Forgotten Economics

Forgotten economics and the American economy
by
Herb Engstrom

NOTE: This essay was written well into the administration of President Bill Clinton. The examples are a bit out of date, but the economics and the conclusions never are.
Herb Engstrom, January 2005.

    Picture yourself alone on an isolated Caribbean island with a huge chest of pirate treasure - gold, silver, and jewels beyond your wildest dreams. But being alone you can't spend any of it. You can't eat it; when it rains it won't keep you dry; when the wind blows, it won't keep you warm. It is – in a word – worthless.
    Now picture yourself on that same island with that same treasure but no longer alone. The island is filled with people that are willing to raise food and sell it to you in exchange for gold or silver. Others are happy to build you a palatial home for you also for gold or silver. Others will sing, dance, and provide whatever entertainment you prefer for a few Spanish doubloons. Your treasure has suddenly become valuable. Why? Because with it you can purchase human labor – people are willing to work for you.
    But suppose as a result of this luxurious lifestyle that your treasure now provides you, you develop a serious ailment – maybe hypertension – that requires the intervention of a skilled physician. Your treasure is not quite so valuable if all it can buy is the labor of farmers, carpenters, and entertainers. You discover that for gold, silver, and jewels to be truly valuable, there must be highly trained physicians, engineers, accountants, and, yes, lawyers, politicians, and public servants.
    Imagine now that you live not on an isolated Caribbean island but in the United States. Imagine, further, that your treasure is not pirate gold, silver, and jewels, but rather it is something less substantial: stocks, bonds, money market funds, greenbacks, and the promise of a Social Security check.
    You could be in as bad a shape as if you were alone on that island with pirate treasure and for exactly the same reason: without a highly trained work force and without highly educated professionals, all your investments, your savings, your wages, and your retirement income become worthless.
    Indeed, if policies advocated by the Republican Party are enacted into law, bankruptcy of the United States may well be the unavoidable consequence. For their policies have specifically targeted education and worker training at all levels. One example: here in California after 14 years of Republican administrations in the state government, we rank dead last in per pupil expenditures in schools. And our children's miserable test scores provide ample evidence of the consequences of these policies.
    Republican attempts to reduce government spending are a classic example of being penny wise and pound foolish. We save a few dollars in the short term by cheating our students, our labor force, and, ultimately, ourselves. Ask yourself:
    How will Medicare help you if there are not enough doctors to go around?
    What will be the value of your savings if your taxes go not to educate and train but to build and operate all those prisons to house the millions that Republicans have denied a good education?
    How will you spend your dollars if no one knows how to build the homes and raise the crops?
    There is an alternative. President Bill Clinton's program has emphasized not only the importance of supporting education but, for the first time, the U.S. government is committed to a program of worker training – training that all Americans will ultimately benefit from.

    Any discussion related to what in Thomas Carlyle's words is the "Dismal Science" of political economy is unlikely to be of gripping fascination to most people. It is no doubt for that reason that our information media – newspapers, TV, radio talk shows, etc. – are replete with accounts of murders and mayhem rather than of serious discussion of politics and economic issues. Yet, as President Clinton emphasized during his 1992 campaign, it is the economic problems, more than any other thing, that constitute the most serious issues at this time.
    Two events have brought considerations of political economy once again to current importance. First is that Communism as a social-political-economic system has been completely discredited allowing us to turn our attention to other areas. Second, there are serious economic problems facing the United States such as the future of Social Security.
    The current debate about the economy poses the questions of what level of government spending and in what areas is desirable if we are to reduce the deficits at all levels of government. Implicit in this debate are the very widely accepted and unexamined assumptions that deficit reduction requires either spending cuts or tax increases, and that tax increases necessarily dampen economic growth and activity. Yet, for the past few years, the U.S has enjoyed a balanced federal budget, relatively low inflation, and relatively high employment, much to the amazement of classical economists. I will argue that an understanding of a couple of fundamental economic principles will show why this happy state of affairs might have been expected.
    To see why this is so, we must realize that these two key principles are fundamental:

1. Money has value only insofar as it represents human labor.
2. All money ultimately ends up in the purchase of human labor.

    The idea that value is added through human labor is, of course, not a new one: it goes back at least as far as John Locke in the 17th century. But I believe the idea that money has no intrinsic value deserves reiteration.
    The lesson that Spain learned in the 16th century is illustrative. Because of the imperial ambitions of Spain's Habsburg emperors, Charles V and successors, the country raised enormous armies thereby removing a good fraction of its population from economically productive enterprises. The financing of the wars of the 16th and 17th centuries required huge sums of money, which the emperors raised in part by importing as much gold and silver as they could extract form their American colonies. But armies, like the rest of us, cannot eat gold, nor can they wear or take shelter under silver. All the money that Spain raised could buy little within the country because sufficient productive capacity was no longer available. The result was horrendous inflation and eventual bankruptcy of the country.
    And you being alone on that Caribbean island with pirate treasure and no way to spend it is certainly an illustration of the value of human labor.
     The second principle, that money ultimately buys human labor, is something of a corollary to the first proposition, and one that seems always to be overlooked, even by economists. Let us understand why this concept is true and how it leads to a specific course of action in addressing current political and economic problems.
    Consider the production, distribution, and sale of a common item, an automobile, for example. Economists, like the accountants of the automobile company, like to break down a company's expenditures into many categories only one of which, often a small fraction of the total, is direct labor costs. The other categories will be such things at materials, overhead, rent, interest, taxes, utilities, profit, etc. But if we carefully track any one of these other items, we find that the money spent will eventually end up buying somebody's time and effort.
    Pick rent, for example. The owner of the building in which the product is manufactured receives the rent money and in turn disposes of these funds in a way that can be similarly broken down. The landlord maintains the property by hiring someone to mow the lawn, wash the windows, paint the building, keep the books – all labor costs to him. But the landlord, too, pays taxes, utilities, and also retains a portion as his own, equivalent to a salary he pays himself for his labor in administering this enterprise.
    Let us consider another category of expenditure: The taxes that the car manufacturer pays also purchase labor. A large part of Federal taxes go, as a further example, into the Department of Defense, where it too may be tracked according to expenditure category. Much goes into salaries from those of infantry privates to that of the Secretary of Defense. Much goes to the purchase of equipment including cars, which, as we have already noted, includes a much larger proportion of labor costs than found in the accountants' "direct labor" category. In addition to the salaries of the military personnel and the equipment they use, there are other D.O.D. expenditures; consider fuel for the tanks, planes, and ships, for example. The money spent for gasoline goes to the salaries of the field hands that pump the petroleum from the wells, of the merchant mariners that transport it across the seas, of the refinery workers that convert the raw petroleum to gasoline, of the shippers that transport it to the military installations, and of the numberless accountants and bureaucrats in the oil industry whose labor is, to be sure, essential for the smooth operation of a very complex production and distribution system.
    To consider your taxes, mine, and those of General Motors somewhat further, what of the governmental expenditures that do not buy labor of direct use to the American people? I am thinking of those expenditures of the Department of Health and Human Services and in particular such things as Aid to Families with Dependent Children – welfare. Certainly a welfare check from the government does not buy labor. Not directly, that is true, but again, ultimately, these expenditures must purchase labor to have any value at all. We must ask: what does the welfare recipient use the money for? A large fraction normally goes to rent (and we've already seen what happens to that) and much of the rest goes for food. That is, the food expenditures go to buy the labor of the farmer who produces the crops, of the truck drivers that deliver it to the grocery stores, and of the shelf stockers that make it accessible to consumers, and of the checkers that sell directly to the consumer.
    But suppose, as it is often charged and is no doubt true in some cases, that the welfare recipient uses a portion of the funds to support a cocaine habit. Even here one could break down the expenditure in terms of payments for the labor of many people from the Peruvian coca farmer to the neighborhood dealer. In an economic sense we don't require labor to be socially useful.
    But in an ethical and even practical sense we do indeed require labor to be productive and socially useful. We need to explore this concept, social utility, in somewhat more detail.

GOALS FOR A JUST SOCIETY

We should perhaps first ask what should be the goals of a just and democratic society. A specific agenda, and one that I think most Americans could support, was proposed by Franklin Roosevelt in his State of the Union address on January 11, 1944. In that address he proposed an Economic Bill of Rights and said that among these rights are:

The right to a useful and remunerative job in the industries or shops or farms or mines of the nation;
The right to earn enough to provide adequate food and clothing and recreation;
The right of every farmer to raise and sell his products at a return which will give him and his family a decent living;
The right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad;
The right of every family to a decent home;
The right to adequate medical care and the opportunity to achieve and enjoy good health;
The right to adequate protection from the economic fears of old age, sickness, accident, and unemployment;
The right to a good education.

Not a bad list, this. One could, I suppose, add a few more items in the light of 50 years of "progress" such as the right to breathe clean air, to drink uncontaminated water, and to be protected by a healthy ozone layer, but Roosevelt's list will do for starters.
A simple definition of socially useful labor might be any work that contributes to the attainment of these goals. Examples might be:

    the farmers, truck drivers, stock clerks, and grocery checkers that ensure an adequate supply of food;
    the miners, loggers, millwrights, carpenters, electricians, and plumbers that provide us with housing;
    the actors musicians, and writers that make our lives a little more pleasant in our leisure hours and days;
    the health care workers;
    the teachers and aides, janitors and gardeners, psychologists and administrators that staff our education system;
    and not to omit the government workers at all levels that ensure the peace and stability required for an orderly functioning of society.

ACTIVITIES WE MIGHT DO WITHOUT

    There are other human economic activities that are marginally useful or not at all in the social sense. These are the activities that do not contribute to the improvement of the standard of living of the public. Which activities fall into this category is bound to be controversial, certainly among those people engaged in them. Let me offer a few examples from my list:
    Attorneys have been receiving a bad rap recently, but I have to admit that there is much truth to the allegations made by former Vice Present Dan Quayle before the annual meeting of the American Bar Association in August of 1991. He pointed out that America is the most litigious country in the world. Do we really need, he asked, 75% of the worlds lawyers? The answer has to be "no" if we examine carefully the activities of some of these lawyers. The ambulance chasers are not nearly as troubling as the legions of very highly paid corporate tax lawyers whose mission in life is to seek out loopholes in the tax code that have a reasonable probability of escaping the attention of the IRS.
    This deplorable situation is due in some degree to the activities of Congress, whose members have wasted years creating an unreasonably complex tax code that allows these abuses to take place. Those Congressional activities I would also characterize as not socially useful.
    Although, as I have pointed out already, the medical industry is essential for the attainment of a satisfactory standard of living, abuses within the medical system occur. The medical insurance industry has grown too large, partly because of the continual necessity to monitor the activities of doctors, who require of their patients superfluous medical tests because of the doctors' fears of litigation. Like tax law the personal liability laws have become unreasonably complex, unfair, and consequently a drain on the nation's resources.
    Not all such socially unproductive groups are necessarily undesirable. One very large economic activity is the defense establishment of the United States. Most people, and I among them, would agree that a standing military and supporting defense industries are necessary. But these are unproductive in the social sense in that the purchase of an F16 fighter, although necessary for our security, does not add directly to our standard of living. It is quite the reverse; the taxes I pay to purchase military equipment could be used to pay for a new car for me, a longer and more comfortable vacation, a new roof on my home, or dozens of other indulgences that would contribute directly to an improved lifestyle for me and my family.
    There are of course many other examples of socially unuseful enterprises that one could cite, but in addition to these we must consider the group of activities that are not merely unproductive: those that are socially dysfunctional. These are the activities that actually contribute to a decline in our standard of living. The examples that come quickly to mind – drug dealing, burglary, mugging, etc. – may have an important effect on the economy, but I would include in this category individuals whose activities are entirely legal but which have a far greater impact. These include the directors of the failed Savings and Loan institutions, the junk bond dealers, and the arbitrageurs. I include these because their activities are not directed toward increasing the size of the economic pie, but rather in dividing the same size pie in such a way to achieve a larger slice for themselves. In doing so, others are left with a smaller slice and consequently not only is the standard of living of those others adversely affected, but the productivity of society as a whole is reduced.
    Finally, we must consider one other group, that of the unemployed. I include in this group not only those that are actively seeking employment, which is the definition used by the Department of Labor, but all those who have no economic activity, useful or otherwise. These are the people whose search for employment has been so fruitless that they have given up the search, as well as the homeless, the welfare recipients, and even inmates of our penal institutions. In a way the economic effects of these group are not unlike that of the socially dysfunctional group in that they, like the rest of us, are consumers. They eat, they require shelter and clothing, medical care, and so on. Thus, they utilize society's resources, resources provided only by those engaged in socially useful activities, while contributing nothing in return.
    To achieve the goals of a just society we must bring these nonproductive and counterproductive groups into the production of socially useful labor. The first step is to recognize that it is their labor that is either unutilized or wasted and that making them productive will in the long run save the taxpayer money. We can and should turn these groups from recipients of taxes to producers of taxes.

FALLACY OF THE PEACE DIVIDEND

    In the light of this analysis it becomes clear that some proposals to deal with budget deficits are bound to fail. The "peace dividend" is one such proposal. With the end of the cold war liberals and conservatives alike look on our substantial defense expenditures as a potential source of funds to reduce the federal deficit. But the result of simply cutting defense expenditures, in the absence of a revised industrial policy, would be to create huge increases in unemployment among defense workers. We, the taxpayers, would continue at least partial support of these people through unemployment compensation. Although supporting an unemployed Lockheed engineer through unemployment compensation may at first appear to be a net saving, it is widely recognized that unemployment often leads to a wide variety of social problems – alcoholism, spouse abuse, suicide, and crime for profit. It is certainly not clear that simply cutting the defense expenditures will lead to a net saving for society as a whole.
    A far better solution is to channel the activities of the defense establishment into socially useful enterprises.   For example, electronics is a major component of the defense industry, yet, with the exception of the personal computer industry, America has allowed its consumer electronics industry almost to disappear. American manufacturers now retain only about 10% of that market. At little increased net cost we could, with an intelligent industrial policy, convert our defense electronics industry to consumer electronics. In doing so we would not only reduce defense expenditures, but we would simultaneously reduce our hemorrhaging trade deficit, since almost all of our consumer electronics come from the Pacific Rim countries.
    Another example: During the 1992 presidential campaign President Bush proposed shutting down the shipyards at Groton, Connecticut, which produce nuclear submarines for the navy. Bill Clinton rushed to oppose this shutdown; he would build another submarine, he had promised, to save the jobs in the shipyards. Like consumer electronics, America has allowed its shipbuilding industry, which is certainly vital to America's defense, virtually to disappear.   The only remaining major shipbuilders in this country are those, like Groton, that produce for the Department of Defense. Thus, not only do we import Japanese VCR's, but to do so we transport them on ships built in Japan. A truly progressive industrial policy would preserve the jobs in Groton not by building another useless submarine, but by converting the shipyard to civilian use. Let us resurrect the American shipbuilding industry by building freighters and tankers in Groton, Connecticut, Newport News, Virginia, and Mare Island, California. The shipyard workers win, the American merchant marine wins, the consumer wins, and the taxpayer wins.

DEFICIT REDUCTION

    Recognition that money is of value only insofar as it can purchase human labor also points the way toward solving the enormous social problems of the U.S. while simultaneously balancing the federal budget. If this sounds too good to be true, one need consider only such countries as Japan, Sweden, Germany, and many of the other countries of Western Europe. These countries have neither the massive deficits nor the scale of America's problems of crime, unemployment, and inadequate health care.
    The deteriorating infrastructure is frequently cited as a serious impediment to American economic recovery and growth. Our highways need repair, our railroads need modernization, our harbors dredged and so forth. "But where will the money come from?" is the question invariably posed. Raising taxes, it is asserted, will dampen economic activity and slow the recovery from the recession. Most importantly, if the truth be told, raising taxes makes voters unhappy.
    Yet the analysis presented here suggests that we could make enormous improvements to our infrastructure at much less cost than it would first appear. We need to bring those groups representing socially unproductive, dysfunctional, and unemployed labor into the socially useful category.
    Some states and localities have already begun to provide jobs for welfare recipients in programs sometimes termed "workfare." But these programs are fragmented, uncoordinated, and insufficient. What is required are massive, coordinated programs at the federal level to guarantee the availability of a job for any and all people presently on welfare simultaneously with the cessation of welfare payments as such. It is vitally important that such jobs be productive in the socially useful sense. These jobs must create wealth; they must add materially to our standard of living. Herein lies the distinction between traditional (and discredited) liberal policy and a genuinely fair and progressive one.
    Our bulging prison population represents another resource that can be effectively used. It costs at least $20,000 per year to incarcerate a criminal, and America has the largest per capita rate of incarceration of any industrialized nation. Here we have a situation where prison authorities – the guards and administrators – are performing socially unproductive work to maintain a group of the socially dysfunctional. At little greater cost we could turn the prison guards into cops on the beat, while employing many of the former prisoners in such jobs as filling the potholes in our highways that our turning our cars and trucks prematurely into junk. Certainly providing useful, remunerative employment for ex-convicts would go far to reduce the rate of recidivism. Again, society wins: rather than waste tax money on penal institutions, we benefit from the labor of these people whose salaries would otherwise be wasted on those of the prison administration and supplies. Socially useful work could, and should, be required of all those that remain in prison as well. Organized labor has in the past opposed such work but only because it has competed with domestic employment. But as we have seen, there are many industries like consumer electronics and shipbuilding, but also machine tool manufacturing, whose domestic production is limited or nonexistent. Prison industries in these areas would not adversely affect labor's interests while promoting a militarily strong America and helping the American consumer, the taxpayer, and the prisoners themselves by providing skills and education. Not least, hard work at essentially no pay would provide a disincentive for young people to engage in those activities that might land them in prison. This would be especially true if we were to guarantee good, remunerative jobs outside of prison as an alternative to petty and not-so-petty crime.
    The understanding that money represents labor sheds light on what in the recent past has been a serious and troubling problem facing the U.S., that of the budget deficit. Conservative, and some not so conservative, politicians rail against spending money today that our grandchildren will have to repay. But it is very important to realize that our grandchildren are not the ones building the highways and submarines and F16 fighters today. The labor for all these projects is provided at the present time. Where does the money used to finance these deficit expenditures come from? It is surplus funds that people invest in bank deposits, stocks, bonds, and other financial instruments. That is, the people with this money, small investors as well as large, choose not to spend the money on their own personal acquisitions – homes, VCRs, yachts, etc. – but rather they invest these surplus funds, which are then used by the government for social purposes. Thus, the investors choose not to buy the labor of the carpenters, electronics assemblers, and boat builders, for their own personal use at the present time and thereby enable the government to buy the labor of essentially the same workers (or types of worker) for its use. But the investor receives an IOU usually in the form of a bond from the government (or from an investment institution that in turn receives one from the government). The IOU is a promise to pay back at a later time the invested amount with interest, an amount that the investor, or his grandchildren, can then redeem in the form of the labor of the carpenter, electronics assembler, or boat builder.
    If the funds-labor for spending by private investors is available at the present time, the government, in principle, need not borrow it, The government, if it had the courage, could simply appropriate these funds and the labor it represents through taxation. Unfortunately, the government finds it easier to borrow with a promise to repay than to tax. People are far more willing to postpone than give up entirely the benefits of their own labor.

CREATION OF WEALTH

    There is one conservative argument against taxation that requires examination. Conservatives will argue that the funds are better left in the hands of private investors, who will "create wealth." That is, in private hands the funds will go toward the construction of new factories and other productive enterprises. The government, they argue, will waste the money in nonproductive ways.   The argument has had validity. In the past the government, although often motivated by good intentions, has spent much money on what I have characterized as unproductive or unemployed labor. But there is no real economic difference between the government and private enterprise investing in productive enterprises. Certainly, public sector money spent for education, training, Project Head Start, and similar human investments are potentially at least as profitable as private sector investments in capital goods. Capital goods wear out and depreciate; human resources are self-perpetuating and renewing.
    The budget deficit is certainly an important issue, as it has been ever since I can remember (and my memory of presidential elections goes back 40 years!). But under the Reagan and Bush administrations the budget deficit had reached a crisis level.   The ex-candidate Ross Perot – Republican in independent clothing – was only the latest to propose eliminating the deficit by reducing "waste in government." Ronald Reagan used the same slogan.
    Let us consider the numbers: in 1992, when Perot offered his solution, the deficit ran at about 400 billion dollars per year. Perot suggested a savings of 100 billion by eliminating waste, or only about one quarter of the entire annual deficit. We invoke principle number 1, that 100 billion dollars represents an equivalent amount of human labor. This means we save this amount by laying off enough government workers (or private sector workers supplying goods and services to the government) that we no longer need pay 100 billion dollars in salaries. How many workers would this be? Even if we consider the costs of benefits, overhead, and other costs related to the employment of a worker in addition to the salary, I believe even a figure of $100,000 per worker is generous. (And remember, employed government workers also pay taxes, so the government recoups a good fraction of that number.) But let's be conservative and say $100,000 could be saved by laying off a government supported worker. My arithmetic tells me that $100 billion dollars in "waste" divided by $100,000 per worker represents the layoffs of one million workers. I'm certain that any human institution, being made up of imperfect human beings, is not quite as efficient as it ideally could be, but were there really that many goldbrickers in the government? It is no wonder that Ronald Reagan failed to make good on his promise to balance the budget, and it is no wonder that Ross Perot would similarly have failed.
    "Entitlements" is another term that some politicians tremulously put forth as requiring re-examination.   Specifically, the entitlement that causes politicians the most anguish about "putting on the table" is Social Security. Many retirees and people approaching retirement age make an argument that has much validity: "I paid into Social Security for 40 years," they say, "and I have a right to receive a decent return from it!" Often the people making such an assertion regard Social Security as an investment such as stocks, bonds, or a savings account. But it is common knowledge these days that Social Security is not really an investment; it is a tax just like income tax. Without an educated and productive work force, those taxes collected in the current year will not purchase the goods and services required by the Social Security recipients.
    Principle number one - that money represents labor - shows that it makes not the least bit of difference whether Social Security is regarded as a tax or as an investment, Without a plentiful, educated, and productive work force, even the stocks, bonds, and savings accounts held by our retired population will be essentially worthless.   The ineluctable conclusion is that we require massive investment in human resources to get full value from our taxes as well as from our monetary investments.
    Certain economic "realists," fault the Republican administrations (and some Democratic ones) for refusing to face up to a fundamental economic trilemma.

It is obviously impossible, they confidently assert, simultaneously

to maintain the present high level of government services;
to retain a relatively low level of taxes;
to achieve a balanced budget.

Within the context of traditional Republican and even Democratic ideology I would certainly agree. However, these "realists" are overlooking one very important consideration – one that I have been emphasizing: We can achieve a balanced budget while maintaining high government services without unacceptable tax increases by widening the tax base. That means bringing the nonproductive sectors of the population into areas of socially useful and productive activities.
    The 1999 projected budget surplus of $115 billion is an illustration. We are currently enjoying a very low rate of unemployment. People are working relatively productively and paying taxes. There have been, admittedly, reductions in government services (and expenditures) – welfare and the military are two that come to mind – but the emphasis of the Clinton administration on "growing the economy" and the emphasis on work rather than welfare has contributed to the budget surplus.
    The fundamental flaw with conservative ideology is the belief that only the private sector is capable of maintaining a healthy economy. Turning this economy around in the way I have suggested will require an initial investment with little short term return. The private sector is never willing to make investments under such conditions. What is required are coordinated programs guided, if not sponsored, by the federal government to achieve these ends.
    Thus, we have begun, in a small way, to convert unproductive, dysfunctional, and unemployed labor into the socially useful. We need to continue this process to establish a virtuous circle of economic growth, increased tax revenues, and reduced social problems. What is required of our political establishment, and what had been almost entirely lacking for nearly three decades, was vision, imagination, and courage.

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