Jobs creation and government policy,

Excerpt from a speech Mr. Jordan originally delivered in November at the Instituto Mexicano de Ejecutivos de Finanzas AC in Merida, Mexico.

Jerry L. Jordan | President and Chief Executive Officer, Federal Reserve Bank of Cleveland

Published January 1, 1997  | January 1997 issue

I. Jobs as an Objective of Government Policy

The dominant view of economic policymakers for much of the 20th century has been that a competitive marketplace will not generate enough employment opportunities. This view underlies the advocacy of government programs to "create jobs." At least since the Great Depression of the 1930s, we have seen aspiring politicians declare that their number-one economic objective would be to increase employment.

The intellectual justification for attempting to use government budgetary and monetary policies to fine-tune macroeconomic activity was provided by John Maynard Keynes' The General Theory of Employment, Interest and Money. This landmark book, born in the great global Depression of the 1930s, was the cornerstone of the economic doctrine that dominated western macroeconomic policies for several decades following World War II.

Before that, the notion of jobs creation as an objective of government would have seemed absurd. I am reminded of a story that a western businessman told me a few years ago. He had recently been touring China, where he came upon a team of nearly a hundred workers building an earthen dam with shovels. The businessman commented that with an earth-moving machine, a single worker could create the dam in an afternoon. The curious response from the local official was, "Yes, but think of all the unemployment that would create." "Oh," said the businessman, "I thought you were building a dam. If it's jobs you want to create, then take away their shovels and give them spoons!"

In the final decade of this century, the role of government has been moving away from the Depression-era way of thinking. In the 21st century, creating work for people to do will not be viewed as a desirable goal of government policy; fostering an environment for wealth creation will be.

Work is the necessary means of achieving wealth: In order to be consumers, we must also be producers. Despite whatever good intentions are presumed, when government shifts the focus away from creating wealth and toward creating jobs, it inevitably engenders a lower aggregate standard of living. A successful government policy—one that helps create wealth for the people—must simultaneously reduce the work burdens of the labor force. That does not mean people will need to "share jobs," or take low-paying jobs or go unemployed. Wealth creation occurs as the muscle component of employment diminishes and the brainware component increases.

The work record of industrialized countries in the past century is clear. In the United States, for example, the average workweek has fallen by roughly half since 1900. Among the benefits of wealth accumulation is the increase in leisure that it affords. Very poor nations are typically characterized by people who work most of their waking hours. To do otherwise would be disastrous. Where you find impoverished nations with high rates of joblessness, you will also find political/economic systems that have large disincentives to create and accumulate wealth.

The distinction between creating wealth and creating "work" can be illustrated by an economy that has experienced a catastrophic natural disaster. A well-known feature of market economies is that in the wake of a disaster, such as a hurricane or earthquake, employment and production tend to rise. One conclusion from this observation might be that market economies routinely maintain armies of unemployed workers who are gratefully called into service by the new demands of rebuilding houses, roads and all of the other investments that were damaged or destroyed. But clearly, these people are not better off because they are working long, hard hours. A more reasoned conclusion is that these natural disasters are destroyers of wealth—and creators of work in the sense that households and firms must now toil harder to help minimize and recover from their losses. I doubt that this is the sort of "jobs creation" program voters have in mind when they cast their ballots, although I suspect that many government "jobs" programs operate much like a post-disaster cleanup program.

II. Government and Jobs Preservation

Many people support a government role in maximizing employment in the belief that markets will not optimally provide opportunities for everyone who is willing and able to work. But what sorts of opportunities should the government provide under this philosophy?

Given the importance politicians generally assign to the task of creating employment for people, it is surprising how little they know about the nature of jobs creation in market economies. Studies of the U.S. record show no identifiable, systematic factors related to industry, region, wages, employer size, capital and energy intensity, or foreign competition that would account for a significant share of the types or number of jobs created or destroyed in the economy. Because policy-makers have no clear foresight of where entrepreneurial energies will be directed in the future, it's impossible for them to predict where jobs creation "should" occur. For example, two or three years ago, who could have predicted, let alone planned, that a rapidly growing occupation for young people would be designing home pages for Web sites?

It is not surprising, then, that government policies which seek to direct the flow of entrepreneurial talents in a effort to promote "good" jobs, and presumably to discourage "bad" jobs, will have uncertain and potentially negative effects on economic prosperity.

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I am of the generation that can still operate a slide rule—for what purpose I can only scarcely remember. But this technology must necessarily have been supplanted by the invention of electronic calculators, and already miniature personal computers are making calculators obsolete. This is the nature of progress—to make obsolete old technology. Innovation means to "creatively destroy" the pre-existing order.

Because of their imperfect vision, government jobs programs are almost everywhere jobs protection policies, which by extension tend to inhibit the creation of new, wealth-enhancing technology. The stagnant labor markets in Europe are a direct result of labor laws and regulations designed to protect existing jobs, even at the social cost of discouraging new capital formation and therefore wealth creation.

III. Borders, Prosperity and Capital Freedom

The two sides of a political border illustrate what government can and cannot accomplish. Why economic prosperity varies greatly along a seemingly arbitrary boundary poses perhaps the critical question for an economic policy-maker. What is the economic importance of borders that separate prosperity on one side and poverty on the other?

In the simplest terms, there can be only two reasons for divergent levels of per capita income: 1) different levels of resources or 2) differences in the allocation of resources (which may be either how the resources are employed or how many of the resources are employed). Moreover, these two sources of economic prosperity are interdependent: how a nation decides to allocate its resources will ultimately determine how many resources it has to allocate.

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It is a great conceit of governments on both sides of any border to behave as if market forces can be forestalled by more vigilant attention to guarding such borders. And it is a great myopia of governments to misconceive how these flows are the byproducts of their anti-market policies. On both sides of a border, a government's first inclination will likely be to build a fence—to try to circumvent the imbalance that the market is attempting to correct.

IV. The Role of Government in the Economy

The role of governments in the economy was laid out 10 years ago in a wonderful essay by the late economist Karl Brunner, "The Poverty of Nations." A person in an economy can use resources in only one of four basic endeavors: He can produce, trade, influence the political process in an effort to redirect greater resources to his advantage or protect himself against the wealth-redistributing efforts of others. In the first two uses—production and trade—the total welfare generated by the economy increases. In the language of economists, these activities represent a positive-sum gain. However, the latter two efforts—redirecting the flow of resources or protecting against the wealth—redistributing efforts of others-are zero-sum, or even negative-sum, games. They add no value and therefore generate a lower standard of living for people as resources are directed away from production and trade. Government institutions—laws, rules, regulations and the judicial system—influence each of the resource allocation decisions.

The influence of government as a wealth-redistributing body is well known in both eastern and western economies. As we have had ample opportunity to observe, government wealth redistribution by way of explicit or implicit taxation necessarily lowers the incentive to create and accumulate wealth, thereby lowering the potential productive power of the economic system. But governments also promote production and trade, because they are assignors and protectors of property rights, and provide for the enforcement of private contracts. These are wealth-enhancing activities that help the productive capacity of an economy to blossom. Thus, governments have two necessarily contradictory and coexisting modes, "the protective mode" and "the redistributive mode."

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The ability of governments to influence the creation of wealth has been documented in a recent study produced by a consortium of research institutes in Canada, Mexico and the United States. The study attempted to gauge, in a methodical way, the economic freedom of a broad cross-section of nations. The conclusion from examining more than 100 countries over a 20-year period was that governments with a strong commitment to economic freedoms—free personal choice, the freedom of exchange, and the protection of private property—tended to be faster-growing and wealthier countries. No nation with a persistently high economic freedom rating during the 20-year period failed to achieve a high level of income. Furthermore, the 17 countries with the most improved freedom ratings all had positive and generally strong growth rates, while the 15 countries where economic freedoms declined recorded real per capita wealth declines.

V. A Wealth-Creation Role for Monetary Policy

There is a presumption that monetary policy in industrial democracies has two objectives—to promote price stability (low inflation) and to promote employment growth. Although many contend that these objectives are in conflict, I disagree. It's false to conclude that a tradeoff exists between price stability and jobs creation. Such a perception puts proponents of stable monetary systems in the position of appearing to be anti-jobs. On the contrary, by protecting the purchasing power of a nation's money—and thereby protecting the property rights of the private enterprises that use the publicly provided money—the central bank promotes the creation and accumulation of wealth.

The alternative of allowing the purchasing power of a nation's monetary standard to erode over time—to allow inflation to occur—redirects a nation's resources from activities that create new wealth toward efforts to protect existing wealth from the ravages of inflation and currency devaluations. If the wealth-redistributive effects become great enough—that is, if the inflation rate becomes extreme—the monetary standard will be abandoned by the people, and a monetary standard that is outside the political boundaries will emerge.

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The evidence on wealth creation and inflation is incomplete, but there can be little doubt that this view is gaining broad appeal. A recent study for the Bank of England reported that a 10-percentage-point increase in average inflation reduces the growth rate of real per capita income by about 1/4 percentage point and lowers the ratio of investment to GDP. These results imply that the long-run effects of inflation on a nation's standard of living can be large when accumulated over a number of years. This work is consistent with findings by economists at the Federal Reserve: "... evidence consistently points to a negative correlation between inflation and the growth of productivity over the post-Korean-war period in the United States."

Economists will debate the details on how best to implement a stable price objective for central banks. Indeed, such debates have been occurring in the United States for many years now, as they have around the world. But there is one essential element of this objective: Governments must abandon the notion that unstable payments systems—inflationary payments systems—are useful jobs creation strategies. The record on this point is clear. To allow for the highest standard of living for the people, the central bank must provide the highest possible incentives for the creation and accumulation of wealth, and that, above all else, means they must provide a stable monetary system.