Romer Takes the Economy’s Temperature

On the eve of the new year, this NYT article asked 6 well-known economists—Greg Mankiw, Christina Romer, Tyler Cowen, Robert Frank, Robert Shiller, and Richard Thaler—their views on the economy.  The article is too long to examine all their responses, but this post examines some of the problems with Romer’s views.  Like a doctor, Romer precedes to take the economy’s temperature, and then prescribes her centrally-planned solution.  As it turns out, the economy is suffering from a little hypothermia, but government spending is just the trick to raise the economy’s temperature to a healthy level!

In her first sentence she alerts us to her innovative policy approach: more of the same (in her words, “an aggressive form of fiscal policy.”)  Specifically, she focuses on the problem of persistent unemployment.  She argues: “Persistent unemployment is destroying the lives and talents of more than 13 million Americans.”

Before prescribing a solution to a problem, it’s best to have an idea of how the problem originated in the first place.  What’s strange about the persistent unemployment of 13 million people?  Simply the fact that labor is a price, and that all other prices clear markets when they are allowed to adjust.  If people find themselves involuntarily unemployed, this can only be because something is preventing them from finding a job.  Anything from minimum wage laws, union power, business regulation, etc…can cause widespread unemployment.  By preventing the fall of wages, these policies actually perpetuate unemployment.  A fall in wages is necessary to reallocate labor away from where it has been malinvested, and towards where it is most highly valued.

Involuntary unemployment is never the result of there not being “enough” work to do (in other words, it can’t be caused by better technology) because human beings have unlimited wants.  Involuntary unemployment is the result of government policy that prevents wages from adjusting.  The market aligns productivity with wage rates, and the conclusion is that unemployment would be eradicated on the unhampered market.  The answer is not to simply increase government spending.

Romer states that “the evidence that fiscal stimulus raises employment and lowers joblessness is stronger than ever.”  Whatever Romer’s supposed evidence, logic does not support her claim.  Government cannot produce anything of its own—it can only transfer wealth from one group to another.  It does this through taxing and spending.  You might be tempted to think that, at best, fiscal policy is simply a wash—some benefit and others lose.  This is incorrect—taxation takes from those that are currently the most productive, essentially reducing their ability to create wealth.   The net effect of fiscal policy will be a lower real standard of living.  For those who rely on the multiplier effect, suffice it say that there are numerous theoretical problems with it (see here, for instance), but for those who prefer empiricism (virtually all mainstream economists), see here.

She argues that “extended unemployment insurance” would also help reduce unemployment.  To the contrary, this will make businesses less likely to hire (because it is harder to fire) and will reduce the opportunity cost of leisure for those unemployed.  In other words, unemployed individuals will simply see an increased benefit to not having a job.  The consequences of this should be obvious…

Lastly, she again champions the unoriginal idea of government infrastructure investment.  Only, she claims it should be done by state governments rather than the federal government—as if this makes any difference in the absence of a profit and loss system.  For more on this fallacy, see here, here, and here.

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