Stimulating the Employment Of Labor: Wrong

Greg Mankiw juxtaposes opinion pieces by Paul Krugman and Gary Becker on dealing with the cyclical unemployment problem (aka “how to create jobs”). Becker’s blog post is especially worth reading.

Whatever the political benefits of appearing to stimulate the employment of labor, the economic problem really shouldn’t be stated that way. We do not want to bias the system toward utilization of labor instead of other factors of production. I don’t think the distortions created by cheap credit should be remedied by trying to create further distortions. Most of Krugman’s suggestions are along these distortionary lines.

…the federal government could provide jobs by … providing jobs. It’s time for at least a small-scale version of the New Deal’s Works Progress Administration, one that would offer relatively low-paying (but much better than nothing) public-service employment.

…we can offer businesses direct incentives for employment. It’s probably too late for a job-conserving program, like the highly successful subsidy Germany offered to employers who maintained their work forces. But employers could be encouraged to add workers as the economy expands. The Economic Policy Institute proposes a tax credit for employers who increase their payrolls, which is certainly worth trying.

Tax credits, especially, create all sorts of perverse incentives, as Becker explains. But, if successful, they impart a bias toward labor inputs.

None of these suggestions exhibits the slightest understanding that labor markets need time to readjust. It is as if, for Krugman, some nasty irrational force has it in for labor employment (the “lagging indicator”). Yet entrepreneurs must figure out what the sustainable lines of production will be after a bubble period. All of this is presumably viewed as a minor issue because the major problem is consumers are too afraid to spend (on what?). Anything will do in Krugman’s world.

On the other hand, Becker’s suggestions are more even-handed.

I fully endorse Posner’s suggestions to cut the minimum wage, but I do not see that happening with the present Congress. My favorite approach it to try to stimulate the economy by cutting income taxes, especially corporate income taxes and other taxes on capital, both physical and human capital. Such tax cuts will stimulate investments in the economy, and in this way increase the demand for workers.

They seek to lessen the tax burdens on labor and capital as well as the burden of the minimum wage. In principle, there is little to object to here.

On a related note, the contrast in the two sets of suggestions illustrates the difference between an economist who thinks that the current recession entails an indefinite suspension of the principles of microeconomics (Krugman) and one who is still concerned about incentives at the margin (Becker).

Nevertheless, both economists are, I think, too much in the spell of the Principle of Aggregate Demand.  Aggregate demand theories abstract from concern about the need for readjustments in lines of production after credit-induced unsustainable sectoral expansions.

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