By John Sykes
Arnold Kling’s When Labor Is Capital: The Limits of Keynesian Policy is a valuable addition to the contra-Keynes arsenal, joining the schools that say to stimulate get the government out of the way. Kling puts it this way:
For the followers of John Maynard Keynes, economic activity consists of spending. When economic activity slows down, their prescription is to increase spending by government, businesses, consumers, or all three. Instead, what I like to say is that “economic activity consists of sustainable patterns of specialization and trade.” This is my mantra of macroeconomics. (I also have a mantra of microeconomics, which is that “price discrimination explains everything.” But that is another topic.)
Here is a simple pattern of specialization and trade: Suppose that all of us eat grain and fruit, which we could grow for ourselves. If some of us have land better for fruit trees, while others have land better for growing grain, then specialization and trading can pay off. It is inefficient to waste good tree land by growing grain on it and to waste good grain land by planting trees on it. Instead, economic activity gives all of us more to eat.
The economy is increasingly complex. Labor is capital. In this day and age this means that:
… we have lost the automatic tight connection between spending and employment. Firms can vary their output with little or no variation in employment. This explains how we can have a “jobless recovery,” meaning a large percentage increase in output without a comparable percentage increase in employment. For firms in today's economy, labor represents an investment. Firms hire workers in order to develop capabilities that will eventually produce output more efficiently. The return on an investment in workers may take as long or longer to realize as the return on investment in a machine. The return on investing in workers may be at least as uncertain as the return on investing in equipment.
The market has to figure out how to use its workers better which Kling calls a “recalculation:
The market needs to undertake a recalculation in order to deploy workers in a new, sustainable pattern of specialization and trade. The process involves gradual, decentralized trial and error. Firms need to be launched by entrepreneurs, who will make risky investments in employees. The failure rate will be high, but eventually the successes will have a cumulative effect that brings about more economic activity.
So what does this all mean other than the Keynesian solutions don’t work? More from Kling:
What needs to emerge are new, sustainable patterns of specialization and trade. Government does not have much incentive to create sustainable patterns of specialization and trade. In fact, the political system tends to favor subsidies to outmoded and unsustainable businesses.
Government could reduce the cost of investing in labor-capital. If it can be done in a fiscally responsible way, it would help to reduce the marginal tax rates on investment (the corporate profits tax) and employment (the payroll tax). This may require offsetting tax changes, such as eliminating the mortgage interest deduction or the deductibility of employer-provided health insurance.
On the whole, the best way to help the process of market recalculation and the creation of sustainable patterns of specialization and trade may be for government to get out of the way.
Let me see if I can sum this up. In a complex economy “labor is capital” and this market needs to “recalculate” that capital. Re-calculation uses decentralized risk-taking to create “sustainable patterns of specialization and trade”. In order for this to work, the government needs to get out of the way, to reject statism.