Free-Market Economists vs Unemployment

Bryan Caplan wrote:Free-market economists rarely declare, "We have to do X about unemployment." Why not? Free-market economists' standard reply is just, "We expect X to fail." Their critics, however, have a less favorable explanation: Free-market economists oppose X because free-market economists are cavalier and callous. They cavalierly deny the reality of involuntary unemployment, and callously belittle the suffering of the unemployed.

I know hundreds of free-market economists. They're friends of mine. Indeed, I'm a free-market economist myself. It saddens me to say, then, that our critics are often right. While some free-market economists merely doubt the efficacy of policies intended to alleviate unemployment, the average free-market economist doesn't take the unemployment problem seriously.

Why not? At the level of high theory, free-market economists love market-clearing models. If there's surplus wheat, the price of wheat will fall to clear the market. If there's surplus labor, similarly, the wage will fall to eliminate unemployment. What about nominal wage rigidity? Most free-market economists concede that nominal wage rigidity exists to some degree, but think the problem is mild and short-lived: "It's been three years. The labor market must have fully adjusted by now."

High theory aside, though, free-market economists have a toolbox of quips they use to belittle the problem of unemployment.

There's the argument from the safety net: "Why would anyone want to go back to work when he can collect 99 weeks of unemployment insurance?"

There's the argument from relocation: "There are plenty of jobs in North Dakota. Anyone who refuses to move there is therefore voluntarily unemployed."

There's the argument from worker hubris: "If he's an 'unemployed carpenter,' then I'm an 'unemployed astronaut.'"

There's the argument from Zero Marginal Product: "If the guy can't find a job, his labor must be worthless."

I'd be delighted if my fellow free-market economists' high theory and belittling quips were entirely correct. But they aren't. The high theory's wrong: Nominal wage rigidity is both strong and durable. And the quips are far less insightful than they sound. Yes, unemployment insurance discourages job search; but this hardly means that most unemployed people affirmatively prefer the dole to a job. Yes, the unemployed could move to North Dakota; but in a market-clearing model of the labor market, workers wouldn't have to flee their state to sell their skills. Yes, some workers overestimate their own abilities; but the typical unemployed carpenter is competent in his craft. Yes, many workers have low marginal products; but almost no one has a marginal product of zero.

Once you admit the severity and durability of nominal rigidities, it's hard to avoid the conclusion that much unemployment is involuntary. And once you admit that much unemployment is involuntary, it's hard to avoid the conclusion that unemployment is a serious problem. In terms of standard cost-benefit analysis, nominal rigidities have the same effects as price floors. Society loses the difference between each involuntarily unemployed worker's marginal product and his reservation wage.

Yet on further reflection, simple cost-benefit analysis grossly understates the horrors of unemployment. We should also consider the effect of unemployment on happiness. When workers don't get a raise, they're often disappointed or angry. But when workers lose their jobs, they literally weep. For most of us, a job isn't only a paycheck. A job also provides a sense of identity, purpose, and community. Happiness research strongly supports this fact, but introspection should suffice. Think about the shame and despair you'd feel if you were suddenly unable to support your children.

Free-market economists should be especially dismayed by the cultural and political effects of unemployment. When every able-bodied worker can easily find a place to sell his skills, the economy reveals a clear connection between moral desert and practical success. You can fairly dismiss many complaints about capitalism by harumphing, "Get a job!" Workers can proudly tell statist activists and intellectuals, "I don't need your charity. I can take care of myself just fine." Once people lose their confidence that every able-bodied person can easily take care of himself, this individualist ethos withers - and the welfare state grows like a weed.

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 bitterly oppose these regulations - and vigorously reject the cavalier, callous view that a heavy-duty safety net is a good substitute for a job. Government regulation is hardly the sole cause of nominal wage rigidity, but it definitely makes a bad situation worse.

At this point, good Keynesians will object, "Asking government to stop exacerbating nominal wage rigidity is a fine start. But 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. Imagine how much statist legislation could have been averted if the world's central banks had kept NGDP on a steady course from 2008 to the present.

I'm proud to call myself a free-market economist. But free-market economics can and should improve. Our cavalier and callous attitudes about unemployment are deeply misguided. Free-market economists should eagerly share their insights on how to alleviate the grave evil of unemployment instead of putting their heads in the sand and calling idle misery "optimal."

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. Imagine how much statist legislation could have been averted if the world's central banks had kept NGDP on a steady course from 2008 to the present.

BarrileteCosmico wrote:On the subject I read an article a few weeks back summarizing a study that concluded that unemployment creates about 3 times more misery than inflation, which makes you wonder why so many central banks only have an inflation target with no consideration for unemployment or output.