What's the Goal of an Economy?

If you are like many people, you immediately thought, “Jobs.” People from all political walks of life stress jobs as the goal. Think about it for a bit, why do we want jobs? In the individual sense, we want jobs for a living. We take jobs to earn money, but not for money alone. Money is a means to an end; money is used to sustain, advance, and satisfy oneself. Money could also be used against that end. Similarly, in the economic sense, we want jobs because they lead to higher living standards, or a lack of jobs certainly leads to lower living standards. That is the goal of an economy: higher living standards. Just like money, jobs can lead toward higher living standards, or jobs (especially make-work jobs) can lead to lower living standards, or just prevent higher living standards. I will explain how many policies meant to stimulate jobs are counterproductive to the economic goal of higher living standards.

Some people are familiar with Frédéric Bastiat’s parable of the broken window. The logic in this fallacy can be seen in many policy justifications. The parable goes like this: a street thug throws a brick through your window, or windows. I’m sure you would agree such is criminal. Is it really? By the fallacy, this broken window will stimulate aggregate demand and therefore economic activity. You hire a glazier to replace it, and say it costs $100. You pay $100, an economic transaction took place, the glazier will now spend that $100, and the street thug spurred economic activity. Some may say the economic gain is the diamond in the rough. We have no economic gain, however.

We see the transaction with the glazier, and the glazier being able to use more money, but we are forgetting what we don’t get to see: you now have $100 less to use. Mathematically it amounts to zero gain. The broken window actually amounts to a loss. First, capital and labor have been directed toward what could have been avoided, instead of being used to improve living standards. And, instead of having your window and $100, you just have your window. You now cannot spend that $100 on whatever you would have if the window was never broken. The glazier is better off, you are worse off, and whoever you would have engaged in transaction with had your window not broken is worse off.

We see this fallacy used in many policies. An extreme example would be someone saying that crime and fires create jobs for police officers and firefighters, etc... After all, if we had no crime, the only people we would need working in the legal system are those to settle honest disputes. By this logic, it sounds like waving a magic wand to get rid of all crime and accidental fires would be bad for the economy. It would not be bad for the economy, it would actually be good for it. I’m going to exclude the direct impact crime and fires have on the economy, even though that helps my point even more. Yes, people who are police officers and firefighters now have work in those occupations. We see that, and then think that is all, then say, “Without crime and accidental fires, as great as that would be, unemployment would go up.” Well maybe, but that is only temporary. We would be way better off if we had no crime or fires to worry about, and the labor and capital currently in the public safety departments could move to other uses.

Technological examples provide much more practical examples. The cell phone took business from the landline industry, the internet took business from the newspaper industry, CD’s took business from cassette tapes, then MP3 players took business from CD’s, and automated toll collectors caused human toll collectors to be unemployed. Unemployment results from these advances, but these advances result in more efficiency, enabling us to get more in the economy with the same amount of capital and labor, consequently freeing up capital and labor for other areas, and we are better for it. In all, it increases the total amount of goods and services. To subsidize the struggling industries to prevent unemployment among its workers is just delaying the inevitable.

One example right here in Oregon is a third rail: no self-serve gasoline. I remember my first time, asking if this was a self-serve station, and the attendant said, “You’ll run out of gas looking for a self-serve station in Oregon. There isn’t one.” What we see from this policy is more people employed at gas stations. If you argue that this policy is good for people who wish to work as fuel attendants, I would not disagree. They choose to work there, suggesting it is their current best alternative. They have money to spend that will ripple through the economy. However, this policy is not economically beneficial. These jobs are make-work jobs; few of these jobs would be there if we did not have the no self-serve gasoline policy. Why? They do not make the company more money than they are being paid. Furthermore, we do not see where the money used to pay them would be spent otherwise, by the consumers and the owners. We also do not see where they would be working if not for this policy. If the law is the only reason a certain job exists, we have ample evidence that a certain job is not economical. Jobs that exist on their own make economic sense, otherwise they would not exist. We would be better off if labor moved to one of those jobs.

We can see that broken windows policies do not increase aggregate demand, but stimulating aggregate demand does not provide higher living standards anyway. What is the foundation of demand? People’s subjective happiness (broad use). The demand curve shows how many people value said product or service at a certain price more than that amount of money. Others value that amount of money more, and will instead use it on something else. To prop up demand in an industry may result in more production in the industry to match the increase in demand, that’s what we see. We don’t see where it moves capital away from. Capital is moved away from uses that make more economic sense, which leads to a decrease in living standards.

The whole basis of economics is the fact that we have unlimited wants and needs, but limited resources, otherwise known as scarcity. Therefore, the only way to lead to higher living standards is to increase the amount of stuff (broad use), or in economic terms, make aggregate supply closer to aggregate demand. The government can do two things: turn decisions that previously made economic sense into ones that don’t (through taxes and artificially high interest rates), and turn decisions that previously didn’t make economic sense into ones that do (through subsidies and artificially low interest rates). When the government cuts taxes, it is allowing some decisions it previously made non-economical to be economical again. When it provides subsidies, it’s turning decisions that are non-economical into ones that seem economical, both resulting in overconsumption and malinvestments, and diverting resources away from wherever they otherwise would have been used. They both result in more money being circulated, but very different results. They both result in jobs, but subsidies cause jobs in places that do not lead to higher living standards.

On the other side of the coin, pigovian taxes (and pigovian subsidies), which internalize the costs (and benefits) of economic activity, result in higher living standards. The more the costs of an activity are externalized, the more economical that activity seems. By doing a certain activity, imposing costs on others, and avoiding the costs themselves, they are essentially given a subsidy and others are being taxed. Conversely, the more the costs are internalized, the less economical it seems, and the better the economic perspective on such activity is. For example, a carbon tax internalizes the costs of polluting CO2, causing less resources to be used for carbon, more resources to be used elsewhere. The only decisions which no longer make economic sense are those which depended on imposing the costs on others.

The more the benefits of an activity are externalized, the less economical it seems. By doing a certain activity, providing benefits to everyone including those who did not participate in the transaction, and getting less benefits than the activity is truly worth, they are essentially being taxed. A pigovian subsidy, for example, would be a partial subsidy to mass transit. Not for environmental reasons (less pollution is not a public good, it’s less of a public bad, and a carbon tax would take care of that), but because riding mass transit results in less traffic for those who still drive, therefore less time on the road for those who drive, and less money spent on gasoline by those who drive. More time and money for them, when they were just doing the same thing they had been doing. The mass transit rider still gets the primary benefit from mass transit, but car drivers get a positive externality.

Jobs is not the goal of an economy. Anybody can do jobs. The goal is higher living standards. Jobs are necessary but not sufficient for higher living standards, and policies that “increase” jobs are counterproductive to higher living standards just as policies that decrease jobs are.

Republicans and Democrats emphasizing jobs as the goal