#77 Reader Q&A: Unemployment and Recessions

Hi Collin,

A friend pointed me at Unpopular Opinions 119 where you are Ben were
guests.  I hadn’t seen it before or heard of WTF1971 or Bitcoin Echo
Chamber.  You stood out as the one who could briefly get across the
salient points and since then I’ve been reading wtf1791.com from the
first post and cherry-picking BEC episodes.

https://wtf1971.com/2020/07/20/41-unemployment-and-the-market-new-deal/
is the first post where I don’t think I’ve quite got the answer to:

    …periods of low unemployment correlate with upcoming recessions.
    But why?

Here’s what I do understand.  The article says:

    The profit of a laborer is where technological inefficiencies are
    met with human capital.  Entrepreneurs are incentivized by the
    feedback mechanisms of profit and competition in the marketplace, to
    provide the same goods and services for less.  To do this, they must
    increase efficiency by targeting the greatest costs to production.

Low unemployment increases labour cost due to lack of labour supply
which increases reward to those entrepreneurs who technically
innovative.  Lessen technological inefficiencies and less expensive
labour will be required giving more profit.

I still don’t see the connection to a following recession only an
increase in unemployment.  Sorry if I’m missing the obvious.  Perhaps
that article needs an extra sentence or two for others like me who miss
the point.

Thanks for all you’re doing to educate us.  I’ve long thought Austrian
economics made common sense from what little I heard of it, but your
series of brief posts at wtf1971.com are the first time I’ve found
consumable material which can be chipped away at each day.


Cheers, Ralph.

Hi Ralph,

Thanks for reaching out. The first thing you need to keep in mind in order for the context to make sense are the stated goals of the federal reserve. They are as follows:
1. maximum employment,
2. stable prices,
3. moderate long-term interest rates

As per the FAQ in federalreserve.gov:

“Maximum employment is the highest level of employment or lowest level of unemployment that the economy can sustain while maintaining a stable inflation rate. Over the past few decades, experience has shown that it is possible to keep unemployment low and the jobs market strong without leading to an unwanted increase in inflation.”

Here we can see that the Fed is very clear about the nature of a relationship between employment (particularly low unemployment) and inflation. But why? Let us keep in mind that this is not an objective goal…that is simply stating “the lowest level of unemployment that the economy can sustain while maintaining a stable inflation rate” doesn’t give a very good clue of what the Fed is trying to do.

When prompted about unemployment during a recent press conference, Jerome Powell responded, “maximum employment will require more than supportive monetary policy….It will require a society-wide commitment, with contributions from across government and the private sector.” (I’ve bolded the bits that I find particularly striking).

It seems to me that people often forget that the Fed is (supposedly) doing more than just buying up assets and printing money. They are allegedly also engineering monetary policy around what they consider maximum employment. Henry Hazlitt actually covers this in chapter 4 of his book “Economics in One Lesson“.

“Everywhere government spending is presented as a panacea for all our economic ills. Is private industry partially stagnant? We can fix it all by government spending.Is there unemployment? That is obviously due to ‘insufficient private purchasing power.’ The remedy is just as obvious. All that is necessary is for the government to spend enough to make up the ‘deficiency.’ “

Hazlitt uses a hypothetical example where a “job shortage” is identified by central planners and the proposed solution is for a new bridge to be built. The justification is that this new bridge building project will create new jobs and help “stimulate” the economy.

“For every dollar that is spent on the bridge a dollar will be taken away from taxpayers. If the bridge costs $1,000,000 the taxpayers will lose$1,000,000. They will have that much taken away from them which they would otherwise have spent on the things they needed most. Therefore for every public job created by the bridge project a private job has been destroyed somewhere else.”

It is important to remember that governments do not create wealth. Governments (via taxes and arcane institutional mechanisms) redistribute wealth, away from productive workers and entrepreneurs who solve problems for profit, for public projects. It stands to reason, if we believe that free and open markets profitably and voluntarily solving problems are ideal, then public works to “make up for the deficiencies in the market” is at best zero sum.

Said another way, if maximum employment were truly an ideal goal, then technological progress would be our enemy. Destroy all the internal combustion engines and farm machinery and we could put every man, woman, and child on earth tomorrow morning plowing fields with rocks. But we know this is not true, because technological progress not only makes our lives easier but allows goods and services to be provided at market faster and cheaper. This in turn improves our quality of life and allows us to direct our energies and capital at solving other problems.

In fact, I would go so far as to say that some unemployment (barring boom bust cycles created by government intervention) can actually be a good thing. I know it sounds a little crazy, but consider that disruptive technologies, which can improve life by orders of magnitude, can potentially put thousands of people out of work overnight. It is representative in the ebb and flow of human capital being put to use to make up for technological deficiencies in the market process.

Should we then halt all technological progress to protect established order of operations in our economic system? Certainly not as that would mean all progress towards solving problems faster and more efficiently must cease. Imagine the wasted resources in a world where we were still protecting guilds of lamp lighters and town criers.

So Ralph, to answer your question a bit more directly, low unemployment is often indicative of increased levels of government intervention in the economy (at the expense of the productive facilities of the market) and this is why historical trends tend to make it a predictive measure of an upcoming recession. Government economic intervention requires increased spending in the form of more taxes, more credit expansion, and more inflation. And as our research has shown, these mechanisms create inflationary bubbles which lead to deflationary busts.

Sounds like a net negative to me.

-Collin

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