Madness is Not Statesmanship

By George P. Brockway, originally published August 11, 1997

1997-8-11 Madness is Not StatesmanshipI SUBMIT that it’s time to give it up, quit, call a halt, put an end to the nonsense and the grief it has caused. The charade has had a run of almost 30 years. That is surely long enough for any group of people to toy with the wealth, health and happiness of their fellows.

It was on December 29, 1967, that Professor Milton Friedman, then of the University of Chicago, in his presidential address to the American Economic Association, publicized the notion of a natural rate of unemployment-now known as the nonaccelerating inflation rate of unemployment, or NAIRU. The idea proved to be protean. Theorizing about it was a game anyone could play, and the game soon had as little resemblance to the one Friedman invented as the slam-dunk has to the shots invented by Dr. James Naismith of the YMCA College in Springfield, Massachusetts, in 1891.

Friedman himself based the theory on mumbo-jumbo about nominal wages and real wages that would make inflation rise à outrance if unemployment fell below the natural rate. Some stirred that up with the productivity scam; a standard reference book disregarded the foregoing ploys but introduced three others; and an international conference was devoted to the imagined connection between NAIRU and hysteresis, a phenomenon characteristic of ferrous metals in an electromagnetic field. (No, no, I did not make that up.)

1997-8-11 Madness is Not Statesmanship Milton FriedmanAs the natural rate theories began to unfold, their beauty, not to say elegance, began to be appreciated. For, look you: If there is a natural rate of unemployment, the most difficult and most important questions of economics-those that have to do with people-are answered. Better, they’re made to disappear; there’s no point in asking them.

To struggling scholars, the theory of a natural rate of unemployment has been a godsend. The frosting on the cake is Professor Friedman’s dictum that, for certain technical reasons, “the monetary authority [aka the Federal Reserve Board] cannot know what the ‘natural’ rate is.” This being accepted, tenure-track economists can consolidate their careers by writing learned articles conclusively demonstrating whatever rate tickles their fancy, and no one can say them nay.

Well, that’s not quite right. Reasoning from the pronouncements of professional economists, we conclude that, whatever the actual rate of unemployment, the natural rate must always be higher, because the actual rate is always low enough to convince pundits that a lot of people must be fired at once to prevent runaway inflation, or to allow us to compete in the new global economy, or to keep the Federal Reserve from raising the interest rate and disquieting the stock market.

In the new welfare-as-we-never-knew-it-world, we are beginning to push people off welfare and onto workfare, and we are beginning to see the absurdities and the nastiness of the schemes. In New York an attempt is being made to unionize the new workers. The local authorities are resisting on the ground that the new workers are not really workers at all, because they don’t work full time, and they don’t have vacations, and they don’t have proper tools and equipment, and they aren’t paid a living wage.

I expect that the Bureau of Labor Statistics will go along and not count them, just as it didn’t count as employed the millions who worked for the CCC and WPA and the rest of the “alphabet soup” programs of New Deal days. (How else do you think unemployment hit 17.2 percent in 1939, as the books say it did, under that Old Democrat FDR?) These people were paid for what they did, and much of it survives for our pleasure and enlightenment to this day, but they didn’t get counted.

Think what would happen to the natural rate of unemployment if the millions of victims of workfare were counted as really-truly workers. Once the states got the new system in full swing, unemployment would theoretically be cut at least in half-say, to 2 or 2.5 per cent. Inflation would of course go straight up; its curve would be vertical; and the interest rate would have to follow in hot pursuit.

Think of it.

I, too, think that is absurd. But I ask you: Why is it absurd? Don’t tell me that most workfare workers aren’t eager to work. The same can be said for more than a few in the private sector, even at fairly exalted levels-which may explain why golf courses and ski runs are busy seven days a week, in season. After all, the “classics” held that work is a “disutility” that is overcome only when workers are tempted with high wages.

The absurdity is not in the people, whether employed or unemployed. The absurdity is in the theory of a natural rate of unemployment. The theory is fallacious as well as vicious. The fallacy appears at the very beginning, where it is assumed that inflation is caused on the supply side by the cost of labor and on the demand side by the purchases of laborers.

Labor costs are indeed the largest category of expenses, but they are only about 60 per cent of the Gross Domestic Product (GDP). The other 40 per cent includes rent, interest, insurance, taxes, and profits, which obviously don’t all move at the same slow pace as wages, or even in the same direction. Labor costs, moreover, are not homogeneous, but can be usefully divided into three categories with pretty distinctive behavior: the takings of the working rich (say, those with annual incomes in excess of $175,000); the wages of the working poor (those mired below the poverty level); and the salaries of the working middle class.

So we have eight factor costs that affect the supply side of the price level, instead of the single omnibus wage cost of the NAIRU theory. Of the eight, four have certainly soared during the past couple of decades: interest, insurance, profits, and the takings of the working rich (entertainers’ professional athletes, business executives, and other celebrities). The salaries of the middle class, though, have stagnated, while the wages of the working poor have grievously fallen[1].

Now, when the unemployment rate falls a tenth of a point because several hundred thousand people get jobs, who are the new workers? Well, a handful may be newly minted celebrities or previously downsized executives, but most of the rest meld into the bottom half of the working middle class or the working poor-categories that have not been responsible for inflation’s costs.

Nor will the lower categories be responsible for any substantial increase on the demand side. These people, even when unemployed, already did a bit of demanding or consuming. They weren’t quite starving or freezing to death. The welfare reformers, in fact, thought they had it too good. Since most of the new workers will be paid close to the minimum wage (which is below the poverty level), they will not be able to demand much more in the way of goods and services than they did when unemployed. That is not the way things ought to be, but it shamefully is the way they are and will be for the foreseeable future.

When unemployment falls, the new members of the working poor will not make a crucial difference to either the supply side or the demand side. Their effect on the price level will be negligible. They will, however, make a salutary contribution to the GDP, cause a great fall in welfare expenses, and add nicely to Federal and state and local tax receipts.

IT IS IN EVERYWAY, at all levels, a good thing for unemployment to fall-and in a rational economy that would be a principal objective of public policy. Yet in the world of conventional economics, this happy event is irrationally supposed by NAIRU theorists to be the harbinger of inflation to come. It sets off a great hue and cry in the universities and on Wall Street, explaining why the Federal Reserve Board will have towill be required by economic law to[2]-raise the interest rate high enough to induce recession.

As an example of the wild claims made by conventional economists, we may consider a 1990 proclamation by Professor Paul Krugman of MIT that if we tried to increase employment by 2 million people, “inflation would begin to accelerate rapidly.” In the event, employment was essentially unchanged for two years, and the Consumer Price Index (CPI) fell from 5.4 per cent to 3.0 per cent. Since 1992, employment has increased by over 4 million a year, and the CPI has, yes, fallen to 1.4 per cent. If we use the figures of the Boskin Commission that economists were praising last winter, inflation now is only 0.3 per cent-repeat, three-tenths of one per cent-a year.

In its perennial struggle with the inflation banshee, the Federal Reserve has sponsored eight recessions since World War II. Not only were trillions of dollars’ worth of commodities never produced (it can be argued that we have too much stuff anyway), but millions of our fellow men and women were forced into poverty, their hopes for a better life dashed.

That is a monstrous shame we all bear, a shame brought about by arrogance in league with ignorance. After 30 years, the ignorance is no longer excusable-if it ever was. We are at present in an economy whose unemployment rate is falling -even without counting our workfare fellows as employed-and whose inflation rate is approaching zero. And we have seen unemployment fall despite the conventionally feared minimum wage law, specifically mentioned by Professor Friedman as increasing the natural rate of unemployment.

Federal Reserve Chairman Alan Greenspan, we have noted hopefully here more than once, claims not to be a believer in NAIRU. Nevertheless, in his recent semiannual testimony before Congress he felt obligated to warn that if things don’t slow down, the Reserve will raise the interest rate. Should he carry out his threat, he will hurt the poor and especially the lower middle class, who, as we have seen, are not responsible for inflation, and he will benefit the rich, who are to blame. This is not statesmanship; it is madness.

Perhaps the Chairman still fears an over exuberant stock market. That may be sensible, but raising the interest rate will attempt to exorcise the fear by taking billions of dollars from the borrowers among us and giving them to the lenders. The attempt will succeed only if he manages to bring on another recession. This, too, is madness, not statesmanship.

It is also NAIRU by another name. The natural rate of unemployment, the nonaccelerating inflation rate of unemployment, NAIRU-the whole mess-is fallacious in theory, erroneous in fact, and immoral in consequence. Let there be an end to it.

The New Leader

[1] Italics are not in the original

[2] THESE italics ARE in the original…


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