Full Employment Without Inflation
Arthur P. Becker, Ph.D.
[Reprinted from Survey of Business,
|Arthur P. Becker (1918-1978) was at the time
this paper was published Professor of Economics at the University
of Wisconsin, Milwaukee. He specialized in Public Finance and
Urban Land Economics.
Since 1933 persistent and reoccurring unemployment has produced
pressure for increased federal spending, resulting in higher taxes,
deficits and prices. Government intervention has grown to the point
where the public sector now comprises 35 percent of Gross National
Product and 40 Percent of national income.
Nevertheless, unemployment is worse today than at any time since
the Great Depression and inflationary pressures in the past few
years have been greater than at any time since World War II. Of
course, much of this growth was stimulated for other purposes (such
as the development of the Great Society programs) rather than merely
/or countering persistently high unemployment.
Persistently high unemployment accompanied by even moderate
inflation stems from one condition. Our Present economic system
cannot maintain general equilibrium without motivating full
employment through appropriate adjustments in the real income or
factors of production.
According to Keynesian monetary and fiscal demand management
policies, high unemployment should be countered with a combination
of such actions as an increase in the total money supply, a
reduction in taxes or an increase in government spending through an
"appropriate" deficit. This increase in aggregate demand
with moderate price increases will supposedly create profit
opportunities and incentives for business to borrow at prevailing or
lower rates of interest.
However, economic experience during the 1970s has shown that
demand management policies are not successful when inflation is
substantial and continual. With this kind of inflation lenders will
boost interest rates in an effort to protect the purchasing power of
the funds they lend. Thus, inflationary expectations induced by
commodity shortages or overly expansionary monetary and fiscal
policies will make interest rates rise. High interest rates will
reduce profit expectations (reflected in the fall of stock prices)
and investment incentives.
More specific remedies are needed to deal with the energy crisis,
the world food shortage and irresponsible government spending which
are largely responsible for the recent siege of inflation and
unemployment. Specific remedies are also needed to treat persistent
large scale unemployment which directly or indirectly contributes to
much of our inflationary pressure. Supply management policies that
will increase economic incentives for investment and work are the
specific remedies for long-term, and often short-term unemployment
According to modern economic theory, the major purpose of monetary
and fiscal policies for demand management is to reduce real wages,
thereby increasing profit expectations, production, investment and
employment. However, it would be far more equitable to increase
expectations in higher real income for investors and workers by
reducing the real income of unnecessary and undeserving
In our system of private enterprise, the immediate goal of supply
management programs is to provide adequate incentives and
opportunities for individuals and businesses to increase production
voluntarily by working, saving and investing. This approach toward
full employment contrasts with demand management policies which accept
the weakened condition of incentives and try to revive real
investment incentives and job opportunities by means of inflation.
Economic incentive to invest and work and thereby to increase
employment and production (which in turn could prevent prices from
rising as much) is maximized when all of the national income is
channeled into the hands of those who contribute to production. This
does not preclude public sector activities which are supported by
the majority of producers, both workers and investors.
Unfortunately, the private enterprise system in the United States
has suffered an erosion of those very incentives upon which Its
The rivulets of erosion of economic incentive are countless.
However, it seems that most of the real national income which is
drained off to nonproductive individuals can be grouped into the
following categories: the economic rent of land, monopoly and the
restraint of competition, waste and inefficiency, crime, and
transfer payments. These conditions drain the productive vitality of
the private enterprise system siphoning off a large portion of the
real national income from the potential real wages of workers and
potential real profits of investors in capital. Each of these
drains, in one way or another, increases costs of production,
reduces profits and wages, discourages investment and the desire to
work, decreases productivity and increases unemployment and
While these income drains can more fully account for the endemic
unemployment and inflation of our system of private enterprise, they
are also at least partially responsible for the acute symptoms of
these economic ailments. There seems to be ample evidence that the
economic rents and values of land, monopoly profits, waste,
inefficiency and crime increase at faster rates than the Gross
National Product during periods of relatively full employment and
prosperity. These drains on investment and worker income tend to
reduce investment and work incentives to the point where total
employment increases very little or not at all, and the rate of
unemployment may rise.
What is the nature of these nonproductive drains on national
income and their macro-economic significance? We should take a
closer look at each of these income drains.
The Economic Rent or Price of Land
The drain of the economic rent of land is the most pervasive
income drain of all. Since land and its services are supplied by
nature, the economic rent of land constitutes a surplus payment for
production and therefore one variety of nonproductive income.
Because all economic activity requires the use of land for space and
for other resources as well, the drain imposed by land rents for
leasing or land values for purchase is inevitable and enormous,
ranging all the way from choice urban land sites to oil lands.
The barriers which this income drain imposes on investment
opportunities are largely hidden in debt instruments of vast
magnitude and high or prohibitive fixed interest charges. As an
example, a young farmer may have to pay $250,000 for 360 acres of
tillable wheat land that can net him an economic rent of $25,000 per
annum. The purchase price would reflect the capitalized value of the
economic rent at a rate of 1O percent. Now, our young farmer must
pay a 10 percent rate of interest on the $250,000 mortgage loan to
buy the farm land. The net economic rent of land is converted in
this manner into a fixed interest obligation.
Higher economic rents of land (net of taxes on the land) caused by
general inflation or scarcities of land resources, such as oil, are
capitalized into higher market prices. The acquisition of these
resources for use will require a larger volume of borrowing and
fixed interest charges. Thus, the marginal efficiency of investment
is reduced as the returns to owners of natural resources increase
(absolutely and relatively) and are capitalized into higher values.
Dollar investments must constantly rise in order to have the same
Simply maintaining dollar investments will lead to increasing
unemployment. In this sense, high speculative land values lower
profitable investment opportunities and lead to unemployment.(5)
If land ownership were distributed according to the ownership of
capital and if such ownership reflected entrepreneurship, the drain
would coincide with the productive contributions of the
investor-capitalist. However, the business investor often is neither
the owner of land nor capital (real or money) and therefore finds
himself exceedingly vulnerable to a decline in gross income. A small
decline in gross income may turn the marginal efficiency of
investment to negative values and jeopardize the business enterprise
and the employment opportunities which it affords. Thus, as the
economic rents and prices of land rise to new heights during
prosperity and inflation, the marginal efficiency of capital falls
and investment and employment opportunities fall along with it.
Monopoly and Restraining Competition
The practices of monopoly and restraining competition
traditionally have been viewed as problems of equity. The theory of
aggregate supply considers them primarily as problems of the
inefficient allocation of real income and resources causing the
underemployment of labor. Thus, many businesses which dominate their
market, including inadequately regulated public utilities, set their
prices and output at levels that maximize profits. On the other
hand, if they are faced with competition or adequate regulation,
output and employment opportunities would be increased. Similarly,
as the bargaining power of labor or minimum wage legislation causes
the cost of labor to rise, business usually must either cut back
output and employment to maximize profits (or minimize losses) or
substitute capital for labor.
The macro-economic significance of the practices of monopoly and
the restraint of competition are already recognized to some extent,
inasmuch as they are often cited as the causes of cost-push
inflation. Thus, administering prices by some business
organizations and collective bargaining by powerful labor
organizations result in price and wage increases that often exceed
the annual rate of growth in national productivity. These practices
essentially are conducive to greater unemployment, whereas
competition and downward flexibility or stability of prices and
wages are compatible with full employment.
The problem of inefficient allocation of resources and large scale
unemployment is influenced by practices that restrain competition
other than those directly affecting prices and wages. These
practices are too numerous to list completely. However, a few might
be mentioned to suggest their scope: dividing markets, allocating
products, limiting production, buying up and sitting on patents, and
bribery. These merely reveal some of what business can do to
restrain competition. Even in the absence of monopoly, many
industries are dominated by just a few firms which find ways to
cooperate for their mutual advantage against the small independents
in each industry.
Occasionally, the bargaining power of labor organizations is too
great for either public or private employers to oppose. This may
well be why the wages of some workers, such as those in steel, auto
manufacturing, trucking and sanitation, are surprisingly high and
constitute compensation that may be in excess of what is necessary
to fill these jobs. Moreover, labor organizations, especially those
involving some skill and training, not only limit membership but
also require membership in order to work for business or government.
Labor organizations also establish arbitrary work rules that affect
the rate of production and often the quality of the product which
may be higher or lower than what the market demands.
Many professional associations clearly engage in restrictive
practices. These organizations determine who will be admitted.
Qualified men and women who wish To practice a certain craft or
profession (or a competitive wage are arbitrarily restricted from
entering the craft or profession. Thus, these practices increase the
real income of members of certain labor organizations and
professions and are responsible for the unemployment of those denied
entrance to them. Moreover, the aggregate supply of goods and
services produced by restricting employment is less.
The role of government in creating and supporting monopoly and
reducing competition is well known. The controls over fares and
entry into the transportation industry are good illustrations of
excessive interference. When a little regulation is good, it is not
justified to conclude that a lot of regulation is better. A greater
degree of competition in trucking, airline passenger service, and
even in railroads may he highly desirable from the consumer's
viewpoint and poses no threat to the industry as a whole. Yet many
transportation firms fear greater competition.
The government may itself provide direct services through a
monopoly such as the U.S. Postal Service. Or in a given community
there may be little or no alternative to the local public school
system. Such government monopolies tend to lead to mediocre service
as well as to inefficiency, waste and high costs of providing the
Government at alt levels exerts a pervasive influence on wages,
prices and interest rates. This ranges from minimum wage laws, wages
and salaries paid to government workers in comparable jobs with the
private sector, and the size of government debt as well as debt
management policies. It includes even direct rent controls in New
York City. These serve as guidelines or minimums for the private
sector, and either directly or indirectly affect the taxes and costs
of production in the private sector. As these costs are racheted
upward, the marginal efficiency of capital falls, and with it
investment and employment opportunities decline.
Waste and Inefficiency
Waste and inefficiency constitute a real income drain to labor and
capital which is often overlooked. For convenience we can separate
and trace this drain in both the private and public sectors of the
economy. Waste and inefficiency in the private sector may be due to
bigness and its inflexibility, lack of capital or incompetent or
irresponsible managers and employees. Union work rules and
government regulations may reduce productivity or force the hiring
or retention of less competent and productive workers.
The tax structure can affect the effect the extent of waste and
inefficiency in many ways. For example, taxes based on net income
single out those businesses that succeed in producing efficiently,
whereas inefficient businesses are exempted. Another tax that is
enormously inefficient is the real property tax on improvements.
This ad valorem tax increases the cost of additional investment in
improvements, lowers investment in improvements and restricts
Taxes on employment increase labor costs for the employer as well
as reduce the real income of the worker. The difference between the
wages paid by a business firm and the wages received by employees
should be regarded as a disincentive "wedge."
The wedge includes not only payroll taxes but also fringe benefits
and costs of complying with government taxes and regulations, since
they do not add directly to the productivity of the firm. This
growing wedge will cause some employers to go out of business while
those remaining will hire fewer workers. Moreover, as the wedge
grows the real wages of employees often shrink and the willingness
of some to work will be impaired. All of these effects will decrease
productivity generally, lower supplies of goods and increase prices.
The Full Employment and Balanced Growth Act of 1976 provides for
an increase in the tax wedge during recessions and a decrease in the
wedge during prosperity. This policy is just the reverse of what is
necessary to increase profitable employment during a recession and
curb inflation during full employment. In reality, the act makes the
unemployment problem even worse than it is already.
Is a fact that many services rendered by the public sector provide
benefits such as lower costs of production and a higher real income
equivalent for productive workers, thereby adding to incentives for
investment and work. While this may not ease the disincentive for
investment and work in a given firm or industry, it would reduce the
"gross wedge" to a smaller "net wedge" in the
Waste end inefficiency in the public sector is probably greater
than in the private sector. This is because there is no profit
motive, no market discipline and lessened concern when the
enterprise is not managed by the owner. Consequently, employment
objectives, productivity standards and rules frequently counteract
productive efficiency and conservation, particularly in the amount
of labor required to achieve certain tasks.
It is exceedingly difficult, and often impossible to determine
voters' true preferences for certain public services and projects.
The election of government representatives and administrators all
too often is not an expression of the preferences of the electorate,
especially when candidates are vague and inconsistent on various
expenditure matters. Furthermore, once elected, public officials do
not always make a sincere and reasonable effort to sense the
dominant and changing preferences of their constituents.
It seems reasonable to believe that the public projects and
services actually provided substantially exceed what a majority of
the voters actually prefer. Many government projects are approved by
clever subterfuge and misinformation or inadequate information. For
example, the initial phase of a project is funded frequently without
voters or legislators having any estimates of the total cost of the
completed project. Some departments may make self-serving
benefit-cost studies to justify certain projects of limited value.
What is needed is an evaluation by competent and disinterested
analysts outside of government.
The Costs of Crime
Somehow the macro-economic significance of the costs of crime are
disregarded. Yet, the real income drains that these costs place on
productive capital and labor exceed those of national defense,
according to the estimate of the Joint Economic Committee.
Undoubtedly, many legitimate businesses succumb to the increased
cost, taxes, losses, wastes and inefficiencies due to all sorts of
crime. White collar crime alone is estimated to cause losses ($44
billion in 1976) twice as great as that spent on the entire criminal
The cost of narcotics and other dangerous drugs is approximately
equal to that of the criminal justice system, whereas violent crimes
(including murder) and crimes against property cost about one half
as much. However, when we examine the nature of certain victimless
crimes such as illegal gambling and prostitution, we find that a
great deal of disagreement exists as to their net cost. The same is
true of illegal immigration.
Transfer payments and Subsidies
Transfer payments such as unemployment compensation, welfare
payments, food stamps, rent subsidies, etc. further serve to
solidify the floor to money-wage fixing by contract or law. There is
little incentive for many to accept employment at a wage lower than
available transfer payments. Moreover, however welfare and
unemployment benefits increase the length of time that recipients
remain unemployed. The incentive and success in finding work by
unemployed persons is inversely related to the level of welfare and
jobless benefits. For example, Texas families remain on welfare for
an average of 11 months compared to 34 months in New York where
benefits are three times larger.
I am not suggesting that all transfer payments and other
government activities of little or no productive value should be put
to an end. Humane and equity considerations will require substantial
expenditures. However, a methods of income maintenance must be
devised that does not destroy incentives to work.
Transfer payments, subsidies and consumer-type public services
affect the willingness of unemployed labor to work. They also affect
the willingness of workers to continue their employment since
payroll taxes for social security are levied on earnings up to
$16,500 for 1977. These taxes constitute real income drains on all
taxpaying workers and owners of capital who employ those workers.
Large real Income drains on productive labor and capital arise out
of well-meaning government subsidies which are capitalized into
higher land values. For example, government payments for producing
certain crops does not help new farmers as much as those who owned
the land when the subsidies began. An inevitable result of this
practice has been to increase the values and economic rents of
The value of farmland has increased to the point where today farm
ownership for the new generation is virtually prohibitive, and farm
subsidies share a large part of the responsibility for that critical
problem. Moreover, there is good reason to believe that much of the
benefit of government expenditures on expressways, urban renewal and
Medicaid, to name but a few, goes to landowners rather than
investors in capital, labor or professional service.
Supply Management Policies
The brief preceding sketch of a theory of aggregate supply implies
that supply management policies should aim at increasing the real
income of producers in the private sector in order to realize higher
investment and employment targets. Furthermore, the real income of
capital and labor should be achieved by redistributing a portion of
the numerous income drains in favor of capital investors and workers
without increasing fiscal deficits and monetary expansion.
Tax policies in supply management should establish as a first
priority the taxing of the producers surplus or land, labor capital.
Implementing this goal will require a skillful design. It is not
sufficient for total tax burdens to be less than total producers'
surplus. Incentives can be impaired if some portions of the supply
of labor and capital are taxed in excess of their producers' surplus
while other portions of labor and capital are taxed at less than
their producers' surplus. if labor and capital are sufficiently
mobile these disparities may be overcome in time, otherwise they
will persist with the consequences of lower real incomes in the
overtaxed areas and industries, as well as lower investment,
employment and output.
Expenditure policies in supply management should limit
nonproductive public services, i.e., consumer-type services and
transfer payments, to the producers' surplus that is taxed. Public
expenditures for productive public services may justify taxing the
real income of capital and labor beyond their producers' surplus,
since such expenditures increase efficiency, lower production costs,
increase total output, and thus increase real wages or the marginal
efficiency of capital in real terms.
Since the Great Depression of the 1930s and the simultaneous birth
of Keynesian economic theories, the nation has been conditioned to
believe that only the federal government is capable of coping with
the problem of mass unemployment. The expenditures required to raise
aggregate demand require fiscal and monetary resources that only the
federal government can command. Thus, the very nature and scale of
operation required by demand management policies are such that state
and local governments are regarded as impotent bystanders. Citizens
feel persuaded, although somewhat reluctantly, to support a highly
centralized and powerful government.
This theory of aggregate supply should encourage those who have
lamented the helplessness of state and local government as well as
those who have viewed with grave concern the awesome power that has
been assumed by the federal government. As a matter of fact, state
and local governments can perform a major role in supply management
policies inasmuch as many of these policies fall within their
Moreover, these governments can take many effective supply
management measures that also lie within their financial capacities.
Indeed, if properly conceived, supply management policies could
place a lesser strain upon the financial capacity of our economy as
well as on all levels of government.
It may shock many to realize that state and local governments can
assume an important role in macro-economic policy. They are in a key
position for initiating a wide variety of policies aimed at reducing
nonproductive income drains and increasing the real income of labor
and capital. The seriousness and magnitude of real income drains
vary among cities and states. Once these are identified, each city
and state can devise its own multi-pronged attack against those
A comprehensive program designed to reduce nonproductive real
income drains will require far more than measures in public finance
alone. For example, state and local governments can take measures
for facilitating the entry of labor and business into existing
markets, increasing freedom and flexibility In wage and price
competition, and repealing minimum wage laws. The cost of crime can
be cut by enacting more effective laws, establishing administrative
practices and securing community involvement for crime prevention.
Reducing delays in the criminal justice process, increasing
certainty and uniformity in penalties for similar offenses, and
discouraging the release of habitual criminals back into society may
help cut the enormous costs of crime.
A reduction in nonproductive real income drains requires that
total expenditures be limited to minimize the taxation of the
nonsurplus income of labor and capital, unless the productive
benefits of certain expenditures exceed such taxes. This will
necessitate a careful review of state and local budgets to reduce
waste in capital and operating outlays. Public service and capital
expenditures should be made only after careful study and with the
support of a clear and strong majority of the electorate. Serious
efforts must be made in improving administrative efficiency and
Tax measures require that top priority be given to reforming the
property tax to reduce or exempt the ad valorem tax on capital and
to increase the tax on land values. In addition, as many public
services as possible, such as sewer and water services, should be
financed by service charges rather than taxes.
If the services are essential, low income families can be assisted
with transfer payments. Property tax reform and greater reliance on
service charges certainly are not new. However, their significance
as important measures for increasing investment, employment and
productivity can be accepted with confidence and urgency.
- The lower interest rates are
normally expected to occur with government induced increases in
the supply of money.
- William Fellner, "Lessons
From the Failure of Demand-Management Policies; A Look at the
Theoretical Foundations," The Journal of Economic Literature,
March 1976, Vol. 14. No. 1, pp. 34-53.
- Capital is defined here in
the traditional economic sense to mean man-made goods intended for
further production, thus excluding land and other nature
- If the work force itself
increases as it has during the 1970s, it is possible for both
total employment and the rate of unemployment to rise
- Henry George, Progress and
Poverty, 1879 (New York: Robert Schalkenbach Foundation, 1942).
- Arthur B. Laffer, "The
Iniquitous Wedge," The Wall Street Journal, July 28, 1976,
- "The Costly White Collar
Mob," The New York Times, January 2, 1977, p. 15.
- June Kronhoiz "No
Welfare State," The Wall Street Journal, November 11, 1976,
- Robert F. Boxley, end William
D. Anderson, "The Incidence of Benefits from Commodity
Price-Support Programs," Government Spending and Land Values,
C. Lowell Harriss, Editor, Madison, 1971.
- Arthur P. Becker, "Arguments
for Changing the Real Estate Tax to a Land Value Tax," Land
Value Taxation: Pro and Con, Arthur P. Becker, C. Lowell Harriss,
Manuel Gottlieb and A. H. Schaaf, Tax Policy, Princeton, 1970.
- Werner Z. Hirsch, The
Economics of State and Local Government, New York, 1970.