William R. Hawkins is Assistant Professor of Economics, Radford University, Radford, Virginia.

In the Fall of 1982, as inflation rates continued to drop, the public shifted its concern from rising prices to rising unemployment. The concern was real, as unemployment reached lev els unequaled since the Great Depression of the 1930s. Of course the media overplayed the comparison with the 1930s. Nearly half of those unemployed were from households which had more than one income earner prior to the recession and which still had at least one breadwinner working. The unemployment figures were also overstated because of the sociological shift of more women who were listed as “looking for work.” The increased labor force participation rate of women makes comparison of current unemployment figures with past years suspect. The increased use of unemployment benefits also softened the impact of job loss and may have contributed to the unemployment figures by allowing those out of work to pursue new job opportunities 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 tragedy in both economic and human terms. In economic terms, unemployment 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-esteem. Those who are forced to live on charity or see their dreams of advancement destroyed by lack of opportunity suffer a loss to the spirit. A worker who loses his job for no direct fault of his own is fundamentally different from the idler who out of laziness or other defect becomes a permanent member of the welfare 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 October 1982, about three per cent was due to the recession, amounting to approximately 3.4 million workers. The second cause is the secular decline of key sectors of the American industrial base such as autos, steel, shipbuilding, and textiles. This contributed about 2.5 per cent to the rate or about 2.7 million jobs. Thus, solving the unemployment problem will take more than just recovering from the recession.[1]

Keynesian Philosophy

The dominant economic philosophy 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, Interest 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 mode] but because it appeared 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 investment opportunities in the private sector were played out. Therefore, saving no longer served a useful economic function. In fact, saving was now a detriment, a drag on the economy because it would not be converted into investment spending. Saving should therefore be converted into spending by the government 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 campaign that was calculated to entice far more support than a direct appeal to redistribution or socialism. That there was a wider political consequence 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 conditions the growth of wealth so far from being dependent on abstinence of the rich, as is commonly supposed, is more likely to be impeded by it. One of the chief social justifications of great inequality of wealth is, therefore, removed.[2]

However, it became clear by the dawn of the 1970s that the Keynesian description of the economy did not fit reality. The United States economy was not being dragged into stagnation because it was generating too much capital. Just the opposite. 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” economics. 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 denied to even the most powerful aristocrats of the past.

The Industrial Revolution

Perhaps when the leaders of the seven largest industrial democracies 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 toilets, telephones or television. And they might have contrasted their arrival 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 of Nations. In fact, the death of the French Monarch and the birth of the Scottish philosopher were separated by only eight years. In the classical tradition which Smith began, capital played the central role:

Wherever capital predominates, industry prevails . . . . Every increase or diminution of capital, therefore, naturally 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 vanquished this idea in academic circles but he could not vanquish the chain of cause and effect which it stated. Smith was not forming abstract theory, but observing human actions.

It offends the egalitarian notions of many to accept that economies always advance from the top down, yet it defies logic to believe that growth can be based solely on poverty and consumption. A natural hierarchy 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 enrich society as well as themselves. This hierarchy is not the static, class-bound structure of the feudal aristocracy, 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 himself in a modest way. A considerable part of the capital working in American business is the counterpart of the savings of the masses.[4]

The development of capital markets, joint-stock companies and corporations, banks and other financial intermediaries provided the institutional framework for mobilizing the savings of the masses for productive use.

Prior to the wedding of capital and technology which spawned the Industrial Revolution, even the rich were limited by the fact that their wealth could only purchase the services of human or animal labor. Labor 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 support 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.

Yet capital, like all economic resources, is finite. Though it may be increased over time, at any particular 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 capital as a scarce resource and its unconcern 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 representing the same pool of savings that business and consumers depend on to finance their activities. The increase in demand for funds emanating 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 investment projects no longer yield a return high enough to cover the increased interest rates. These projects are canceled. For consumers, buying a new house or even an automobile is no longer feasible. Private 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 nonproductive government programs results in deterioration of the very structure of the economy. The federal government has run a deficit every year since 1969, which means capital withdrawn from the private sector is never replaced by repayment 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 billion, indicating that the government had absorbed $514.1 billion in capital 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 foreign capital would have been invested in industry in the United States had it not gone into government debt, this is also a loss to the economy.

With future budget deficits expected to run over $100 billion per year, the fear is that the government 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 formation just as it is about to produce results. The first two installments of the tax cuts, with their reduction in taxation and their increased incentives 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 completion 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 counterproductive. The impact of taxes on business earnings or returns from investment are obviously harmful. Increasing 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, does not convert premiums into investments. Instead the system pays out its benefits from current revenue. This simply makes Social Security another mechanism for converting 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 recovery 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 recovery can proceed in a timely fashion. Cutting $30 billion from currently planned expenditures should be sufficient, though additional cuts in 1984 might be necessary if the deficit fails to close fast enough during 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, particularly 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 unemployment which is due to the decline of American 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 apparent in those sectors where foreign competition has advanced into formerly American markets displacing not only American-made products but also the workers who manufacture them. However, the decline of productivity is an economy-wide phenomenon. The consequence may not always show up in lay-offs, 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 providing them better tools and organization. As Peter F. Drucker has argued, it is not the individual worker who is productive in the modern economy, it is the industrial system which is productive. It is by combining labor and capital in harmony that productivity is found. When unemployment exists it means that this harmony has been disrupted. Labor is available, but its partner capital is not.

Capital is the future. It is the provision for the risks, the uncertainties, the changes and the jobs of tomorrow . . . . An economy that does not form enough capital to cover its future costs is an economy that condemns itself to decline and continuing crisis, the crisis of stagflation.[6]

If this long-term problem of productivity and jobs is to be solved, there must be a long-run commitment to limiting the adverse effects of government spending on the economy. Fiscal policy must not only encourage capital formation (primarily by ceasing to place obstacles in its path) but must cease to divert the capital so formed into nonproductive programs. For if the capita] is available and the tax and regulatory environments are conducive to entreprenuerial activity, then the process of reindustrialization will bear fruit. In fact, entire new industries 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 because 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 unemployment have created the conditions for both intellectual and policy 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 revealed, the unemployed are still the prey of those who champion larger government expenditures and debt. This must change. As the chief beneficiaries of expanded capital investment, the unemployed should become the natural allies of the movement to balance the Federal budget.

1.   Even when the economy is operating at what is considered to be full employment, the unemployment rate is about five percent due to people being temporarily, and voluntarily, between jobs.

2.   John Maynard Keynes, The General Theory of Employment, Interest and Money (Harcourt, Brace & Co., 1936) p. 373.

3.   Adam Smith, The Wealth of Nations (Modern Library, 1937) pp. 320-21.

4.   Ludwig von Mises, “Wages, Unemployment and Inflation,” Planning for Freedom (Libertar ian Press, 1974) p. 160.

5.   Monetary Trends (Federal Reserve Bank of St. Louis) September 23, 1982, p. 13.

6.   Peter F. Drucker, “Towards the Next Economics,” The Crisis in Economic Theory, Daniel Bell and Irving Kristol, editors (Basic Books, 1981) p. 11.