Wednesday, 24 April 2013


Via Scott Sumner's now famous blog (The Money Illusion, permalink on the side), I read the following post by Bryan Caplan: 

And it confirmed everything I thought about free-market economists! They're cruel, evil sadists (and they smell)! Caplan describing his fellow free-marketeers:

"They cavalierly deny the reality of involuntary unemployment, and callously belittle the suffering of the unemployed".

More seriously, Caplan offers an interesting and worthwhile post on why unemployment might remain high despite the unemployed willing to work for lower pay. The problem is that I disagree with a lot of his economic reasoning but even more so with his proposed solutions to our unemployment issues.

For example, Caplan references one of his article explaining that nominal wages rigidity are strong and durable. I've given my views on sticky wages before and I don't think Caplan's arguments are cause for me to change them because what he describes as 'nominal wage rigidity' is really an institutional reluctance from the employers to recruiting people at their re-set lower salary demands... 

Personally, I would still suspect that the real issue is that employers aren't all that interested in hiring at whatever price but, regardless, the point is that I think it is wrong to call employers' reluctance to recruit new employees at lower wages "nominal wage rigidity". The unemployed are doing what they are supposed to do - lowering their reservation price - and it's not working out the way the law of Supply and Demand says it's supposed to work out...

Where I get rather totally frustrated, though, is that, after having accepted the seriousness of unemployment and its involuntary nature (already a big step for a free-market economist), Caplan starts proposing free-market solutions to unemployment.

And, oh boy!

"Instead of downplaying the grave evil of unemployment, we free-market economists should urge governments to redouble their efforts to fight it.  How can we do so and remain free-market economists?  First and foremost, by emphasizing the obvious: Every government imposes a vast array of employment-destroying regulations.  Minimum wages.  Licensing laws.  Pro-union laws.  Mandated benefits - especially mandated health insurance.  Anyone who appreciates the grave evil of unemployment should (...) vigorously reject the cavalier, callous view that a heavy-duty safety net is a good substitute for a job.

At this point, good Keynesians will object, "(...) what about old-fashioned Aggregate Demand policies?"  There's no reason for free-market economists to fear this question.  Tax cuts - especially tax cuts on employers - increase Aggregate Demand and employment, and they're as free-market as Frederic Bastiat.  

Isn't monetary policy is a far more effective and sustainable way to boost Aggregate Demand?  Sure. Given the existence of a central bank, though, it's hard to see why free-market economists should run away from this conclusion.  How is Nominal GDP targeting any less free-market than constant growth in M2, or a frozen monetary base, or short-run interest-rate targeting?  If, as seems highly likely, Scott Sumner is right to blame the Great Recession on central banks' tight monetary policies, free-market economists should not be afraid to honor him".

Let's review this by chunks.

On Employment-destroying regulations: I am happy to review any and all regulations on employment. I too have doubts about minimum wage laws even if, trying to analyse the data, they seem to be doing very little ill and actually quite a bit of good. Licensing laws seem clearly designed to protect existing businesses from competition. They probably go too far when local businesses have to vote on whether to allow a newcomer to open shop. I mean, who's local trader is going to vote for more competition? But I seriously doubt that removing safety rules and regulations is a good idea. And, while a heavy-duty safety net is NOT a good substitute for a job, we must also face the reality that, one, it's better than starving or homelessness and, two, there may not be enough jobs for everyone.

On AD boosting policy: Cutting taxes. On Companies. Again. Of course. To be fair, I am actually in favour of getting rid of payroll taxes. My general point of view is that it is stupid to make Labour more expensive than necessary. On the other hand, I doubt that Caplan would like my way of making up the lost tax revenue - I would do so by taxing either corporate revenues or profits higher. I would prefer Caplan suggested cutting taxes on the middle class. And making up for the lost tax revenue by taxing the very high earners. But, of course, that's not free-market...

On Monetary Policy: I will have to re-do a post on monetary policy soon but my main reply to Caplan would be that, no, contrary to what Scott Sumner is claiming at the top of his lungs, monetary policy is NOT more efficient than fiscal policy, merely more politically feasible (at least in the USA. In Europe, neither seem to be politically do-able). The latest quarterly review from Hoisington Investment makes that case very clearly: "Not only does the Fed not control money but it cannot determine velocity either" and "[t]wo flaws exist in the belief that the Fed can create rising aggregate demand. First, they do not directly control M2. Second, velocity is almost entirely outside their control".

Conclusion: I am glad that a free-market economist like Caplan admits to the ugliness of unemployment and also admits that there are real-world effects, ill-described by neo-classical economy, that prevents 'market-clearing' and thus unemployment is indeed involuntary. That you still have to argue that unemployment or under-employment is involuntary in this day and age is a damn shame but hey.

However, his 'solutions' are all supply-sided. If I and others are right that people don't consume because they can't (tapped out due to low or negative wage growth and  exhausted borrowing capacity) and firms don't increase their investments both in capital and labour because they don't see any potential revenue growth, none of these solutions, regardless of their individual merits, will actually work to reduce unemployment.


  1. If you have not done so already, a post on how the greatest growth in Europe and the USA during the 19th century came at the end of said century when all countries save Britain had higher tariffs (e.g., the USA had Yankee interests protected by tariff, and yet grew mightily, as did Germany, see , despite German increases in tariffs). Only the UK had lower tariffs, though I've seen some data indicating this was only for corn (wheat).

    In short, like the paradox "high taxes do not necessarily inhibit growth" so too the paradox that lack of free trade does not, within reason, inhibit commercial trade nor prosperity.

    1. I'll have to read the paper first but I do find the 19C a very interesting and somewhat neglected period for economic analysis.

      I mean, we study it vaguely when we learn about the Classics (Smith, Ricardo, Marx etc) but, practically, economists tend to concentrate on post-WWII (better data, I guess).

      And, yes, I have meant to be doing a blog-post on trade and immigration but my thinking is still a bit hazy on these subjects. I got 'hunches' but I'd like to read more about the issues before I start opening my mouth... :)

  2. There are other transmission mechanisms for monetary policy. As the Fed purchases more and more Treasury debt, it can monetize the debt lowering the amount of taxes which need to be collected to pay it off. Lowered taxes without corresponding lowered spending or deficits will cause inflation. Sooner or later, massive QE will eventually debase the currency.

    1. The 'same spending at a lower given tax rate' is certainly an interesting point - and logical. I am just noting that QE, so far, may have kept the USA from going over the cliff but not much more. It suggests a lack of traction.

      As to your second point, I disagree with the 'will cause inflation' in the sense that there is no risk of crowding out private investments or gun & butter inflation at present but, all the same, I too am not comfortable with the debasing of the currency, if only in comparison with other currencies...

      Basically, QE seems relatively inefficient right now and no one knows for dead certain sure the longer term effects of it. The Fed seems utterly convinced they could withdraw the liquidity in a hurry if needed. I am less confident. 'Why risk it?' would be my personal conclusion...