Capital, Deficits, and Full Employment; W. Hawkins

ened the impact of job loss and may have contributed to the unemploy ment figures by allowing those out of work to pursue new job opportu nities with less vigor. In any event, the recession of 1980-82 did not see a return of breadlines and tent cities. Yet, unemployment is still a trag edy in both economic and human terms. In economic terms, unem ployment means lost production and a lower material standard of living. In human terms it means not just lost income but the severance of a social bond forged in the workplace community and the loss of self-es teem. Those who are forced to live on charity or see their dreams of ad vancement destroyed by lack of op portunity suffer a loss to the spirit. A worker who loses his job for no direct fault of his own is fundamen tally different from the idler who out of laziness or other defect becomes a permanent member of the welfare 175 176 THE FREEMAN March underclass. A society which values the work ethic needs to be concerned with unemployment.

There are two components of the high jobless rate. First is the cyclical unemployment resulting from the recession. When the unemployment rate reached 10.4 per cent in Octo ber 1982, about three per cent was due to the recession, amounting to approximately 3.4 million workers. The second cause is the secular de cline of key sectors of the American industrial base such as autos, steel, shipbuilding, and textiles. This con tributed about 2.5 per cent to the rate or about 2.7 million jobs. Thus, solv ing the unemployment problem will take more than just recovering from the recession.! KeynesianPhilosophy The dominant economic philoso phy for the last 45 years has been Keynesianism. It won its claim to the position of "orthodoxy" because it professed to have the answer to unemployment. It was born in 1936 when J.M. Keynes published The General Theory of Employment, In terest and Money. The United States was in the midst of the Great Depression and it was thought that older theories of the economy had failed. Keynes' timing was perfect to fill the perceived intellectual vacuum.

Keynesian theory has long held sway among liberals, however, not because of any inherent truth in the Keynesian model but because it ap peared to give objective "scientific" support to redistribution schemes originally favored for ideological reasons. One of the central tenets of Keynes was that depressions are caused by too much saving relative to planned investment. Though he felt that investment was the key to prosperity and growth, in the black mood of the 1930s he felt that in vestment opportunities in the pri vate sector were played out. There fore, saving no longer served a useful economic function. In fact, saving was now a detriment, a drag on the econ omy because it would not be con verted into investment spending. Saving should therefore be con verted into spending by the govern ment either by taxing it away from private hands or by borrowing it away to finance budget deficits.

Public works and welfare could be promoted on the grounds that the entire economy benefited, a cam paign that was calculated to entice far more support than a direct ap peal to redistribution or socialism. That there was a wider political con sequence to his theory than pure economics was not lost on Keynes. At the end of The General Theory he wrote: Thus our argument leads towards the conclusion that in contemporary condi tions the growth of wealth so far from being dependent on abstinence of the rich, 1983 CAPITAL, DEFICITS AND FULL EMPLOYMENT 177 as is commonly supposed, is more likely to be impeded by it. One of the chief so cial justifications of great inequality of wealth is, therefore, removed. 2 However, it became clear by the dawn of the 1970s that the Keyne sian description of the economy did not fit reality. The United States economy was not being dragged into stagnation because it was generat ing too much capital. Just the oppo site. Americans were saving a smaller percentage of their incomes than were the populations of any other industrial country and even a smaller share than many nations of the Third World. Capital shortages, rising interest rates and lagging productivity became major concerns.

Liberals quickly disparaged such concerns as "trickle-down" econom ics. Yet, the so-called "trickle-down" system is the very foundation of all modern economic systems. And the results have not been a trickle but a raging flood that has given even those at the very bottom of the eco nomic ladder access to luxuries de nied to even the most powerful aristocrats of the past. The IndustrialRevolution Perhaps when the leaders of the seven largest industrial democra cies met at Louis XIV's palace at Versailles last summer, it occurred to at least some of them that when the Sun King resided at Versailles, he had no electricity, central heating or air conditioning, no flush toi lets, telephones or television. And they might have contrasted their ar rival by airliner and limousine with Louis' long and painful trips by horse drawn carriage over dirt roads. The reign of Louis XIV occurred near the end of the pre-industrial era.

Only 61 years after Louis' death in 1715, Adam Smith published The Wealth ofNations. In fact, the death of the French Monarch and the birth of the Scottish philosopher were sep arated by only eight years. In the classical tradition which Smith be gan, capital played the central role: Wherever capital predominates, in dustry prevails.... Every increase or diminution of capital, therefore, natu rally tends to increase or diminish the real quantity of industry, the number of productive hands, and, consequently ... the real wealth and revenue of all its inhabitants. Capitals are increased by parsimony, and diminished by prodigality and misconduct. 3 Keynes may have temporarily van quished this idea in academic circles but he could not vanquish the chain of cause and effect which it stated. Smith was not forming abstract the ory, but observing human actions. It offends the egalitarian notions of many to accept that economies al ways advance from the top down, yet it defies logic to believe that growth can be based solely on poverty and consumption. A natural hierarchy 178 THE FREEMAN March develops, where it can, of those who can invent and apply new devices and those whose talents lie in business, efficiently allocating resources (wealth/capital) in ways which en rich society as well as themselves.

This hierarchy is not the static, class bound structure of the feudal aris tocracy, but one in which a broad spectrum of the population can take part. As Ludwig von Mises argued: One further observation must still be made about this matter of savings and capital formation. The improvement of well-being brought about by capitalism made it possible for the common man to save and thus to become a capitalist him self in a modest way. A considerable part of the capital working in American busi ness is the counterpart of the savings of the mass~s. 4 The development of capital markets, joint-stock companies and corpora tions, banks and other financial in termediaries provided the institu tional framework for mobilizing the savings of the masses for productive use. Prior to the wedding of capital and technology which spawned the In dustrial Revolution, even the rich were limited by the, fact that their wealth could only purchase the ser vices of human or animal labor. La bor is a vital factor of production, but for the thousands of years when labor was essentially all mankind had to work with, it was not enough to raise the general 'standard of living much above subsistence. It was only with the rise of capitalism, both in the sense of physical capital in machinery, factories and power plants and also in financial.capital to s"UPport the implementation of technology, that modern industry was possible and men were able to raise their sights so that no goal has seemed beyond reach.

Yetcapital, like all economic re sources, is finite. Though it may be increased over time, at any particu lar point in time it is scarce relative to all the possible uses for it. What makes Keynesianism so heretical to sound economics is its denial of cap ital as a scarce resource and its un concern for capital development and its productive allocation. And the principal offender in the Keynesian doctrine' is the budget deficit. When the government at any level runs a budget deficit, it must go into the capital market to finance it. This is the same capital market repre senting the same pool of savings that business and consumers depend on to finance their activities. The in crease in demand for fundsemanat ing from the government pushes up the price of capital, that is, interest rates. Some private borrowers find these higher rates a deterrent to borrowing. For business, some in vestment projects no longer yield· a return high enough to cover the in creased interest rates. These proj ects are canceled. For consumers, 1983 CAPITAL, DEFICITS AND FULL EMPLOYMENT 179 buying a new house or even an au tomobile is no longer feasible. Pri vate economic activity thus slows down, production declines and some workers lose their jobs.

Years of Malinvestment Over time, the diversion of capital from productive private use to non productive government programs results in deterioration of the very structure of the economy. The fed eral government has run a deficit every year since 1969, which means capital withdrawn from the private sector is never replaced by repay ment of the debt. In 1969, Federal debt held by private investors in the United States was $222.8 billion. At the end of the second quarter of 1982 this figure had grown to $736.9 bil lion, indicating that the government had absorbed $514.1 billion in capi tal during the intervening years. 5 The sum would have been even higher had not foreign investors purchased $129.5 billion in United States Federal debt during the same period. But since some of this for eign capital would have been in vested in industry in the United States had it not gone into govern ment debt, this is also a loss to the economy.

With future budget deficits ex pected to run over $100 billion per year, the fear is that the govern ment will divert between one-third and one-half of all the available capital to the national debt between 1982 and 1985 unless major changes in government expenditure policy are undertaken. However, as important as it is to balance the budget, it is also important that the deficit be eliminated in the right way. Raising taxes will do as much harm as good. Postponing the third installment of the tax cuts voted in 1981 and scheduled for 1983 will close off a potential increase in capital forma tion just as it is about to produce results. The first two installments of the tax cuts, with their reduction in taxation and their increased incen tives for saving, have produced real, though modest, results. In 1980, Americans were saving only 5.5 per cent of their incomes, but by the end of the third quarter of 1982 this had increased to 8.8 per cent. The com pletion of the program might just be enough to boost the United States savings rate into the lower end of the rates enjoyed by the rest of the industrial countries (which range from 10 per cent for Canada to 30 per cent for Japan on average.) Attempts to raise taxes in other areas will also be counterproduc tive. The impact of taxes on business earnings or returns from invest ment are obviously harmful. In creasing taxes to bail out the nearly insolvent Social Security system would also syphon funds out of the private sector. The Social Security system, unlike private pension plans, 180 THE FREEMAN March does not convert premiums into in vestments. Instead the system pays out its benefits from current reve nue. This simply makes Social Se curity another mechanism for con verting capital into consumption.

Cut Spending The only method of reducing the deficit which will yield the benefits of economic growth and job creation is to cut spending. How much should be cut? An estimated budget deficit of $115 billion for fiscal 1983 does not require a spending cut of that same magnitude. An economic re covery will close much of the deficit automatically by expanding the tax base. What is needed is a spending cut to reduce that part of the deficit in excess of this amount so that re covery can proceed in a timely fash ion. Cutting $30 billion from cur rently planned expenditures should be sufficient, though additional cuts in 1984 might be necessary if the deficit fails to close fast enough dur ing the recovery to prevent another spiral upward in interest rates. Interest rates will be an indicator during the recovery of the balance between private and public demand for borrowed funds. As the recovery progresses, private borrowing, par ticularly by business will increase.

If government borrowing does not decline at the same pace or faster, interest rates will move upward and could choke off the recovery. Balancing the budget during the economic recovery will eliminate that part of unemployment which is due to the recession. That part of unem ployment which is due to the decline ofAmerican industry will take longer to correct. American industry did not deteriorate overnight and it will not be rebuilt overnight. The economy is faced with a productivity crisis of the first magnitude. This is most appar ent in those sectors where foreign competition has advanced into formerly American markets displac ing not only American-made prod ucts but also the workers who man ufacture them. However, the decline of productivity is an economy-wide phenomenon. The consequence may not always show up in layoffs, it may work in ways which are "invisible" such as fewer new jobs created or lower real wages for those who hold jobs. Whichever way the results are felt, it is the workers who suffer.

We know from the research of growth specialists like Frederick W. Taylor and Simon Kuznets and from observing contemporary systems like that of Japan, that productivity can be multiplied, perhaps indefinitely. But the method for achieving this is not to make workers work "harder" as some would have it, but to enable workers to work "smarter" by pro viding them better tools and orga nization. As Peter F. Drucker has argued, it is not the individual worker who is productive in the 1983 CAPITAL, DEFICITS AND FULL EMPLOYMENT 181 modern economy, it is the industrial system which is productive. It is by combining labor and capital in har mony that productivity is found. When unemployment exists it means that this harmony has been dis rupted. Labor is available, but its partner capital is not. Capital is the future. It is the provi sion for the risks, the uncertainties, the changes and the jobs of tomorrow .... An economy that does not form enough cap ital to cover its future costs is an econ omy that condemns itself to decline and continuing crisis, the cris~s of stagflation. 6 If this longterm problem of pro ductivity and jobs is to be solved, there must be a longrun commit ment to limiting the adverse effects of government spending on the economy. Fiscal policy must not only encourage capital formation (pri marily by ceasing to place obstacles in its path) but must cease to divert the capital so formed into nonpro ductive programs. For if the capital is available and the tax and regula tory environments are conducive to entreprenuerial activity, then the process of reindustrialization will bear fruit. In fact, entire new indus tries based on computer and other high technology processes are in the offing provided that American busi ness is in a position to act. It would be a tragedy of the first order if these new opportunities are missed be cause reforms in government policy were not implemented.

A Time for Change The advent of massive deficits in the 1970s followed by economic stagnation and persistent high un employment have created the con ditions for both intellectual and pol icy changes. The advocates of fiscal responsibility, limited government and capital formation have made headway but have not yet fully seized the moment. As the November elections re vealed, the unemployed are still the prey of those who champion larger government expenditures and debt. This must change. As the chief be neficiaries of expanded capital in vestment, the unemployed should become the natural allies of the movement to balance the Federal budget. , -FOOTNOTES1Even when the economy is operating at what is considered to be full employment, the unem ployment rate is about five percent due to peo ple being temporarily, and voluntarily, between jobs. 2John Maynard Keynes, The General Theory ofEmployment, Interest and Money (Harcourt, Brace & Co., 1936) p. 373.

3Adam Smith, The Wealth of Nations (Mod ern Library, 1937) pp. 320-21. 4Ludwig von Mises, "Wages, Unemployment and Inflation," Planning for Freedom (Libertar ian Press, 1974) p. 160. 5Monetary Trends (Federal Reserve Bank of St. Louis) September 23, 1982, p. 13. 6Peter F. Drucker, "Towards the Next Eco nomics," The Crisis in Economic Theory, Daniel Bell and Irving Kristol, editors (Basic Books, 1981) p. 11.