The Continuing Fallacy of Government “Creating Jobs”
Earlier this year, I wrote some commentaries based on Lawrence Reed’s excellent 1981 Freeman article, “7 Fallacies of Economics.” Not surprisingly, these fallacies pop up again and again.
The latest rendition of the “Fallacy of Production for its Own Sake” is in a Wall Street Journal commentary by Robert Reich, secretary of labor during Bill Clinton’s administration. Lamenting what he sees as an “economic imbalance” between the United States and China, Reich declares:
Its productive capacity keeps soaring, but Chinese consumers are taking home a shrinking proportion of the total economy. Last year, personal consumption in China amounted to only 35% of the Chinese economy; 10 years ago consumption was almost 50%. Capital investment, by contrast, rose to 44% from 35% over the decade.
…the larger explanation for Chinese frugality is that the nation is oriented to production, not consumption. China wants to become the world’s pre-eminent producer nation. It also wants to take the lead in the production of advanced technologies. The U.S. would like to retain the lead, but our economy is oriented to consumption rather than production.
Unfortunately, there’s more:
Deep down inside the cerebral cortex of our national consciousness we assume that the basic purpose of an economy is to provide more opportunities to consume. We grudgingly support government efforts to rebuild our infrastructure. We want our companies to invest in new equipment and technologies but also want them to pay generous dividends. We approve of government investments in basic research and development, but mainly for the purpose of making the nation more secure through advanced military technologies.
Even getting past silly terms like “inside the cerebral cortex or our national consciousness,” this article reflects the utter ignorance that influential Americans have about economics. Reflected in Reich’s article is the same mantra that he and others like him have been spouting for years: The government must direct the economy through subsidies, laws, and taxes to ensure that we engage in more production and less consumption. For example, 25 years ago Lester Thurow claimed that the implementation of a European-style “value-added” tax would “stimulate” more production and would be a “true supply-side policy.”
Now, I don’t have a degree from MIT and am not an economic “elite,” but I do remember something in my studies that said that a tax on producers would push supply curves to the left. A nice way to say it is this: More taxes on production means less production. And this is a “supply-side” economic solution?
Unfortunately, people like Reich see the economy as putty to be manipulated as government officials would like. Do we have “global warming”? Then subsidize the manufacturing of windmills and other high-cost devices to produce electricity or the making of vegetation-based fuels. Despite the fact that subsidies mean that we must use more resources to create fewer goods, lawmakers and their advisers apparently see no irony in this fact.
For example, we hear that by directing production of electricity and fuels, government is “creating green jobs.” While that might be true in that new jobs will have to exist to make these particular goods, nonetheless it is akin to claiming that going back to the horse-and-buggy will “solve” transportation problems.
Adam Smith said it best when he noted that “consumption is the sole end and purpose of all production.” Unlike what Reich claims, an economy cannot be oriented solely toward production or solely toward consumption. One cannot consume unless one produces, and if one produces but those who produce are not permitted to consume, then we see the perverse result of increased production actually making people poorer than they should be.
The United States has not earned its standard of living for many years. Government has been hostile to free markets and common sense. We have lived on virtual handouts from the rest of the world by sending them depreciating dollars, a state of affairs that is going to end soon enough, especially if the government makes it difficult to produce goods in the name of “creating jobs.”
Comment by Monty Pelerin on 25 November 2009:
Nice article. I posted one somewhat related to yours on American Thinker recently. Here it is
November 23, 2009
Why Obamanomics Will Not Improve the Economy
By Monty Pelerin
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
– Friedrich Hayek
The economic programs and policies currently in place are truly astounding. I don’t think I have ever seen a more harmful economic environment for the country. While some of these programs started with Bush, the Obama administration has advanced them to insane levels. Logic, economics, common sense, and history must be defied to believe a recovery is possible in this environment. The nation’s standard of living will be substantially lowered without prompt changes in policy.
To understand why this economy cannot recover under these policies, it is necessary to differentiate between the macroeconomic and microeconomic approach. Arguably, macroeconomics is not economics, but that topic cannot be fully explored today.
Macroeconomics deals with aggregates, statistics, and mathematical models. Macroeconomics purports to describe and explain the behavior of the economy. But economics is not about aggregates; it is about human beings and their behavior. The building block for meaningful economics must be the individual, not some aggregate called Consumption, Investment, or Government. These aggregates are nothing more than the outcomes of millions of individual decisions, summed up and categorized into classifications.
The field of economics that studies the individual is known as microeconomics. This segment of economics deals with the institutional framework and incentive structures that influence human behavior. When faced with a stable microeconomic environment, aggregate individual decisions tend to appear stable over time. Under such conditions, correlation can be found between some aggregates.
A key point to understand is that aggregates do not make decisions; aggregates result from decisions. Aggregates are statistical constructs only. They are often useful to summarize history. However, no causal relationship exists amongst aggregates. The economy cannot be treated as if it were some giant machine, yet the machine analogy forms the basis for macroeconomics. If you “input” more Investment, then the “output” of the machine will increase. If you increase Government spending, it will increase GDP. If you increase the Money Supply then… Such is the world of macroeconomics, which confuses correlation with causality.
Macro advocates implicitly assume causality, an assumption that easily leads to the conclusion that an economy can be centrally managed. Macroeconomic policy “works” only in the sense that a crowing rooster “causes” the sun to rise. Macro policies provide “scientific” cover for politicians to add more power and control to their portfolio. This rationale, and the fact that professing belief in macroeconomics raises the incomes of pseudo-economists, are probably the two primary reasons the macro myth lives on.
The Obama economic program has much to be disliked even when viewed through a macroeconomic prism. Commentary amongst economists is nowhere near consensus: our deficits are too large, we are spending too much, we are not spending enough, more should go to Main Street, banks should be allowed to fail, etc., etc. Even the political allocation of funds has been criticized. Chris Dunn at the Huffington Post states:
According to the most recent data, 98 percent of all U.S. firms have less than 100 employees. These firms are responsible for 98 percent of all new jobs in America and employ 50.2 percent of the private sector workforce. American small businesses are responsible for over 97 percent of all exported goods and generate the majority of innovations that come from the United States.
Not one dollar of the $2.3 trillion in economic stimulus funds will go to the 27 million small businesses where most Americans work. One hundred percent of the stimulus bill funds not destined for states will go to the top 1 percent of U.S. firms. The firms in that top 1 percent have not created one net new job in America since 1977.
Criticism at the microeconomic level has been limited. That results more from the complexity of the field rather than any sense of satisfaction. Microeconomics is not simplistic like macroeconomics. No recognizable model can be developed because microeconomics is too complex. The famous supply-demand cross-diagram might be pointed to as a model, but it is useful merely as a simplistic pedagogical tool, nothing more.
In our “cookbook” world, people and journalists want simple answers even when the situation does not allow for them. Macroeconomics produces simple (often wrong) answers. Microeconomics cannot do so. Microeconomics cannot be captured in a sound bite. Complex analysis of incentives, interactions, prices, expectations, uncertainties, etc. is required. These must be analyzed at the level of the economic decision-maker, and this type of analysis is not easy. Once completed, the results are virtually impossible to communicate in sound-bite terms.
What can be said about the microeconomic effects of current economic policy? Probably the best answer is expressed by the words, reactions, intentions, and deeds of actual decision-makers. Unfortunately, such information is scarce and necessarily anecdotal. Most businessmen don’t usually express their intentions under the best of conditions. It is even rarer for them to do so when they feel targeted by government.
Larger businesses are especially vulnerable to targeting, although many have been co-opted by various government programs. Emerson Electric is an exception. They are a $1.7-billion-dollar company. David Farr, their CEO, commented bravely (and perhaps foolishly) in Bloomberg:
Washington is doing everything in their manpower capability, to destroy U.S. manufacturing,” “Cap and trade, medical reform, labor rules.
I’m not going to hire anybody in the United States. I’m moving. They are doing everything possible to destroy jobs.
We as a company today are putting our best people, our best technology and our best investment in these marketplaces [overseas] to grow,” he said. “My job is to grow that top line, grow my earnings, grow my cash flow and grow my returns to the shareholders. My job is not to shrink and roll over for the U.S. government.
An informative article on businessmen and incentives by C. Edmund Wright appeared in American Thinker. Some of his observations follow:
With the threat of this administration and Congress, what is the possible motivation for anyone with ideas and capital to invest his time, talent, and money into a risky endeavor? There appears to be none. In fact, there appear to be powerful incentives not to invest any time or treasure — thus an economy with almost zero creative inertia.
This is not about tax policy. It is not about health care. It is not about Cap and Trade. While all of those things are terrible and need to be stopped, the dying American dream is in trouble because there is a class of people in Washington now that will relentlessly pursue these and a never ending stream of similarly un-American agenda’s until they are removed from power.
The businessman is under attack, and he/she knows it.
The reason that Obamanomics will not and cannot work is because an economy cannot be managed from the top. Economics is a bottom-up process that depends upon individual incentives. Critical incentives have been diminished or destroyed by recent economic policies. Fear, uncertainty, threats, tax increases, penalties, and violations of the rule of law are but some of the conditions anathema to entrepreneurs, small business, and large business. Businesses will not hire, invest, or expand in a climate of disincentives. No commands from on high can force economic activity. That was a lesson that should have been learned from Eastern Europe and the former USSR.
If these disincentives are left in place, our economy will continue to shrink and our standard of living will continue to diminish. Capital has no nationality, and it will start to flee our shores. Talent will follow. We will not recover from this economic downturn until businesses and individuals have a more favorable incentive structure.
It is unlikely that the Obama administration will reverse course and put in place the structure necessary to foster a recovery.
Monty Pelerin economicnoise.com
43 Comments on “Why Obamanomics Will Not Improve the Economy”
Comment by Jonathan Finegold Catalán on 25 November 2009:
I think what Robert Reich is suggesting is that China will become the prime production center for the entire world. In other words, while China focuses on production, the rest of the world will consume what it produces. I think he is not taking into consideration two important points (one of which you give):
1. Economic growth is driven by capital accumulation, not consumption. Yet, all production is a means to consume.
2. Capital which exists the United States, in the form of U.S. Dollars, eventually comes back through capital markets. Unfortunately, the majority of this capital comes back through the purchase of government securities, and so the capital is squandered on public works projects and other public spending. It’s no wonder that our productivity is going down, while China’s is increasing.
On the other hand, he does bring about a good point (even if he muddles it in the consumption-leaning fallacies he supports): a higher rate of savings in China is leading to higher productivity, and more wealth. In the article he gives examples on how Chinese consumption has increased if you are referring to the amount of goods they can buy (as opposed to actual income spent). Their purchasing power, I think, has been increasing. This allows them to buy slightly more consumer-goods, but at the same time increase their rate of savings. This is the mark of a healthy economy.
Maybe Americans should pull out the notepad, and take some notes.