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FALLACY 15 OF FINANCIAL FUNDAMENTALISM
William Vickrey, 1996 Nobel Award in Economics

October 5, 1996

Unemployment is not due to lack of effective demand, reducible by demand-increasing deficits, but is "structural," resulting from a mismatch between the skills of the unemployed and the requirements of jobs, or is "regulatory," resulting from minimum wage laws, restrictions on the employment of classes of individuals in certain occupations, requirements for medical coverage, or burdensome dismissal constraints, or is "voluntary," in part the result of excessively generous and poorly designed social insurance and relief provisions.

Current situation: To anyone acquainted with labor market conditions, it is abundantly apparent that a large proportion of those currently officially registered as unemployed, as well as large numbers who are not, are ready and able to take most, if not all, of the kinds of jobs that would be opened up by an increase in market demand. In the absence of such an increase, at current levels of unemployment, attempts to move selected unemployed individuals or groups into jobs by training, instruction in job search techniques, threats of benefit withdrawal or denial, and the like, merely move the selected individuals to the head of the queue without reducing the length of the queue. Merely because any one traveler can secure a seat on a flight by getting to the airport sufficiently early does not mean that if everyone gets to the airport sufficiently early 200 passengers can get on a flight with seats for 150.

Even if jobs are specifically created for selected clients, as by facilitating the opening of a new shop or business, while there may be a temporary stimulus to the economy from whatever capital investment is involved, ultimately in many cases this will merely draw purchasing power from other establishments, resulting in reduced sales, reduced capital value, and eventually reduced employment elsewhere. Only if some element of novelty tempts consumers to spend additional amounts, impinging on their planned savings, or if "workfare" involves producing a free public good or service enhancement that does not compete for purchasing power or replace other public employment, will there be any net reduction in unemployment. But while such public works programs can indeed convert unemployed labor into improved public amenities and facilities of various types, as long as they are financed on the basis of an unchanged deficit, any further impact on the economy as a whole will be limited to the difference between the spending rate of those deriving income from the program and the spending rate of those paying the taxes to finance it.

Aside from such a public works program, the result of attempts to push people into jobs is simply a vast game of musical chairs in which local agencies instruct their clients in the art of rapid sitting, with "workfare" curmudgeons threatening to confiscate the crutches of the unsuccessful, while Washington is busy removing the chairs by deficit slashing.
As for "voluntary" unemployment, much of this would disappear as demand and activity increases, and overqualified workers move up out of low-skill jobs into the expanding demand for higher skills, leaving more openings for low-skilled unemployed to fill, and removing the depressing effect of high unemployment levels on low-skill wages. Wages for low-skill but necessary jobs would tend to increase, raising them sufficiently above the safety-net level to mitigate the adverse incentives of the welfare state. Higher wages would raise the prices of low-skill products, increasing the measured "productivity" of such jobs and diminishing the stigma attached to them as "low-productivity" or "dead-end" jobs. Prices of high-skill products may fall to offset this, possibly as a result of technological advance or economies of scale, but if not there may be a small one-shot increase in the cost of living. This would still be a small price to pay for the benefits of full employment. It should not be assumed that this is the beginning of an inflationary spiral.

To be sure, there are horror stories of individuals who quite rationally decline employment because of the combined impact of the resulting reductions in various means-tested welfare benefits, increases in taxes and social security contributions, and travel, child care, and other costs associated with employment. To a considerable extent this is the result of designing a variety of welfare and income-dependent programs independently of each other without regard to interactions and combined effects. As each means-tested program is set up separately, the benefits tend to be phased out or capped in ways designed to keep the direct costs attributed to the particular program or measure down. These phase-outs and caps may seem quite reasonable when considered separately, but when several of them happen to overlap the combined results create absurdly high effective marginal "tax" rates. Slower phase-outs are called for, even if this increases the budgeted cost of the programs.

In many cases there is no overall justification for any phase-out. In the case of the earned income credit, for example, eliminating the phase-out and recouping the revenue by increases in marginal rates on upper income brackets would result in a smoother pattern of effective marginal rates with smaller overall disincentive effects and a considerable simplification of tax forms and reduction in compliance costs. The existing law seems to have arisen because the earned income credit was enacted as a patch on the preexisting law, subject to a taboo against raising nominal marginal rates, while the raising of effective marginal rates by the phase-out could get by. Political posturing and the arcane mechanics of the legislative process prevented a rational examination of the tax structure as a whole.

Ready availability of jobs at respectable wages would make it easier to deny benefits to those unduly finicky about the type of employment they will accept, and reduce the need for severance pay and other forms of featherbedding. Real full employment would also reduce the pressure for protectionism, resistance to the abandonment of redundant military installations and other obsolete activities, and make job security generally less of an issue. Real full employment would also encourage employers to compete in arranging work schedules and workplace arrangements to accommodate those with family obligations or other constraints, and otherwise pay more attention to improvement of working conditions. There will be less need for minimum-wage laws and other government regulation of working conditions, and less difficulty in the enforcement of those that there are.