Economics for Politicians Chapter 4: You Don't Create Jobs - It's Time to Get Over FDR!

*** UPDATE - Cross Posted at Flopping Aces! ***

Welcome back, class! I took some time away for some brief diversions regarding leftist intolerance, and with last week's natural disaster I probably didn't have your attention anyway. So now we're back, and congratulations on staying awake through my two lectures on economic theory, but it's going to pay off! Now we start to look at how the theory I've taught relates to the real world, and your learning has progressed to the point where we can explain to you why you don't create jobs! If you need a refresher, links to the first three lessons are at the bottom of this post. Now, onto the next chapter of your enlightenment!

On weekends I lead tour groups here in the nation's capitol, and when I take my charges to the second room of the FDR Memorial I dispel the mythology that the New Deal created jobs. Here is the example I use for my group to better illustrate:

I suggest a scenario where my tour group and I decide to run off to a remote island and form our own country, Bobylvania. We all have our own jobs that contribute to the country, but one day I lose my job. The good citizens decide that they want Bobylvania to be a leader in green energy, so they give me a government job creating windmills and solar panels to provide our energy, and they pay me a decent wage of $50,000 (or about $24 / hour) per year. This is great for me, but that money has to come from somewhere. If there are ten people in my tour group the easiest way to gather our revenue enhancements (or as we non-politicians call them, "taxes") is for each of them to pay $5,000 per year to fund my job. For simplicity we'll leave out my generous health benefits to which I don't contribute or the unfunded liability known as my pension that the children and grandchildren of Bobylvania will have to pay (The Association of Federated Bobs local 101 chapter are good negotiators).

Going back to the Great Depression as well as our current economic woes we need a brief aside on a school of thought that has paralyzed the left from taking constructive action known as Keynsianism. What the Keynsians (thinking modeled after the British economist John Maynard Keynes) believe is that an economy needs to be stimulated from time to time if there is not great enough aggregate demand (generally speaking - not enough money) for the economy's goods to be brought. Without the private sector to do this the task then falls onto the government to spend, or "stimulate" the economy. The government spends this money, puts it in people's hands, and they then spend it elsewhere, and that third party spends it elsewhere, creating what is called a "multiplier" effect. It is this exact thinking that enables Nancy Pelosi to make statements like food stamps being a stimulus. The government has pushed money into people's hands and the economy gets moving again. So why haven't the various stimulus programs worked? If the New Deal was such a triumph in creating jobs why, save for two brief periods, did unemployment never drop below 15% before the start of World War II? How come Japan hasn't fully recovered from it's "Lost Decade" of the 1990's? An why does unemployment continue to remain "unexpectedly" high?

Here is where we introduce you to another piece of economic theory known as the"Broken Window Theory", which originated with the French Economist Frederic Bastiat. Wealth can not be created from nothing, nor can it be created via destruction. If you have a few minutes Declaration Entertainment's Bill Whittle does a great job of explaining how wealth is only created by producing something of value. The example that Bastiat uses to illustrate his theory is of a boy walking down the street who throws a brick through the local baker shop's window. When the baker comes out to express his unhappiness with what the boy has done the boy responds that he had helped the town. By breaking the window the boy has created a stimulus for the economy. The new window that the shop keeper buys will put money in the hands of the glazier, who might then use it to buy a new pair of shoes. The extra money in the cobbler's hands may help him to buy a new wagon, giving more money to the wagon maker to spend, and you get the idea. Lost in all of this is the baker. What Keynsians miss is all of the unseen activity that does not take place as a reult of the wealth that they displace. The money that the baker is forced to spend on a new window might have been used in all of the places that the boy mentioned, or maybe the baker chooses to buy a better oven to produce more bread, which will force the baker to hire more employees to sell all of the extra bread that he sells (or as this private investment is called outside of DC, "Job creation"). Maybe the baker's store becomes successful enough that he believes he can earn more profits by taking the risk of opening more stores. In turn, he puts to work the people who build his shops or renovates an otherwise vacant space, and hires more employees, and maybe becomes successful enough to go public, and his bakery becomes one of the stocks that fuels the mutual funds that help to fund various pension plans and he makes enough money to build a bigger home, reinvest in other ventures, and put more people to work in our economy.

Or he can use that money to pay for a broken window instead, and - HEY! I see some of your eyes are glazing over thinking about how the baker is accumulating wealth that he doesn't need and how his taxes should be raised to pay for programs that the groups who funded your election campaign are calling for. Go back and re-read chapter 1, and you are not allowed to read any further until you understand it. Go ahead and bookmark this page - I'll be here when you get back.

For the rest of the class, this was the same effect with FDR's New Deal policy and with Obama's today. FDR kept passing ever more regulations that left businesses reluctant to expand because they were afraid of what he would do next. And many of FDR's programs caused more harm than good. His price supports for farmers guaranteed them minimum prices for their crops, while increasing the price of food. Since poor people pay a greater percentage of their incomes to buy food they were disproportionately punished by the president. FDR was big on having business collude to stay in business, but less competition leads to higher prices and fewer goods sold. Creating minimum wages, the 40 hour work week, and helping employees gain the right to unionize are not necessarily bad things on their own, but each of these makes hiring more expensive, which naturally leads to higher unemployment.

Lefties love to argue that in 1937 when unemployment surged to 25% that it was because FDR tried to reign in spending. In 1936 the exact words of his Treasury Secretary, Henry Morgenthau were, “We have tried spending money. We are spending more than we have ever spent before and it does not work.” Sound familiar? FDR viewed his re-election in 1936 as a mandate to become more aggressive in his New Deal policies. We saw increased taxes on the wealthy as well as the Wagner Act which gave greater power to organized labor. The spending "cuts" weren't enough to cause the surge in unemployment on their own, and even if the cuts themselves could have caused the increase in unemployment, the timelines are wrong.

One of the few things that economists of all stripes agree on is that unemployment is a lagging indicator, meaning that unemployment actually reflects how the economy was doing, and not necessarily where it is now. Think about the general timeline using generic examples. Say in a period of time we see sweeping legislation that will "improve" our economy. We see laws passed designed to nationalize health insurance, allow the NLRB to force companies to shut down new factories, prevent any offshore drilling in the US, bankrupt coal companies, and even put an end to that ever present and corrupt example of big business at its worst, lemonade stands. As these industries fnd themselves becoming less profitable, they end up doing less business. As they do less business they find that they need fewer employees. As the companies realize they need fewer employees layoffs start to happen, assuming that the company doesn't simply decide to close its doors and as its remaing contracts expire everyone loses their jobs. These steps don't happen overnight, and only after these occur do the unemployment claims start to be filed and counted in the statistics. The point is that it takes time for the true impacts of any policy to reflect in the unemployment numbers - just right for the Second New Deal of 1936, but far too short for the "austerity" of 1937.

Some economists argue that what finally took us out of the Great Depression was the onset of World War II and how it ramped up our industry and agriculture, leaving the US as the only major industrialized country at the end of that was mostly untouched by the fighting. But if Keysnian theory held true, why didn't this surge of returning GI's leaving their jobs in the military (government) suddenly cause a surge in unemployment? How did government spending dropping as a percentage of GDP at the end of the war not take money out of people's hands and cause an economic downturn? How did America get mobilized and employed and lead to unprecedented growth and prosperity? This is not a kind thing to say (and I stop just short of this on my tours unless someone asks me to elaborate), but the biggest factor in finally getting us out of the depression was the death of FDR. Without this powerfully charismatic figure to champion his various innovation-strangling policies, the Republicans who had taken control of Congress in the 1946 election were able to push back on President Truman and get America back to work. Needless to say, these views are none too popular here in DC. In fact, on two occasions I've had elderly ladies who were passing by stop to yell at me for speaking unkindly about this president for whom they had such fond memories of and all of the jobs they saw him "create" firsthand. I've tried to explain The Broken Window Theory to them, but to no avail. To quote FDR's successor Harry S. Truman, "I never gave them Hell. I told them the truth and they took it as Hell."

So how does all of this tie together to suggest that only the private sector can create jobs and spur an economy? There is more to tell here but this lesson has already gone on longer than I had intended.

A logical next lesson would be to go into the chapter on unintended consequences, but I don't think you're quite ready for that yet. So we'll take a side trip for our next lesson and kick off next time with:

Chapter 5: Businesses are Greedy - This is not Necessarily a Bad Thing!

Previous Chapters:

Lesson One: It's Not Your Money

Lesson Two: Intro to Microeconomics, or Why Prices Matter

Lesson Three: Intro to Macroeconomics. or So that's Where Government Fits In!