by Richard A. Epstein
Grim is the right word to describe the latest economic
news from both the European Union and the United States. Throughout the
European Union, austerity programs have failed both politically and
economically. In Spain, unemployment rates have soared above 24 percent. The
Dutch government is on the edge of collapse because of the popular and
political unwillingness to accept the austerity program proposed by its
conservative government. Romania is not far behind. Greece, Italy, and Portugal
remain in perilous condition. France faces the free-spending socialist candidate Franciose Hollande. On the
American front, the decline of GDP growth to 2.2 percent rightly raises fears that our sputtering domestic recovery is just about over.
It is no surprise, therefore, that leading columnists like Paul Krugman have taken this opportunity to announce triumphantly that austerity is a “fairy tale” that shatters the social confidence that it is designed to shore up. It is futile to invoke fiscal austerity, he argues, when economically beleaguered countries really need to be “spending more to offset falling private demand.” The cure is supposed to be increased government spending, but that solution has its own serious problems. Krugman assumes that the declines in private demand and private investment are attributable to mysterious external forces that are beyond the power of government to control.
The rise in public expenditures has to be financed in
one of three ways: higher taxes, increased inflation, or more borrowing. The
question of which device is used is, in general, a secondary issue. But the
primary insight is this: Any increase in public expenditures in either good or
bad times will necessarily result in a larger fraction of the economy under
government control.
The ostensible short-term benefit of increased
spending comes with a high, but hidden, cost of substituting unwise government
expenditures for more sensible private ones. The upshot is that these
expenditures might give life-support in the short run, but in the long run they
will surely delay the increase in private expenditures that make the stimulus
gains unnecessary. And sooner or later, the long-term debt will come due, at
which point the only alternative to austerity is wholesale default on key
social obligations.
Focusing, therefore, solely on monetary and fiscal
policy has dire consequences that the macroeconomic establishment wants to
ignore. It is right to say that austerity, taken alone, will fail. But it is
wrong to think that increased public expenditures are the road to long-term
salvation. The slowness of the American recovery offers solid evidence that
priming the pump will fail as well. Even if it does not raise debt costs in the
short run, it sops up resources better deployed by sustainable private
investment.
How then to create desirable conditions for growth?
The first key element is to focus on growth by calling off the
acerbic attack on the top one percent. The good Keynesian concentrates on the
fall in aggregate demand in the private sector, and should therefore not be
concerned with whether that demand is flexed by the rich or the poor or any
combination thereof.
All too often, macro-types engage in fancy footwork by
claiming that skewing the tax breaks to those at the bottom of the income
distribution will hasten the recovery because of their greater marginal
propensity to consume. But that bet is exceedingly uncertain because people at
all income levels may choose to save, rather than consume, their money
depending on how they perceive future economic opportunities.
If low-income workers think that the downturn is
permanent, then they will increase their savings to offset the anticipated
decline in their future income. Or they will use some of their tax savings or
public subsidies to pay off overdue debt, or to save for the college education
for their children or, like Joe Nocera, to subsidize their own (underfunded) retirement. Trying to organize a revival
of the economy by jiggering tax rates is doomed to fail. Individuals will
choose to run their own lives as they see fit, and their financial decisions
may negate any supposed advantages that the economic elites can impose through
fiscal or monetary policy
So what next? The best first step is to free up labor
markets world wide. Specifically, we need policies that take aim at the
unbearable political forces that seek to tighten the regulatory noose on
voluntary labor markets.
Unfortunately, the dominant attitude of
macroeconomists is to assume that nothing that takes place within the labor
market (of which Krugman never speaks) is large enough to influence the large
macro trends to which they attribute today’s high employment rates.
The blunt truth is exactly the opposite. The
calcification of labor markets is the primary impediment to economic recovery.
The direct effects of government regulation of labor can matter far more than
the indirect effects of macroeconomic policy, whether Keynesian or austerity-based.
Neither austerity nor lavish public expenditures will improve the overall
situation, which is why the massive increase in American public debt has not
nudged unemployment rates down. The only workable solution has to stress job
creation, not by misdirected subsidies, but by dismantling the government
obstacles to market exchange.
Start with the basic microeconomic theory of contract
relationships. Private parties have objectives they wish to achieve by
coordinated behavior. Voluntary agreements remain the only tool that they have
to improve their joint position. There is nothing that the law can or should do
to identify the gains through cooperation. That is for the parties to do. The
simple combination of labor can allow two individuals to do more together than
they could do separately. Two people can raise a barn wall at a small fraction
of the cost of each person acting alone.
Specialization increases gains from trade. The
function of the law is to reduce the transaction costs to permit the mutual
gains to flow. Put another way, if the gains (G) exceed the transaction costs
(T), then markets can operate. Where the gap narrows, the gains from trade
shrink. When G is less than T, the market folds. Obviously, government should
not work to shrink G or increase T. Today, however, it does both.
That said, some modest forms of regulation actually
increase gains from trade. Think of a requirement that a real estate sales contract
be put in writing. Simple formalities at the outset of a transaction can reduce
the uncertainty about the deal and its terms. But virtually all government
regulations on wages and terms increase that uncertainty. The high transaction
costs reduce the possibilities of cooperation, and the explicit limitations on
substantive terms kill off gains from trade. The common view that labor law
protections are necessary to protect financially weaker workers from
exploitation gets things exactly backwards by, again, raising T and lowering G.
Most voluntary employment contracts are entered into
on an “at will” basis, which means that employers can fire their workers and
employees can quit their jobs for any reason at any time. Parties that want
more complicated deals can write them out. Usually they don’t because of the
efficiency advantage of an “at will” arrangement.
European law at the EU and national level specializes
in a set of “for cause” dismissal rules that make it virtually impossible for
any employer to lay off any worker. Those rules cause massive amounts of labor
market rigidity, which make it difficult for employers to lay off workers for
general incompetence (which can never be proved) or in times of slack demand.
The unfortunate consequence of that civil-service rigidity is that it reduces
the likelihood that an employer will hire workers in the first place. The same
is true of the disability regulations in the United States.
Faced with transactional obstacles, the parties will
resort to inefficient substitute short-term contracts, where employers are less
willing to invest in training workers for the long haul. The eager regulator
can try to block this avenue of escape by imposing special taxes on independent
contractors. But the likely response to that is simply to not hire new workers;
instead, employers may choose to pay current workers overtime, to increase
outsourcing, or to invest in capital equipment that reduces the overall demand
for labor. Protection works, for a while, for the few in power, but in the long
run, it leads to massive layoffs from struggling firms.
Just that outcome describes the fate of heavily
unionized industries in the United States. The deeply protectionist National
Labor Relations Act dictates that many employment contracts be governed by
collective bargaining agreements, which never incorporate at-will principles.
Dismissals are often subject to judicial challenges that leave the courts in
the hapless position of having to decide whether the decision to dismiss the
employee was for anti-union or legitimate employer motives.
In addition to this short-term difficulty, these
agreements can never be economically efficient because no union can just
bargain to get a bigger slice of a larger pie. Instead, the unions have to
worry about maintaining political support from the rank and file. In response,
they opt for inefficient labor contracts—think of the complex set of job rules
found in standard union contracts—to achieve their dual objectives. These
contracts are not easily amenable to mid-term corrections in response to
changes in external conditions, all of which require time-consuming and tense
renegotiation with unions.
The situation gets no better with the endless number
of employer mandates and taxes that are routinely imposed on firms. A typical
statute may say that an employer need not supply any health-care insurance for
its employees at all, but if it chooses that route, it must meet the following
mandates for health, disability insurance, and a host of other conditions. None
of these conditions are bad in and of themselves. But legislators never ask the
hard question of whether they are worth what they cost. If they are, such
provisions would be included voluntarily in the agreement. If they are not,
they should not be imposed at all. The constant uncertainty over the potential
reach of the Health Care Act currently acts as a disincentive to hire workers.
Nor are bad output effects offset by favorable
distributional consequences. The costs of these devices tend to constitute a
larger fraction of total earnings for employees at the bottom end of the income
distribution. The panoply of restrictions exerts its greatest pressure at the
bottom end of the labor market. The upshot is that we see a rise in chronic
unemployment, which has brought forth an endless set of laments—all
warranted—by such notables as the New Yorker’s James Surowiecki about the socially corrosive consequences of the economic current
policies.
But forget the laments. We need to reverse course now.
Think simple: increase G and reduce T and labor markets will start to open up
again. Regulatory costs will decline, unemployment costs will decline, and
consumption will increase. If we fix what is broken, then the economy will
start to recover. But if we fiddle at the macro level, then we will stretch the
current malaise out for years and years.
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