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Morgan Rose

How to Reduce Unemployment, If We Want

Morgan Rose*

Earlier this month, the U.S. Department of Labor released its latest unemployment report, which showed that across the country there were almost 200,000 fewer jobs in mid-September than there were in mid-August.1 Very few of the household surveys used to calculate that figure were conducted after the September 11 terrorist attacks on the World Trade Center and the Pentagon, so job losses occurring as a direct or indirect result of those events will appear in upcoming months' reports. With some forecasts predicting that the unemployment rate will climb from today's 4.9% to 6% and above in the first half of next year,2 it's worthwhile to use this space to make note of two sure-fire things we could do to lower the unemployment rate if we want.

That italicized phrase represents the main lesson to be made here, namely that economics is fundamentally about trade-offs between different things people want. An individual, community, or nation can almost always get more of something, but only at the cost of something else. We can raise the speed limits on our highways, but we have to be ready to accept more car accidents. For $20, you may be able to pay for three extra layers of cheese on your pizza, but only if you forgo the side order of buffalo wings. Reasonable people can come down on different sides of any given fence, but making a smart, informed decision on any issue means first recognizing what the relevant trade-offs are.

Concerning unemployment, minimum wage laws and unemployment benefits programs are two policies that are designed to benefit workers and those who want to work, respectively. The trade-off here is that both of these policies cause unemployment rates to be higher than they would be otherwise. It's a defensible position to argue that workers should be able to make enough money upon which to survive, or that public money should be used to lend a hand to people who find themselves between jobs. What advocates of those policies should be aware of, and what, as we will see below, economists have known for generations, is that embracing those policies implies embracing some additional people being without jobs.

The trade-off inherent to a minimum wage
 

Mises, a staunch defender of capitalism and critic of socialism, pointed out that Karl Marx also opposed government intervention, including minimum wage laws, in labor markets, although for very different reasons. See paragraph 7 of the Epilogue of Socialism for his explanation.

A minimum wage makes employers less likely to hire someone by setting a lower limit on the amount that employers can pay employees. Some workers will be made better off with a higher wage, but workers whose labor is not considered to be worth as much as the law says they must be paid will find themselves without a job. A straightforward expression of this simple trade-off, written a quarter of a century before the Fair Labor Standards Act of 1938 established the first federally mandated minimum wage in the United States, is found in Part IV, Chapter 21, paragraph 35 of The Theory of Money and Credit (1980, first pub. 1912) by Ludwig von Mises:

If a man cannot sell his labor at the price he would like to get for it, he must lower the price he is asking for it or else he remains unemployed. If the government or labor unions fix wage rates at a higher point than the potential rate of the unhampered labor market and if they enforce their minimum-price decree by compulsion and coercion, a part of those who want to find jobs remain unemployed.

According to Mises, the only effective way to raise real wages is raising the amount of capital per worker used, something which occurs most effectively through the private choices of businesses and investors rather than through the intervention of government or labor unions.

 

For a summary of debates about the effects of minimum wage laws, see The Minimum Wage, a survey article at the Federal Reserve Bank of San Francisco.

Other authors, once establishing the trade-off between jobs and a minimum wage, go on to make explicit those they perceive as the winners or the losers of such a policy. In Book III, Chapter 2, paragraph 48 of The Common Sense of Political Economy (1910), British economist Philip Wicksteed pointed a suspicious finger at "powerful Trade Unions" who had an interest in giving those with jobs a higher wage at the expense of those looking for jobs, while James Buchanan and Richard Wagner, in Chapter 6, paragraph 65 of Democracy in Deficit (1977), remarked that "teenaged minority groups" would be most likely to benefit from a repeal of minimum wage laws.3

The trade-off inherent to unemployment benefits
 

Mises did not regard an unemployment benefits program as true insurance. See Part V, Chapter 34, paragraph 34 of Socialism for his explanation of why, in his words, "Unemployment insurance is definitely a misnomer." For a more extensive discussion of several types of insurance, see Part III, Chapter VIII of Risk, Uncertainty, and Profit (1921) by Frank Knight.

Unemployment benefit plans, such as state-run unemployment programs in the United States, provide people who lose their jobs with income for some specified period of time, or until they find another job. Such benefit plans, also termed unemployment insurance, create a trade-off by encouraging some people to be out of work voluntarily. If you are insured against something bad happening to you, like being unemployed, then you will be less prone to prevent it from happening than you would be without the insurance. A person who knows he is eligible for unemployment benefits is more likely to leave his current job more readily, or once unemployed not search as actively for another job, preferring instead to live on the public's dime a while longer. Mises pointed out in Part V, Chapter 34, paragraph 33 of Socialism (1981, first pub. 1922) that "in the case of unemployment insurance, the condition insured against can never develop unless the insured persons so will. If they... reduced their demands and changed their locations and occupations according to the requirements of the labour market, they could eventually find work." Unemployment benefits alter incentives such that people out of work may not face as much pressure to make the efforts and adjustments necessary to get another job as they would without the cushion provided by the government.

Frederic Bastiat took the idea of unemployment benefits altering incentives several steps further. In Chapter 14, paragraphs 86-90 of Economic Harmonies (1996, first pub. 1851), he warned that the reliance on government, rather than on personal saving or private mutual-aid societies, for such funds would instill dependency on the part of workers. He feared that over time, workers "will become accustomed to considering unemployment benefits, not as something provided by the limited funds that they have accumulated by their own foresight, but as a debt that society owes them." Further, he worried that the government's need to deter people from taking advantage of a benefits program through fraud or laziness would lead inevitably to an expansion of government bureaucracy and intrusion into private lives.

Whether or not the implications of unemployment benefits are ultimately so dire, such a program definitely makes it cheaper for a person to choose unemployment over employment, and when the relative price of something falls, more people are attracted to it.

 

For an organized course reading list of current economics articles on the effects of unemployment insurance (and other social insurance) on employment, see Social Insurance, provided by John Rust in pdf format.

Finally, we have Alfred Marshall, who in Book VI, Chapter XIII, paragraph 59 of his textbook Principles of Economics (1920) explicitly laid out the trade-off inherent under both a minimum wage and an unemployment benefit program:

A scheme [for a minimum wage], that has any claim to be ready for practical adoption, must be based on statistical estimates of the numbers of those who under it would be forced to seek the aid of the State, because their work was not worth the minimum wage; with special reference to the question how many of these might have supported life fairly well if it had been possible to work with nature.

Summing up

While several of the passages cited above reveal a pronounced opposition to minimum wage laws and unemployment benefits, they all make clear that there is an unambiguous trade-off between such government interventions and higher unemployment. An acknowledgment of that fact, that trade-offs exist and they matter regardless of your stance on particular positions, is a requirement for intelligent debate over unemployment or any other economic issue.


Footnotes
1.

Steven Pearlstein, "Economists See Recession Now, and Worse Ahead" Washington Post, 6 October 2001, p. E01.

2.

Ibid.

3.

For a recent study of the employment effects by age, race, and sex of the 1990-1991 minimum wage increase in the United States, see Donald Deere, Kevin M. Murphy, and Finis Welch, "Employment and the 1990-1991 Minimum Wage Hike," American Economic Review, Volume 85, No. 2, Papers and Proceedings of the Hundredth and Seventh Annual Meeting of the American Economic Association, Washington, D.C., January 6-8, 1995. (May, 1995), pp. 232-237. For a survey of theoretic and empirical studies of minimum wage laws, see Brown, Charles, Curtis Gilroy, and Andrew Kohen, "The Effect of the Minimum Wage Law on Employment and Unemployment," Journal of Economic Literature, June 1982, _20_, pp. 487-528 (available online through JSTOR at many university libraries or by subscription).


*Morgan Rose is a Ph.D. candidate in economics at Washington University in St. Louis, with research interests in industrial organization, corporate governance and economic history.

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