What Drives Higher Unemployment

One of my economics students traveled to India during spring break this year. Upon her return to class I asked if she had any observations about the Indian economy from an Austrian School of Economics perspective. She thought for a moment and then said that the Indians seemed to be very inefficient. For example, instead of using a backhoe to dig ditches or building foundations, Indian contractors used dozens of men with picks and shovels. I found this to be a wonderful observation, and the class discussed possible reasons for this phenomenon, which ranged from government regulations geared to increasing employment to the obvious surplus of cheap, manual labor.

Kevin D. Williamson addressed this subject in his May 2nd National Review article titled “A Nation of Sharecroppers”. He pointed out that one hundred and fifty years ago picking cotton was a job for slaves; fifty years ago it was a job for the rural working class, and now it is a job for a handful of very wealthy entrepreneurs driving monster John Deere cotton picking machines. What happened to the slaves and the rural working poor? Were all of them driven to destitution? My student worries about this possibility should Indian contractors get wise and buy backhoes, and Mr. Williamson worries that America’s working poor would be driven to dependency alongside the current welfare-dependent underclass. He provides no answers and ends his essay with the lament that for

“…a 21-year old man of average intelligence with a high-school education and a bit of training…his main attractions will be the sedative of dependency or the stimulant of underclass moral anarchy, and we cannot afford much more of either.”

I agree, but I think I know the source of the problem. (Here’s a hint: the word begins with “g” and ends in “ment”.) What Mr. Williamson and my student describe was observed by David Ricardo two hundred years ago and took the name “Ricardo Effect”. This term describes the phenomenon whereby labor is replaced by machinery and occasionally vice versa. Many have twisted Ricardo’s observation for their own purposes. For example, labor unions have justified striking for higher pay by claiming that such actions actually encourage businessmen to invest in productivity-enhancing capital, which raises the productivity of labor and labor wage scales. At the other extreme are the Luddites, who advise prohibiting businessmen from investing in these very same productivity-enhancing capital goods, because machinery causes “technological unemployment”. Both misunderstand what Ricardo observed.

Ludwig von Mises explains the Ricardo Effect, starting on page 767 of his magnum opus, Human Action. Mises explains that machinery replaces men only when the market is driving the cost of labor higher. Labor costs are rising because labor is more productive elsewhere. To remain in business the businessman must invest in capital goods to boost the productivity of labor in his industry, too. Therefore, labor has a choice between equally attractive alternative employments. In an unhampered free market system the Ricardo Effect is benign and just an interesting observation.

However, the Ricardo Effect turns malignant when the cost of labor is rising not due to improved productivity elsewhere but by non-market forces. To the businessman the result is the same; i.e., the cost of labor is rising and he must invest in productivity-improving capital goods. Ah, but here’s the rub. The productivity of labor is NOT rising, only its cost. Government regulations such as minimum wage laws, workers’ compensation insurance, matching social security taxes, family leave benefits, etc. are driving costs higher, not alternative employment at higher wages elsewhere. And these are just the seen costs. There are the unseen costs as well: such as the cost of defending oneself against wrongful employment termination, a new government-invented right to a specific job. Gone forever, apparently, is the concept of employment at will, whereby, absent an employment contract, jobs are “owned” by the employers, since employers create them, and are “offered” and withdrawn at their pleasure.

Today, this malignant Ricardo Effect is something for concern, as my student and Mr. Williamson articulate. Rather than being a product of a more productive labor market with alternative employment for workers whose employers fail to invest, this modern Ricardo Effect offers workers only welfare dependency and societal pathology.

Furthermore, it is not at all clear that elevating low end worker productivity--a goal that Mr. Williamson does perceive but fears cannot be achieved--would reduce unemployment for those at the low end of the wage scale. Government itself needs the unemployed in order to perpetuate its labor-regulating empire that provides it with high paying and secure jobs. What would all those labor lawyers, judges, advocates, investigators, insurance providers, and record-keepers do, if the country scrapped all labor laws and sent the departments of labor at all government levels to the scrap heap? A more likely scenario is that government will do what it has done since the Great Depression—keep raising the bar in all categories to provide itself with a steady supply of welfare dependents to nanny and goldbricks and slackers to defend in its kangaroo courts. After all, human nature has not changed…there is a disincentive to work, which can be abetted with government payments, and government has an infinite ability to rationalize its self-serving and predatory interventions. No wonder that capitalists are becoming more innovative in moving formerly “non-tradable” jobs into the “tradable” category. For example, x-rays can be read in India as easily as the office down the hall. Even shoe salesmen are not immune. Zappos has built a mail order empire selling shoes sans salesmen.

So, what’s the answer to this modern day malignant Ricardo Effect? As usual it is getting government out of the free market, which includes not just eliminating labor laws but also eliminating the entire welfare industry. It is a fallacy that our nation has millions of people who cannot provide for themselves and must ride through life on the backs of others or starve. All willing workers can find gainful employment, compete, and thrive without any government program or policy whatsoever. Jean Baptiste Say explained this phenomenon two hundred years ago. But that is a lesson for another time.