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Fed Impact on Stock Market Trend

Job Creation and Other Economic Myths

Economics / Economic Theory Dec 27, 2010 - 08:44 AM GMT

By: MISES

Economics

Best Financial Markets Analysis ArticleFred Buzzeo writes: Job creation has become the central theme of the current recession. The focus on job growth is widespread among both conservative (if I may use this term liberally) and left-leaning economists. Furthermore, if you ask the man on the street what the pressing economic problem of the time is, he will certainly respond, "Jobs."


In a Gallup poll taken in March of 2010, unemployment was listed as the most important problem facing the country. This finding was reinforced in a poll conducted by the Washington Post in October of 2010. In fact, the lack of job creation was one of the major reasons that the GOP achieved such widespread electoral victory in the 2010 midterm elections.

It is clear that job creation is essential. But where are these jobs to come from? The huge stimulus plan of the Obama Administration and the quantitative easing of the Federal Reserve have failed to solve the problem. In fact, with time, these actions will create greater ills than the problem that they were intended to cure.

The reality of high unemployment continues to plague the economy. Therefore, we must look elsewhere for solutions to the unemployment problem. We must ask, what is the correct path to sustained, noninflationary economic growth?

To answer this question, I suggest that we take a step back in time and examine the writings of the early economic thinkers. In doing so, we find that the main concern of these economists was in the production of goods and services.

Jean-Baptiste Say makes the case most succinctly, He writes,

In a community, city, province, or nation that produces abundantly, and adds every moment to the sum of its product, almost all of the branches of commerce, manufacture, and generally of industry, yield handsome profits, because the demand is great and because there is always a large quantity of products in the market, ready to bid for new productive services. And vice versa, whenever, by reasons of the blunders of a nation or its government, production is stationary, or does not keep pace with consumption, the demand generally declines, the value of the product is less than the charges of its production; no productive exertion is rewarded; profits and wages decrease; the employment of capital becomes less advantageous and more hazardous; it is consumed piecemeal, not through extravagance, but through necessity, and because the sources of capital have dried up.[1]

The above argument is commonly referred to as Say's law. The essence of the argument is that an increase in productive capacity will create employment and naturally increase the demand for products in general. Therefore, productive capacity is seen as the foundation for job creation and for the economic well-being that follows. Say's law had been the foundation of economic growth for decades.

Yet, for the past 50-odd years, it has been a point of contention and ridicule among most mainstream economist. Say's law has been replaced with such economic myths as the Phillip's curve, the stimulation of "aggregate demand," and the specter of deflation. What caused this detrimental change in perception?

All Roads Lead to Keynes

As with most of the pitfalls in economic thinking, John Maynard Keynes is the person responsible for sidetracking most of the generally sound logic of the early profession. It is amazing to see that, with all empirical evidence to the contrary, mainstream economists and government policy makers still cling to the timeworn postulates of the General Theory.

Although his tenets have been proven wrong time and time again, Keynes is constantly rejuvenated by the intellectual fountains of youth that occupy our institutions of "higher learning." As confirmation of this statement, Paul Krugman, the modern-day reincarnation of Keynes, was even awarded the Noble Prize!

The basic thread that holds together the illusions of Keynesian economics is the so-called refutation of Say's law. Henry Hazlitt has eloquently disproven this Keynesian myth. His arguments need not be repeated here.[2]

Therefore, let us simply employ a bit of logic to settle the debate. A businessman does not spend his day considering how a job is to be created. On the contrary, if he is a successful businessman, he spends his time thinking about those activities that he can engage in to produce a profit. Once he has determined the profitable activity, he then channels resources to achieve the desired result: making money.

It is from this profit motive, this potential increase in productive activity, that jobs are created. As a developer, I do not hire an employee before I have conceived of a construction activity that will earn me a decent return. I hire an employee when I have a productive need for his services. As Say so clearly understood, it is the productive activity that creates the employment that puts money in people's pockets that can then be used to purchase other products.

The Phillip's Curve

The Phillip's curve is another economic myth; it leads to the illusion that jobs can be magically created by simply increasing the price level. It is the economic concept that led to the supposed tradeoff between inflation and jobs that nearly wrecked the US economy in the 1970s.

In fact, the 1970s' economy provides the empirical evidence needed to conclusively prove that the Phillip's curve does not work. I stress the use of empirical evidence because it is the lifeline of the mainstream economist. And it is the mainstream economists that indoctrinate us with these economic myths as we pass through their classrooms.

The application of the Phillip's curve by the Johnson and Nixon administrations so devastated the economy that a new term was coined to identify the hitherto unknown condition of high inflation and a stagnant economy: stagflation. Hazlitt has proven the historical lack of empirical evidence to support the myth of the Phillip's curve. Once again, there is no reason to repeat his findings.[3]

Therefore we will simply turn to logic. And logic defies how an action that is designed to bring about an inflationary environment can create a job. As prices increase and public expectations are factored in, we find the economy in an inflationary environment with stagnant job growth.

Productive capacity is diminished because entrepreneurs — those individuals whose actions actually create jobs — are uncertain about the future. And uncertainty is the greatest deterrent to productive investment. Without productive investment there is no economic expansion and no job growth.

Jobs, in the long run, cannot be created by bringing the economy to a higher price level, which discourages productive investment and keeps relative incomes and activity at the same level. Once again, such an activity defies logic. It does not, however, defy the ideological imperatives of those who espouse such "stimulating" action.

The Specter of Deflation

The illogical fear of deflation is one of the main causes of the financial crisis — with its high rate of job loss — that we are still experiencing today. Since 1998, with the collapse of Long Term Capital Management (LTC) — a hedge fund run by Nobel Prize–winning economists — then Federal Reserve chairman Alan Greenspan fought the specter of deflation like a drug addict trying to kick the habit. He was obsessed with it. His response to the LTC crisis was to lower the federal-funds rate by increasing the money supply.

Then in 2000, another crisis hit the financial market. The tech bubble burst and the NASDAQ tanked from its high of 5132.52 on March 10, 2000. What was Chairman Greenspan's response? He once again increased the money supply and lowered the federal-funds rate. It is interesting to note that he apparently never equated his expansionary monetary policy with the "irrational exuberance" that he so vehemently opposed.

In December of 2001, the federal-funds rate was brought down to 1.87 percent. By the end of 2002, it stood at 1.25 percent, the lowest level in 41 years and rapidly heading for the zero bound.[4]

In fact, Chairman Greenspan was so concerned with deflation that he declared inflation beat and no longer a threat. In a statement to the Joint Economic Committee of Congress, Greenspan stated, "Inflation is now sufficiently low that it no longer appears to be much of a factor in economic calculations of households and business."[5] Chairman Greenspan was signaling his new battle on the deflationary front.

Once again we must employ logic to unfold the deflationary myth. First of all, most prices in the past 15 years did not collapse but continued to increase. As a developer during this period, I was shocked at the increase in the price of such commodities as copper and steel that I used in construction projects. I could only have wished that that price had dropped.

Secondly, deflation is good for an inflationary economy if all prices are allowed to drop in tandem. If profits remain the same in relation to the goods and services that I need to buy, I am not concerned with the final price that I sell a unit of housing for. I am only concerned with lower profits in relation to higher prices that I must pay for the things that I need.

As Rothbard has demonstrated, if wages were allowed to drop during the Great Depression, we would not have seen unemployment rates of 25 percent.[6] It is only when prices are not allowed to adjust in tandem that deflation becomes a problem. Such a scenario results when government interferes by keeping the price of commodities and labor high, as occurred in the Great Depression.

The reason that politicians fail to allow prices to drop is to appease pressure groups — such as organized labor — that they are beholden to for votes and political contributions. Another reason is a lack of understanding concerning the quantity of money in a society.

Conclusion

We have seen how economic myths that devastate productive activity are perpetuated by the mainstream economists and implemented by government policy makers. We must now answer the original question asked above: What is the path to sustained, noninflationary economic growth — and hence to sustained job creation?

First, we must understand that artificial job creation by the government is not the answer. As the "Great Society" programs demonstrated, governments cannot produce noninflationary jobs. The reason for this is simple: governments do not produce goods. They do not add to the productive capacity of a nation. Government, through taxation and redistribution, destroys wealth. It does not create wealth.

To create sustained, noninflationary employment, we must, as Jean-Baptiste Say told us 200 years ago, encourage production, not simply the consumption of goods. The Keynesian concept of stimulating aggregate demand is simply another economic myth. It runs counter to all sound economic policy. It is inflationary and does not lead to sustained economic growth.

In the words of John Stewart Mill, "What a country needs to make it rich is never consumption, but production. Where there is the latter, we may be sure that there is no want of the former."

To expand productive activity and thus to create jobs, we must restore confidence in the system. As stated above, entrepreneurs do not invest freely in uncertain times or when they feel that their hard-earned profits will be confiscated in some redistribution-of-income scheme.

Confidence in the system can be restored by simple actions. The principal way is to leave decision making in the hands of the sovereign — the individual. The actions of the individual expressing his utility in the marketplace will determine the correct level of investment, production, and consumption. That is the only foolproof way to achieve a noninflationary economic expansion with healthy job growth.

The above scenario negates the role of the central planner and the government banker. This is the main reason that such a scenario is held in contempt by the mainstream economist. For without a central planner, there is no need for the economists that provide the justification for his existence.

The economic myths explored above must be stricken from the textbooks that will indoctrinate the legions of future economists passing through the education mills. However, because these myths provide a justification for the actions of so many, they unfortunately will remain a reality that continues to plague the economy.

Fred Buzzeo is a real-estate developer and a consultant to small property owners in the New York City area. He resides with his wife and two sons in the Town of Oyster Bay, (Long Island), NY. During the 1990s, he held executive positions in city municipal government. It is during this employment that he saw firsthand the pitfalls of government intervention and regulation. Send him mail. See Fred Buzzeo's article archives. Comment on the blog.

© 2010 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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