NCPA - National Center for Policy Analysis

Beyond Austerity

May 9, 2012

The struggling of EU nations as they attempt to swallow steep austerity measures is a subject of mixed amusement to liberal macroeconomic analysts.  While the plummeting economic situation of that continent is indeed tragic, the continued economic woes of Spain, Greece, Italy and other countries suggests that Keynesians were correct to prescribe increased spending, not austerity, says Richard A. Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution.

However, this conclusion (and its subsidiary prescription for greater government spending within the United States) takes aim at the wrong issue.  Rather than artificially boosting aggregate demand (and accumulating massive government debt), policymakers should focus on freeing up labor markets.

  • The massive increase in American public debt has not nudged unemployment rates down.
  • The only workable solution is to stress job creation, not by misdirected subsidies, but by dismantling the government obstacles to market exchange.
  • This solution requires reducing burdensome regulations on employers that increase the uncertainty in hiring workers, thereby decreasing employers' interest in expanding payrolls.

In this regard, European nations serve as a near-perfect model for how labor markets should not operate if an economy is to gain traction on the road to recovery.

  • European law at the EU and national levels specialize in a set of "for cause" dismissal rules that make it virtually impossible for any employer to lay off any worker.
  • These laws greatly limit the ability of an employer to dismiss workers, even for such sensible reasons as general incompetence.
  • These laws also largely preclude the possibility of widespread layoffs -- actions that, while tragic, allow corporations to adequately adapt to adverse economic conditions.

Cousins of such laws should be struck down in the United States if it is to realize a strong economic recovery.

  • The deeply protectionist National Labor Relations Act dictates that many employment contracts be governed by collective bargaining agreements.
  • This sort of union activity grants disproportionate returns to employees and contributes to the rigidity of labor markets.
  • Employers respond to such market incentives by refusing to hire or hiring only on a part-time basis -- behavior that undermines the labor market's recovery.

Source: Richard A. Epstein, "Beyond Austerity," Defining Ideas, May 1, 2012.

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