance, “snarky”