February 15, 1998
A Good Economist Writes a Silly Book
by
Charles W. Baird
Edmund S. Phelps, the McVickar Professor of Political Economy at Columbia University has a well-deserved reputation as an excellent technical economist. For example, his work in the late 1960s and 1970s on the principle of the natural rate of unemployment was creative and insightful. It nicely complemented the work of Milton Friedman on the same subject. However, few economists can successfully carry their technical excellence over into writing for the general public. Milton Friedman can; but, judging from his new book, Rewarding Work: How to Restore Participation and Self-Support to Free Enterprise, Edmund Phelps cannot.
In this book, published by Harvard University Press in 1997, Phelps proposes a new panacea for the troubles and pathologies of "disadvantaged" people in America - federal government provision of low-wage employment subsidies. He defines the "disadvantaged" as those in the bottom one-third of the income distribution. The subsidies are tax credits against payroll and corporate tax liabilities of "qualified employers" who employ disadvantaged people on "eligible jobs." They start at $3 per hour for a worker whose "private productivity" is valued at $4 per hour, and gradually decline at a decreasing rate to a $0.06 subsidy for a worker whose private productivity is valued at $12 (p. 113). He emphasizes that these are employment subsidies that could not, unlike welfare, be exploited by people who refuse to enter employment. They are limited to private employers and to full-time employment.
Phelps' employment subsidies would, he asserts, empower capitalism by drawing the disadvantaged into increased labor force participation, increasing their self-esteem, and making them more self-supporting (hence the subtitle of the book). Once this happens there will be a greatly diminished role for welfare (only the physically and mentally disabled would need it), and the minimum wage would be redundant.
Phelps provides an outdated Pigouvian (named for AC Pigou who first designed it) justification for his subsidies (pp. 105-109). A disadvantaged worker's "social productivity" is the sum of his "private productivity" and his "external productivity." Private productivity is "the productivity within the business." It is what the worker's labor services are worth to the employer. External productivity is the additional benefit enjoyed by society as a whole because of the worker's increased ability "to support [himself] and exercise responsibility as a citizen, community member, parent and spouse" (p. 107). A Phelps subsidy, "calibrated to the correct size," would internalize this external productivity.
Free-market economists recognize that such a scheme completely ignores all that we have learned from public choice about government failure and all that we have learned from F. A. Hayek about the division of knowledge. Every government subsidy comes with increased government regulation. Just what is an "eligible job"? Who are the "qualified employers"? Is there to be yet another division of the Department of Labor charged with certifying jobs and employers? Phelps claims his plan would pay for itself through savings on welfare and crime. However, once such a scheme is put into place, interest groups like labor unions would advocate expansion of the subsidies just as they have successfully done with the legal minimum wage. The subsidies would inevitably become just another increasingly costly feature of the welfare/transfer society.
Moreover, how can any government decisionmaker calibrate the correct size of the subsidy for each worker in each possible employment? If the subsidy is incorrect, in either direction, in any specific application, the outcome could, on Pigouvian grounds, be worse than the zero subsidy outcome. Phelps' arbitrary sliding scale of subsidies would be applied to all workers at all times and places irrespective of the unique circumstances of time and place. Simply put, because of the knowledge problem there is no way to determine whether the subsidies would make matters better or worse. When we recognize that decisions will be based on politics, not economics, there is nothing left of the Phelps subsidies to recommend.
But there is much more to criticize about this book. For example, Phelps writes
"In acting through the government to pull up the rewards and thus to stimulate the participation and employment of low-wage workers, the more fortunate members of the labor force would be removing a source of some embarrassment. The more advantaged in society would gain pride and self-respect from having met their end of the social contract - of having acted justly. If so, they will be willing to pay something to achieve this satisfaction in the form of higher taxes" (pp. 135-136).
He apparently believes successful people are merely lucky. In fact, of course, most successful people earned every penny they have by perfectly honorable means -voluntary exchange. They did well for themselves by providing opportunities to others. I can think of no better grounds for self-respect. It is apparently necessary to say one more time that if successful people really did think they should donate to less successful people, they would do so. They don't need to wait for taxation to act on their altruistic impulses. There is no free-rider problem because, as Gordon Tullock has shown, to a donor the value of giving is the satisfaction of having done what he perceives to be the right thing. Another person's donation does not satisfy that imperative.
In his Epilogue Phelps asserts his subsidy scheme "fits the founders' conception of our government" (p. 171). He says that Jefferson's assertion in the Declaration of Independence of an inalienable right to the pursuit of happiness necessarily implies a right to a rewarding job (p. 167). This is simply preposterous. It is well established that to the founders the word "rights" meant negative (nonrivalrous) entitlements that are prior to, and independent of, government. Government's principal job is to enforce them. Phelps subsidies are positive (rivalrous) rights. They clearly impose burdens on some to provide means to others.The rights of those who are forced to pay are in conflict with the rights of those who are privileged to receive.
Perhaps the silliest claim in the book is Phelps assertion that Keynes, along with Adam Smith and John Stuart Mill, was a "classical economic liberal" (p. 83). That says it all.