Wednesday, July 21, 2010

How the Government is Causing Unemployment

Although the official unemployment rate stands at about 9.5%, more realistic and accurate assessments put the number at closer to 20-30% (notwithstanding the ridiculous claims of the Obama administration). What is causing unemployment? After all, have people run out of ideas to improve their lives? Have all human desires vanished? Does no one wish to innovate and produce? Is there no work left for the human race to perform? In a previous post, I stated:

If you have one million television sets and you want to sell them but no one wants to buy them, what should you do? If you want to sell your home, but no one wants to buy it, what should you do? If you want to work, but no one will hire you, what should you do?

If you said: "LOWER THE ASKING PRICE!," then you would be likely to sell TVs, sell your home, and find a job.

In other words, when something doesn't sell, like televisions or labor, the reason is that either no one wants it at all or the price is too high. Since human wants have not suddenly vanished, and people want to work, the only reason is that the cost of employment is too high. When there is massive, chronic unemployment, it means that the cost of labor must fall in order to encourage businesses to hire. But why is the cost of labor so high? Can't someone just offer to work for a little less? In a statist economy, the short answer is no.

First of all, by extending unemployment benefits, the government is paying people not to work. Therefore, people who are receiving benefits are not being encouraged to offer less for their labor. However, even if the government were not paying these benefits, and these people wanted to offer less, they could only do so up to a point. Why?

Say, for example, that the government decreed that the minimum wage shall be $1 million per hour. Progressives like Obama and Nancy Pelosi might jump for joy since they would believe that all workers would become millionaires by working for one hour. Of course, such a law would not make anyone a millionaire. It would simply put every business out of business (except maybe film making and professional basketball). Firms simply could not afford to hire anyone at this rate.

For a less extreme example, let's say that a business can afford to put $50 into labor given all other costs and revenue. At $5 per hour, a business can afford to hire 10 workers. If the minimum wage is raised to $10 per hour, then the business can only afford to hire 5 workers. This is why minimum wage laws cause unemployment. These laws make it impossible for workers and employers to contract for services below the statutory rate. To the extent that the prevailing wage for a given job is above the minimum wage rate, the law is not a factor, however, for jobs at the lowest end of the spectrum, these laws cause chronic and persistent unemployment, since no one will pay someone more than a job is worth.

It should also be pointed out that this sudden increase in unemployment, currently being experienced, is a side effect of the boom-bust cycle caused by the government's manipulation of the money supply. The inflationary boom period, caused by excessive credit and money creation, leads to misallocations of capital, that is, investments in unsound business ventures that appear to be profitable only because of the inflation (see the housing market). When the inflation stops, prices fall, and these unsound investments must be liquidated. As businesses and individuals raise their cash levels and pay down debt, spending slows, further exacerbating the slow down and causing widespread bankruptcies, which in turn, puts downward pressure on prices and wages. The recession or depression, depending on the severity, is the process of the economy recovering as equilbrium is restored. To the extent that wages and prices do not fall, by virtue of government policy, chronic unemployment and stagnation will result. This is exactly what happened in the Great Depression of the 1930's as the government "encouraged" employers not to reduce wages. The result was massive unemployment (see The Politically Incorrect Guide to the Great Depression, by Robert Murphy). The blame for this cycle, in the first place, must be squarely placed on government's policy of continual fiat currency inflation. Secondarily, minimum wage laws, in addition to other forms of legislation, and the Fed's monetary policy, restrict wages from falling, either by direct fiat, by propping up failing businesses, or through further inflation which hides and prolongs unsound investments. These government policies turn what would be a short, severe recession, followed by a return to prosperity, into a chronic depression with no end in sight.

While the wage "rate" is crucial, it is important to point out that it is not the only cost to employing persons, nor is it the only consideration when deciding whether to expand a business. In a recent post at, titled No Jobs, the author notes:

[T]he question not enough people are asking is why so many jobs are being lost. Yes, the large global corporations have been sending millions of jobs overseas where labor is far, far cheaper. And yes, the U.S. government has accumulated so much debt that it is absolutely suffocating the U.S. economy. But there is another very important factor that has been largely overlooked. Traditionally, about 75 percent of all new jobs are created by small businesses. But today, hundreds of thousands of small businesses are being strangled out of existence by all of the oppressive taxes, fees, rules, regulations, paperwork and demands that government keeps imposing on them. In such a repressive environment, it is getting close to impossible for small businesses to thrive, and if our small businesses can't succeed, then we simply are not going to see a lot of jobs being created.[emphasis mine]

This tends to effect small businesses disproportionately since larger corporations can better deal with the red tape. He notes:

When it comes to hiring new employees, the federal government has made the process so complicated and so expensive for small businesses that it is hardly worth it anymore. Things have gotten so bad that more small businesses than ever are only hiring part-time workers or independent contractors.

So what we actually have now is a situation where small businesses have lots of incentives not to hire more workers, and if they really do need some extra help the rules make it much more profitable to do whatever you can to keep from bringing people on as full-time employees.

Besides strangling small business with endless costs and regulations, on a larger scale, the government is doing everything in its power to discourage business for firms both big and small. Bill Frezza notes:

The Obama Administration has taken to the hustings to promote its plan to create jobs by ratcheting up federal spending, paying people to stay out of work longer, dishing out billions in subsidies to refugees from the collapsing solar industry in Spain, and terrorizing companies that produce jobs by increasing regulatory uncertainty. Oh, and don't forget jacking up taxes.

Does this make sense to you?

All of this has caused corporate America to go on strike, sitting on an estimated two trillion dollars in cash. Businesses refuse to invest fearing they'll be trashed when Barney Frank has some inspired thought at 2am and sticks some devastating provision in the next abomination working its way through the Congressional sausage

In other words, when it is not clear what the law will be tomorrow, how much you will pay in taxes, how much you will be forced to pay for employee medical insurance, which pet project of which government agency will be funded, whether you will pay more or less for energy, what type of energy will be available, whether you will be sued under some newly discovered provision of a thousand page bill, whether you are in compliance with any of thousands of different regulations enforced by vicious bureaucrats from hundreds of different agencies, whether some new regulations will suddenly upend your industry or subject you to massive liability, whether governments will pay back their debts, whether they will pay back their debts by debasing the currency (printing money) leading to massive inflation, whether the state will offer bail outs to favored industries, etc., is it any surprise that companies are simply doing nothing?

Consider just this list of taxes set to take effect on January 1, 2011, compiled by Ryan Ellis in his article, Six Months to Go Before the Largest Tax Hikes in History, and ask how anyone could be optimistic about expanding a business in this anti-business milieu? Quoting No Jobs:

My small business-owning friends aren't creating one job. Not one. They are shedding jobs. They are learning to do more with fewer employees. They are creating high-tech businesses that don't need employees. And many business owners are making plans to leave the country. In a high-tech world where businesses can be run from anywhere, Obama has a problem. His one-trick pony -- raise taxes, raise taxes, raising taxes -- is chasing away the business owners he desperately needs to pay his bills.

The U.S. government has become like the 500 pound fat guy who jumps on a horse and then gets angry when it won't move.

Passing even more ridiculous regulations and raising taxes even higher is not going to fix business in America.

The government is at war with American business and businessmen are shrugging. So what is the solution? Is it more stifling regulations, more confiscatory taxes, more government spending and debt, more robbing Peter to pay Paul? Absolutely not.

The solution is economic freedom. The government should unshackle and unleash the American entrepreneur by acknowledging and restoring the preconditions to prosperity: the protection of individual rights, as understood by our Founding Fathers, and a system of laissez-faire capitalism. Rather than terrorizing and threatening businessmen, producers, and innovators, the government should be protecting and celebrating the individual's right to pursue his own profit and happiness. At a minimum, this would entail upholding the rule of law, including the sanctity of contracts and the protection of property rights. It would mean minimizing burdensome regulations, ending subsidies and government guarantees, reducing budget deficits by cutting spending, cutting taxes, and pursuing a course of sound money and low inflation.

Unemployment is not natural. In a free society, anyone wishing to work, produce, and innovate has infinite capacity to do so. Who would stop them - except a government?


Trevor said...

Wow. Just wanted to say "Thanks" yet again for a great article. I linked to it via my FB page.

The list of taxes set to go into effect on January 11, 2011 is truly terrifying. As an aside, I'm a small business owner who refuses to hire anyone as an employee. Instead I have half a dozen people I work with who are all 1099s. We're all individual S-CORPs in effect doing business with one another for the benefit of a common client. We've all got complimentary skill sets and together we're a "team" but our business entities are separate. I think we all enjoy less of a tax burden this way as well as a more flexible consulting/job-based model of finding work. When my client's job is done, Sally might have someone that needs work, or we might be working on 2 or more jobs at once. Granted this model probably works better in some fields than others. I'm in I.T.

I would encourage anyone who has a marketable skill to go into such an arrangement for themself rather than trying to hitch their star to a small/mid-size company. I feel that the government is simply poisoning the environment for any business between the size of 1 person and 250 people.

Thanks again!

Doug Reich said...


Thanks much for the comment and feedback.

I think your situation is totally typical these days. Businesses are finding everyway possible of not having to enter "employment" relationships. This is one of the reason that temp services and contract employment have become so popular over the last 10 years.

And, the thresholds for super regulation kick in at various levels - 10 employees, 50, 100, etc. where you become subject to all sorts of nonsense. Therefore, even businesses that do hire people, try and keep the number down.

This is just sickening that we have reached a point where people can not freely contract with one another without mountains of interference.

You can imagine a time when you could just have an idea and go right out and set up shop, hire a few people, and go. Now, you would have to get a license, fill out forms, hire an attorney, get a tax accountant, get proper permits, comply with various agencies, etc.

I heard John Stossel did a piece where he started a business in Hong Kong and in New York to see how long it would take. In Hong Kong, it took a day. In New York, it took several weeks or months and he still wasn't in compliance. If anyone has that video, send in the link.

thanks again.

Anthony said...

Trevor, make sure you follow the progress of The American Jobs and Closing Tax Loopholes Act (HR 4213). S-Corp taxes could be going way up if that passes.

Steve D said...

“If you have one million television sets and you want to sell them but no one wants to buy them, what should you do?”
Raise the price! That way you don’t have to sell as many!
Seriously, excellent article. Your argument for not having a minimum wage is very convincing. I should point out though that it is kind of like arguing 2 + 2 = 4. Setting a minimum wage above the market price for labor MUST cause unemployment in exactly the same sense as rubbing my hands together must cause friction (and then heat). The fact that many people cannot understand or accept this argument is frustrating. It’s not rocket economics people!

Doug Reich said...


"rocket economics" - love it

You're right - this is not complicated. In fact, most basic econ books will make the same point related to the min wage causing unemployment, etc.

Why does this fail to move the left? For the same reason, logical economic arguments never move them. It's why a hundred years of socialist tyranny and misery doesn't sway them. Informed by altruism and egalitarianism, they rather everyone be equally miserable. They completely reject any objective concept of value or justice.

Mo said...

this is something I noticed as well. But it could be reality evasion rather than just altruism per se?

People look at the economic logic and wish it was not because it makes them feel better and not have to face reality.

Anonymous said...

this was a great article
im only 14 so i dont understand government and economics as well but this cleared up alot of stuff

Anonymous said...

Raising taxes is the alternative to increasing workers' wages. CEOs of S&P 500 index companies pay themselves 380 times more than they pay their blue collar workers, and the U.S.'s top 1 percent hold 40% of the nation's wealth. The last time we had this kind of inequality was in 1929. Clearly the issue is not that larger companies can not afford to pay their workers more. By raising salaries, more people can afford goods, which, believe it or not, will increase demand. Wage increases may hinder new businesses, but that's not the biggest challenge they face. The inequality of opportunity that is ingrained in our society caters to the greed of large corporations who will take advantage of loop holes and manipulate numbers.

Doug Reich said...


Your comments violate the laws of economics and of logic.

Anonymous said:
"CEOs of S&P 500 index companies pay themselves 380 times more than they pay their blue collar workers, and the U.S.'s top 1 percent hold 40% of the nation's wealth."

RC: CEO salaries are not arbitrary. If you think you can get a good CEO for less, then go try. Blue collar workers are paid less because they produce less and are easily replaceable, i.e., there is more competition at their skill. Being a CEO is hard, just try it.

Anonymous: "Clearly the issue is not that larger companies can not afford to pay their workers more. By raising salaries, more people can afford goods, which, believe it or not, will increase demand."

RC: Sure, I "could" pay more for a hamburger, but I don't, because competition in the market drives the price to what it is. The market determines wages.

Furthermore, if companies just decided to pay more for wages it would not increase aggregate demand. That's because a dollar more spent on wages is a dollar less spent on something else.

Anonymous: Wage increases may hinder new businesses, but that's not the biggest challenge they face. The inequality of opportunity that is ingrained in our society caters to the greed of large corporations who will take advantage of loop holes and manipulate numbers.

RC: Your right, wage increases will hinder new businesses but that's not a problem? Inequality of opportunity can only be caused by government intervention in the marketplace in the form of artificial barriers to entry through regulation, licensing, government granted monopolies, etc.

Also, the government's policy of money creation (through the Fed) to fund government deficits leads to inflation which does, in fact, lead to economic inequality as those in a position to profit from inflation early in the cycle get rich while those who do not own assets suffer later through increased prices.

These policies are all the result of government intervention in the economy for which the solution is fully free unregulated marketplace in money, banking, and industry.

Doug Reich said...

Part 2


Why is "equality" just in this instance?

If Thomas Edison starts a company to produce his light bulb, and workers voluntarily contract with him to work in his factory at a certain wage, then why is that unjust? What is the "fair" wage?

If people voluntarily enter into a contract, who are you to say what is fair and what is not? Is it more fair for a government committe to determine what is fair and forcibly impose it on businessmen and workers?

Furthermore, if any company pays its workers or its managers more than what the market bears, the market will punish them through competition since their costs will be higher than otherwise.

No one has to invest in a company, work for a company or buy their products...unless the government forces them to which is what happens under socialism - the system which is truly unjust since it forces people to act against their will by arbitrary fiat.