One of the enduring faiths of modern progressive
thought is that omniscient policy makers can cancel out the errors of one form
of economic intervention by implementing a second. That lesson was brought home
to me when I was a third year student at Yale Law School, whenever discussion
turned to the perennial debate over the minimum wage. The charge against the
minimum wage was that it had to introduce some measure of unemployment into
labor markets by raising wages above the market-clearing price. “Not to worry,”
came the confident reply. The way to handle that imperfection is to raise the
level of welfare benefits in order to remove the dislocations created by the
minimum wage. If one government program had its rough edges, a second
government program could ride to the rescue. Implicit in this argument was the
tantalizing, but fatal, assumption of economic abundance: The government has
the power to tax, and with that power, has access to a cornucopia of public
funds that never runs empty—at least until it does.
This abundance-based argument is not confined solely
to the minimum wage, but has been extended to countless programs of state
intervention in labor, or indeed, any market. Thus in 1935, American labor law
created a system of collective bargaining whereby employees bargain with a
single voice. That system allows unions to seek, and often obtain, monopoly
profits for their members. That system in turn reduces the number of workers
hired by the unionized firms. So what is to be done with the excess workers?
They should be shepherded into job-training programs, funded by the public,
which would allow them to reenter the labor force with other jobs.
For example, job training is the solution for those
workers in the Northwest whose skilled jobs in the timber industry have been
decimated by a variety of environmental diktats, of which the Endangered Species Act of 1973 is only the most notable. That same two-pronged strategy is
evident in the American Jobs Act. Key provisions require recipients of government expenditures (of at least
$50 billion) to adopt Buy American programs or to pay prevailing wages, both of
which hobble the recipient firms. One predictable offset is tax credits to
employers who hire long-term unemployed workers, coupled with yet another
“Bridge to Work” job-training program.
The two-sided programs so popular in the United States
also play a large role in the European Union, which has stronglycollectivist labor policies. There, employers find it next to impossible to fire workers, to whom they
owe a rich set of statutory benefits covering everything from maximum hours to
minimum vacations, funded, of course, by government tax revenues. Meanwhile,
displaced or unemployed workers receive generous welfare benefits, which reduce
their incentive to find new work. The upshot is chronic levels of unemployment
in countries like Greece, Italy, Spain, and Portugal, whose fragile financial
conditions have put into doubt the survival of the Euro and indeed the European Union.
The massive level of economic dislocation both at home
and abroad offers conclusive evidence that this venerable two-part strategy
does not, and cannot work. Pinpointing its systematic errors is critical to
avoid expanding on past mistakes. The proper approach is simple to state but
hard to execute: Always seek “first-best” solutions. The correct response to
any restriction on capital or labor is its prompt removal. A “second-best”
effort to introduce some offsetting program only makes matters worse. The two
errors do not cancel out. They cumulate.
The point is made by looking at the interaction
between tough minimum wage laws and high unemployment benefits. The minimum
wage law introduces two immediate distortions into labor markets, which grow as
the gap between the market-clearing wage and the minimum wage increases. First,
it imposes huge administrative burdens on the Department of Labor and other state and federal agencies that have to enforce the law,
and the private firms who have to be sure that they act in compliance with its
commands. It is no easy thing to define an “hour” for the full range of jobs.
There are no uniform answers for dealing with statutory exemptions, commuting
time, work breaks, sick leave, or jobs away from home. Overtime pay is a world
unto itself. The complex regulations needed to implement this one provision of
the labor code require large investments from firms who need to avoid the heavy
exposure to government sanctions and private lawsuits from noncompliance. None
of these costs are eliminated by the adoption of any program of unemployment
benefits or job creation, each of which imposes its own distinct, and costly,
administrative overlay.
These costs have to be borne by someone else, and most
of them are in fact covered by a combination of general revenues and specific
unemployment taxes on current workers. Both of these programs produce
additional distortions. Any tax on general revenues reduces the income
available for both investment and consumption in all sectors of the economy.
Unlike taxes that are imposed to create sensible infrastructure and other
public goods, these unemployment taxes do not generate benefits for the parties
taxed that equal even a small fraction of the costs that they impose. Firms do
not benefit by paying income taxes to government agencies whose job it is to
oversee their operations. The same can be said of specific taxes geared to fund
unemployment programs, which hit most heavily those firms that have expanded
their workforce in ways that reduce the ranks of the unemployed. Make no
mistake about it: Any effort to cushion the blow of unemployment also
functions, in both the short and long run, as an impediment to job creation.
The effort to cushion the blow of unemployment necessarily adds to the ranks of
the unemployed.
The two-part strategy also fails as a long-term
measure. The consequence of higher rates of unemployment is the detachment of
workers from the workforce. One of the serious mistakes of much labor market
regulation, including the minimum wage law, is to assume that the only
compensation given to employees is found in wages and benefits. But a sounder
understanding of labor markets indicates that workers at all levels of the
workforce also gain additional marketable skills from working on a steady job.
For workers at the bottom of the ladder, those key skills could be as simple as
knowing how to keep to a schedule, how to dress for work, how to take instruction,
how to work in teams, and how to balance a ledger. For workers up and down the
income distribution, idleness means a deterioration of work skills that reduces
the potential for job advancement down the road.
Government job-training programs are a feeble
substitute for real work experience. Labor markets are always dynamic while
job-assistance programs are designed by agency bureaucrats who have all the
flexibility of a Soviet bureaucracy. These agencies lack a profit motive, they
are heavily budget-constrained, and they specialize in the use of outdated
equipment for jobs that will have disappeared before the training program is
completed. It has long been known that most
graduates of these programs don’t get jobs. That trend continues today,
especially in fields like energy.
If program participants do get jobs, they rarely lead to long-term employment. Another baleful consequence of the minimum wage is that it inhibits the job-training programs that employers give to their own prospective employees. It makes good economic sense for workers to accept a reduced wage, or even no wage, during a period in which they are in training for jobs that the employer will eventually offer. In these situations, the mismatch between training and placement is negligible relative to that of a government-training program, which necessarily lacks the tight connection between today’s training and tomorrow’s labor.
The adverse effects of these labor market restrictions
are not confined to labor markets. They also negatively affect taxation and
fiscal policy. One of the most dominant features of modern Keynesianism is the
belief that, left to their own devices, markets in both goods and labor will
not clear, so that there can be long-term forms of structural unemployment,
which a government stimulus program could help correct. In dealing with this
issue, Keynes rejected“Say’s Law,” first
promulgated in 1803. In its most famous formulation, that law holds that supply
creates its own demand, which applies to labor as well as goods. Keynes’s
solution to this problem is the use of government stimulus programs to supply
the additional demand for goods and services that markets, left to their own
devices, cannot generate for the want of demand.
Of course, boom and bust cycles have been common both
before and after the Great Depression. But it hardly follows that the source of
all economic difficulty lies in the stunted operation of unregulated labor and
capital markets. Most markets do not involve the simple barter of goods and
services. Since ancient times, everyone has recognized that barter is a highly
inefficient mode of exchange, for it is rare that the purchaser of one set of
goods or services has for sale a market basket of goods and services that fits
the needs of this or that particular purchaser. The introduction of a standard
unit of exchange—money—in effect allows me to buy from A without having to sell
to A a market basket of goods of comparable value. Vast new levels of
efficiency are introduced into the market by the ability to sell goods to A for
cash (or credit), which A can then use to buy goods and services from someone
else.
The establishment of money and credit as mediums of
exchange introduces vast efficiencies into all markets. But, at the same time,
it introduces a pervasive form of government intervention into the private
markets as long as the dollar (or any other currency) is subject to government
control. Monopolies are always dangerous because they are unchecked. That general
proposition applies to the government control of cash and credit. There are, at
best, imperfect institutional constraints against flooding the market with
cheap dollars, or by starving the market by taking too many dollars out of
circulation. The former happened with the housing bubble of 2003-2008, while
the latter happened with the deflation of the depression years.
Learned economists write reams about whether the
imperfections of private labor and capital markets justify imperfect stimulus
programs. But they tend to assume that little can be done to fix the current
imperfect operation of capital and labor markets. This would be the case if
they were generally unregulated, but labor and capital markets are manifestly
not free today. The obstacles to gains from trade in labor markets are larger
than they have ever been before in the United States. In addition to
regulations like minimum wage, overtime pay, and collective bargaining, the
markets face countless other restrictions, like antidiscrimination and quota
laws, insurance, other health-care mandates, and family leave policies.
The Keynesians have very weak explanations for why
labor markets break down: They focus on “sticky” markets. “Stickiness” occurs when transaction costs prevent the quick readjustment
of prices and wages to changes in conditions of supply and demand. But it is
highly unlikely that this supposed phenomenon could carry the huge weight that
is attributed to it, especially in unregulated markets. The point seems wildly
overstated, especially today when there is near instantaneous re-pricing of
everything from airplane tickets, to rental housing, to hotel rooms, to
gasoline, to Google ads, and so on.
These profound microeconomic shifts are driven by
information technology. In recent times, this added measure of price
flexibility has largely removed any supposed macroeconomic obstacle to full
employment. There is nothing about neoclassical economic theory that predicts
that labor markets will always clear. In fact, it predicts the precise
opposite. Burden these labor markets with the barrage of taxes and restrictions
that they now face and it is virtually certain they will fail to clear. That
simple insight gives a prescription for current policy. Government treasuries
do not offer a cornucopia of riches that can be used to fix the short-term
dislocations in labor markets that are caused by government intervention. Those
resources will always run out, and when they do, there is no other government
that can play the role of deus ex machina.
Rather than go down the road of foolish grand public
initiatives that bankrupt nations, government policy, both in the U.S. and the
E.U., should start at the other end. It costs very little to eliminate
elaborate forms of regulation. A thorough-going program of deregulation will
reduce the wealth that is directed into costly compliance and unwise transfer
systems, and increase the total level of goods and services produced in the
overall economy, which in turn should reduce the fiscal drain of government
transfer programs.
Any comprehensive program that addresses labor markets
at large cannot focus exclusively, or even mainly, on expanding job stimulus or
transfer programs, both of which hamper the growth that is necessary to escape
the current malaise. The systematic deregulation of labor markets offers the
best, last hope of tackling unemployment. If only our political leaders understood
that simple and powerful message. Unfortunately, they don’t. So expect
more stagnation going forward.
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