President Clinton says he hopes to jump start the United States economy to alleviate lingering unemployment and raise the sluggish growth raze. But what are the prospects that moderately aggressive government policies can significantly improve the economy? Indeed, does the economy even need to be jump-started?
Mr. Clinton has mentioned a S20 billion annual program of public works, mainly infrastructure spending, as a key component of his economic program. But historically, government attempts to eliminate unemployment through fiscal policy measures have met with very little success.
Public works spending to alleviate unemployment was a hallmark of the depression-fighting strategy of Presidents Herbert Hoover and Franklin Roosevelt. But five years after Mr. Roosevelt launched his New Deal with such infrastructure-creating agencies as the Works Progress Administration and the Tennessee Valley Authority, the nations unemployment rate still exceeded 19 percent.
More recently, similar programs in the 1970s were accompanied by higher, not lower, rates of unemployment than had prevailed for the previous three decades.
Two factors that serve to make public works spending ineffective in dealing with unemployment are timing and crowding out.
Typically, years pass between the time decisions are made to build new highways, schools, or sewage systems and the time work actually begins. This is especially true with todays myriad of environmental, affirmative-action, and other regulations, not to mention the time it takes Congress to act.
Moreover, the financing of new federal spending requires taxes that directly reduce private
borrowing that will raise interest rates, also reducing private-sector activity.
Our research also shows that unemployment grows when the price of labor rises for employers. If what we term the adjusted real wage (wages adjusted for changing prices and productivity) rises, unemployment will increase.
So is it wise even to attempt to jump-start the economy? The recent recession arose when the adjusted real wage increased, caused by erratic price changes and wage demands and by government policies pushing up wages, including a higher federal minimum wage.
For the past year, however, the adjusted real wage has been falling. Money wage increases have moderated, being offset by inflation. Increases in labor productivity have lowered labor costs per dollar of output, enhancing profits and making it profitable to hire new workers.
Unemployment changes lag behind changes in the adjusted real wage, and on the basis of the wage change in recent months we can predict what should happen to the unemployment rate - independent of any government policy response.
We estimate that the unemployment rate will fall to about 6.5 percent by early next summer
- about half way back from the peak raze of 7.8 percent in May to the prerecession level of about 5.3 percent. Moreover, preliminary indications are that the rate should continue to fall further.
Historically, the evidence shows that government interference in markets often aggravates downturns and slows upturns.
For instance, during the Depression, both Hoover and Roosevelt favored high wage policies to maintain purchasing power. Their wage policies needlessly lengthened the Great Depression.
Similarly, erratic changes in monetary policy are likely to be destabilizing, as abrupt shifts in the rate of inflation in both the early 1920s and the beginning of the 1980s demonstrate.
In the long term, it is impossible to both create jobs and raise living standards without increasing labor productivity Clinton seems to be aware of this, and should favor changes that can have some positive impact.
Reforming our inefficient and monopolistic system of educational delivery in the public schools should help in the creation of human capital, and revising our archaic system of taxing physical capital is a must. The effective tax rate on capital gains sometimes exceeds 100 percent (because of taxing of fictitious gains created by inflation).
Presidents and George Bush is an excellent example often succumb to planning policies from a short-term perspective dictated by the quadrennial necessity of running for reelection. While presidential job security considerations cannot be ignored, a visionary leader can achieve a revered place in history by addressing long-term needs.
Clinton needs to address a problem that dwarfs the budget and trade deficits, the crime problem, and the malaise of our cities. The president-elect must address the threat to our economic comfort, living standards, and job opportunities posed by the virtual lack of productivity growth over the past two decades.
In doing so, however, Clinton should learn the lessons of economics and history, namely that markets usually do a better job of allocating resources than well-intentioned but cumbersome government bureaucracies.
CAN TEACHERS OWN THEIR OWN SCHOOLS?: New Strategies for Educational Excellence
In Can Teachers Own Their Own Schools?, Richard Vedder examines the economics, history, and politics of education and argues that public schools should be privatized. Privatized public schools would benefit from competition, market discipline, and the incentives essential to produce cost-effective, educational quality, and attract the additional funding and expertise needed to revolutionize school systems.