The Unemployment Act of 1946; J. Semmens and D. Kresich

Much of this spending has been for the express purpose of stimulating the economy. The rationale behind government stimulation is the presumed need to maintain aggregate de mand and avoid recessions or depressions. During the Great Depression of the 1930s, John Maynard Keynes concocted a "cure" for depressed business conditions. This "cure" in volved deficit spending and debt monetization (i.e., inflating the money supply) as a means of generating adequate aggregate demand, while surreptitiously reducing the real prices of idle inputs, especially labor. The "cure" was de signed to inject money into the spending stream at a time when entrepreneurial timidity and nominal price rigidity combined to produce high unemployment. The Keynesian "cure" was a radical depar ture from the classical approach to business re cessions, which relied upon free-market price adjustments to reallocate resources and thus re verse the economic decline. This approach had always worked in previous depressions, yet seemed to be ineffective during the early years of the Great Depression. The reason for this ap parent failure is not hard to find: Government interventions eliminated any semblance of free market pricing. These interventions included (1) high tariffs to "protect" American jobs, (2) manipulation of the money supply-first inJohn Semmens is an economist and Dianne Kresich is a research associate for the Laissez Faire Institute, a free market research organization headquartered at 1202 West Malibu Drive, Tempe, AZ 85282.

flating, then contracting the quantity of money, (3) tax increases to fund expanded government programs, and (4) price and wage "fixing" via the National Recovery Administration. Given these interferences, it should not have been sur prising that the economy was having difficulty righting itself. The Keynesian approach to this politically engineered economic impasse was to seek downward price flexibility in real terms by de basing the monetary unit. Thus, even though nominal prices and wages would remain high, real prices and wages would be reduced via in flation. To assure that the newly created money would get into the economic flow, the govern ment itself undertook to spend it. That much of this newly created money was wasted on non productive activities was irrelevant to the Keynesian program, since it was only supposed to be a short-term remedy. The episodes of fiscal deficit and monetization of debt were to be offset by balancing fiscal surpluses and monetary restraint during periods of prosperity.

In this way, economic policymakers suppos edly could act to counter the excesses of the business cycle and achieve stable growth. The latter half of the 1930s saw a heavy dose of deficit spending and debt monetization without the attainment of stable economic growth. World ~ar II injected the motive of patriotism to spur economic output of war goods. The ills of the economy were sub merged in the effort to win the war. As the war drew to a close, though, the fear of a return to depressed business conditions dominated the economic policy debate.

Support for the Employment Act of 1946 was generated by those sympathetic with more government control of the economy. Henry Wallace, Vice President under Franklin Roose velt in the 1941-45 term, vigorously backed legislation committing the government to a more active role in the economy in order to achieve full employment. As Wallace saw it, the high unemployment of the 1930s was the result of the "planlessness" of the U. S. economy.1 The New Republic gave editorial support citing, with great admiration, the So viet Union's constitutional guarantee of a job for every citizen.2 While the more mainstream members of Congress did not necessarily buy the entire case for the planned or socialized economy, they did enact the Employment Bill. Falsely blaming laissez faire for the Great Depression, this law made the federal government responsible for creating and maintaining the conditions for full employment. It established the President's Council of Economic Advisers to furnish the expertise that was supposedly needed to antici pate and avoid future recessions.

The Act provided that full employment was to be maintained by "compensatory spending. " That is, the government was to make up for "inadequate" private sector spending by running budget deficits and spending money it created. This anti-reces sionary program was to be put into effect when the President's economic advisers foresaw a decline in the business sector. That these ad visers could do a better job of forecasting than the numerous participants in the marketplace was assumed without evidence. Whether economic fluctuations have been avoided and whether this has been because of, or in spite of, the increasing government inter vention in the economy over the last 40 years are the crucial issues in evaluating the Employ ment Act. Defenders of government interven tion eagerly point out that the nation hasn't seen a repeat of the Great Depression since the Act. This seems impressive until one recalls that until the Great Depression the nation had not seen as devastating an economic decline.

The 150 years of U.S. history prior to the Great Depression were generally laissez faire when compared to the 50 years following this period. 395 The policy of heavy government intervention would have to weather another 100 years without producing a Great Depression before we could even pretend to congratulate our selves for discovering a key to perpetual pros perity. Are We Better Off? Even though the post World War II era has not produced another Great Depression, this alone does not tell us whether we are better or worse off for governmental attempts to manage the economy. From the outset, critics of such management pointed to timing, information, and political problems that would thwart gov ernment efforts to engineer prosperity. Since there is a lag between the initiation of fiscal or monetary stimulation and their impact on em ployment, timing is critical. Government ex perts must anticipate fluctuations in the economy and take action prior to the antici pated events. If predicting the future course of the economy were a science, then all econo mists would be fabulously wealthy. That they are not is ample evidence that there is consider able difficulty in making accurate forecasts.

Obtaining the economic information with which to make forecasts is time-consuming and costly. By the time data are gathered and ana lyzed they most likely are obsolete. To speed up this process or to make it more comprehen sive is expensive. This raises the prospect that the cost of the information may be more than it is worth. Of course, in the final analysis, fac tual data are only inputs to a fundamentally judgmental process. Using sophisticated computers to plot and project the future course of the economy based on past information misses the essential nature of the forecasting task. The future is unknown. It will not be a simple replication of current trends or past cycles. If the future were rou tinely predictable there wouldn't be so many forecasting errors. The trick in forecasting is to anticipate when and how the future inevitably will differ from the past and present. This re quires judgment.

Judgment can be cultivated through learning and experience. On the micro level-where we try to comprehend and deal with developments 396 THE FREEMAN. OCTOBER 1987 in our own family finances, businesses, and in dustries-this is not an insurmountable task. Economic decision-makers, whether business men, employees, or consumers, can have some success in understanding the conditions and re quirements of their particular circumstances. Determining what to sell, where to work, or whether to buy requires detailed knowledge of specific needs and capacities. At the macro level, however, where govern ment planners try to comprehend and anticipate the course of the entire economy, detailed spe cific knowledge doesn't exist. The aggregate statistics which are available do not reveal the many ways in which economic expansions and contractions may occur simultaneously in dif ferent products and different markets. Since the purpose of production is the creation of specific products for specific uses, how particular re sources are used is critically important. The Keynesian macro-management premise that merely maintaining aggregate demand-no matter what is produced-is sufficient to as sure full employment is hopelessly in error.

The government, lacking the necessary infor mation, cannot efficiently deploy resources for the betterment of the economy. To the impediments of improper timing and insufficient information, government interven tion adds political manipulation. Even if the government's experts agreed on the data and timing· for prospective interventions, political factors would distort policy. Keynesian macro management calls for a balanced program of deficits during recessions and surpluses during booms. Strangely, though, the surpluses over the last 40 years have been small and infre quent. In contrast, the federal government's deficits have been huge and repetitive. Macro-management has degenerated into an excuse for excessive Federal spending. When the economy is in recession, politicians can rely upon the Keynesian prescription for stimu lative spending. When the economy is strong, politicians are encouraged to spend more be cause we can afford it. So, no matter what con dition the economy is in, politics opts for more spending.

The penchant for spending has far outrun the inflation it has spawned over the last 40 years. As might be expected, a Keynesian program of deficits and money creation has pushed price indexes up by over 400 per cent since 1946. At the same time, nondefense spending by all levels of government has risen by over 3,000 per cent. This diversion of private resources to government use has imposed large and mostly hidden costs on our nation's economy. Consider that funds can be employed produc tively or nonproductively. In the private sector, it makes a difference to the economic decision maker which outcome or use results. In the public sector, however, the attitude is more ca sual. Unlike entrepreneurs who must employ funds productively to stay in business, govern ment bureaucrats rarely concern themselves with the return on their use of resources. Many in government pridefully assert that the public sector's indifference to profits assures a more socially useful deployment of resources. How ever, this attitude miscontrues the meaning of profit and leads to policies that waste the funds appropriated from the taxpayer.

The Role of Profit The creation of profit indicates that value has been enhanced by the undertaking earning the profit. The maker of profit has accurately iden tified needs and efficiently fulfilled them. The resulting profit is the difference between value and cost as determined by the marketplace. The larger the profit, the greater the social gain in value over cost. Accumulation of gains like this enables the economy to grow to meet even wider needs in the future. For example, an enterprise that made a con sistent 10 per cent profit on its investment year after year would be able to expand 45-fold over a 40-year period. In contrast, an enterprise that consistently lost 10 per cent each year would shrink to less than 1V2 per cent of its original value after 40 years. The assets available to so ciety from these contrasting results are signifi cantly different. Assume that each enterprise started with a million dollars. After 40 years, the enterprise making the 10 per cent annual profit would have grown to $45 million in assets. The enterprise losing 10 per cent per year would have shrunk to $15,000.

Obviously, it does matter how resources are employed. The notion of spending funds on THE UNEMPLOYMENT ACT OF 1946 397 Year 40 YEARS OF EXCESSIVE GOVERNMENT SPENDING ......................................................................... _ Actual Expenditures .•....•Inflation-Adjusted Budget (in billions) 900 400 100 600 700 800 200 500 300 1947 1950 1955 1960 1965 1970 1975 19'80 1985 was nearly $8.1 trillion. Current government spending is now over $800 billion higher than the inflation-adjusted budget would have re.quired. If the excessive spending had not occurred and if the funds had been left in the private sector through reductions in corporate, busi ness, and income taxes, a considerable amount of additional capital could have been created. Using the rather modest rates of return earned by companies comprising the Dow Jones Indus trials, we calculate that an additional $22 tril lion in assets could have been accumulated. In asmuch as the actual estimated corporate assets of the U. S. economy approximate $13 trillion, the impact of excessive government spending is clearly substantial. The failure of public policy to allow the economy to compound profits in this fashion over the past 40 years has signifi cantly reduced job opportunities and real wages-the goods and services an individual's wages can buy.

It must be remembered that this little exer cise is hypothetical. We have not measured the impact of excessive government spending so 1200 1100 1000 The magnitude of the negative impact on employment from excessive government spending can only be estimated. We can't really know what specific options were sacri ficed by this spendthrift era, but we can make a crude approximation. For this purpose, let us imagine that in 1946, instead of committing the government to a wastrel course, politicians at all levels determined to hold government spending constant with respect to population and the purchasing power of the dollar. What might have happened? The accompanying graph tracks actual ex penditures by all levels of government versus a hypothetical inflation-proof, population-growth adjusted budget. This hypothetical budget as sumes that the government would have main tained the same real (inflation-adjusted) per capita expenditures that prevailed in 1947 (the first year after the Employment Act). These budget comparisons omit defense outlays.

Rather than debate over whether defense outlays of the magnitude experienced were nec essary due to forces (hostile nations) outside the U.S. 's control, these expenditures were ex cluded from both the actual and inflation-ad justed budgets. Over the 40-year period, the inflation-proof, growth-adjusted budget grew from $33 billion to $272 billion: a 700 per cent increase. Actual government outlays grew from $33 billion to $1.1 trillion: a 3,200 per cent increase. The cu mulative excess of spending over that needed to maintain real per capita government services What Might Have Happened? make-work schemes to sustain aggregate de mand has a devastating impact on the economy over time. Clearly, a business with $45 million in assets can employ more workers than a busi ness with $15,000 in assets. Yet, government spending has been transferring resources from profitable enterprises for the past 40 years. In deed, the long-term impact of growing govern ment spending has been the destruction rather than the creation of jobs. Far from being the friend of the working man, big-spending politi cians have pursued programs that have dramati cally restrained opportunities and compensation in the U.S. economy.

398 THE FREEMAN. OCTOBER 1987 much as we have gained some insight into the magnitude of the real, long-term burden placed on the economy. One can't really measure the size of a growth that did not occur. Many defenders of government spending are quick to allege that these outlays "create" jobs. While it is true that some specific jobs would not now exist if the spending binge had been contained, it is difficult to see how a net gain from this consumption of resources can be claimed. Transfer Programs Grow The largest growth in government spending has been in income transfer programs. There is no doubt that these programs have created jobs for many bureaucrats. However, this is hardly a net gain in employment. A similar amount of money spent on goods and services by con sumers and businesses would likely employ a comparable number of people, albeit at dif ferent kinds of jobs. In addition, transfer payments discourage people from working. As Charles Murray points out in Losing Ground, the more gen erous the benefits are for being poor or unem ployed, the greater the temptation to be poor or unemployed. The loss of the output of large numbers of discouraged and unmotivated indi viduals clearly reduces the wealth of the so ciety. Less wealth means fewer employment opportunities and lower real wages.

Public funds also are used to provide ser vices that lose money. Whether it be the con struction of dams and canals that produce fewer benefits than costs or the operation of deficit ridden transit systems, almost every govern ment-produced service generates less value than it cost. As a result, capital is consumed and society's wealth declines. Capital also is consumed by government reg ulations. Some people, of course, may argue that regulations provide jobs for clerks, statisti cians, administrators, lawyers, and the like. But at the same time, the resources consumed in pursuing or defending against litigation are resources unavailable for research, new equip ment, training, or other more productive uses. The ultimate result of litigation is a transfer, not a creation, of wealth. The more time and energy diverted to such efforts to transfer wealth, the less that can be invested in adding to wealth. This also has a negative effect on employment.

The crushing burden of taxation and govern ment debt necessary to finance the explosion in spending also contributes to lower levels of employment. On the one hand, taxing profits and wages reduces the rewards for generating valuable output. The motivation to work hard and risk money in investments is diluted by high rates of taxation. On the other hand, the mushrooming public debt has crowded out many private sector ventures, while raising the cost of financing others. At the same time, Fed eral Reserve monetization of Federal debt has inflated the money supply, eroded the value of the dollar, and penalized savers. Excessive government taxing and borrowing have bat tered down both the incentives and the means of accumulating wealth. This also negatively effects employment. Examination of the 40 years since the Em ployment Act of 1946 does not produce evi dence for the success of government interven tion aimed at promoting employment. Instead, our economy has suffered the loss of a signifi cant opportunity to have improved the wealth and well-being of working people. While we cannot retrieve the sunk costs of 40 years of government waste, we can try to go forward to reduce and eventually eliminate this profligacy.

Whether the government can be broken of the habit of excessive spending is the crucial ques tion. D 1. G. J. Santoni, "The Employment Act of 1946: Some History Notes," Review (Federal Reserve Bank of St. Louis, November 1986), pp. 5-16. 2. George Soule, "The Full Employment Bill," The New Republic (August 6, 1945), pp. 154-156.