Freeman

ARTICLE

The Unemployment Act of 1946

OCTOBER 01, 1987 by JOHN SEMMENS, DIANNE KRESICH

John Semmens is an economist and Dianne Kresich is a research associate for the Laissez Faire Institute, a free-market research organization headquartered at J202 West Malibu Drive, Tempe, AZ 85282.

Government in America has been on a spending binge for over 40 years. Much of this spending has been for the express purpose of stimulating the economy. The rationale behind government stimulation is the presumed need to maintain aggregate demand and avoid recessions or depressions.

During the Great Depression of the 1930s, John Maynard Keynes concocted a “cure” for depressed business conditions. This “cure” involved deficit spending and debt monetization (i.e., inflating the money supply) as a means of generating adequate aggregate demand, while surreptitiously reducing the real prices of idle inputs, especially labor. The “cure” was designed to inject money into the spending stream at a time when entrepreneurial timidity and nominal price rigidity combined to produce high unemployment.

The Keynesian “cure” was a radical departure from the classical approach to business re cessions, which relied upon free-market price adjustments to reallocate resources and thus re verse the economic decline. This approach had always worked in previous depressions, yet seemed to be ineffective during the early years of the Great Depression. The reason for this ap parent failure is not hard to find: Government interventions eliminated any semblance of free- market pricing. These interventions included (1) high tariffs to “protect” American jobs, (2) manipulation of the money supply—first inflating, then contracting the quantity of money, (3) tax increases to fund expanded government programs, and (4) price and wage “fixing” via the National Recovery Administration. Given these interferences, it should not have been surprising that the economy was having difficulty righting itself.

The Keynesian approach to this politically engineered economic impasse was to seek downward price flexibility in real terms by debasing the monetary unit. Thus, even though nominal prices and wages would remain high, real prices and wages would be reduced via inflation. To assure that the newly created money would get into the economic flow, the government itself undertook to spend it. That much of this newly created money was wasted on non- productive activities was irrelevant to the Keynesian program, since it was only supposed to be a short-term remedy. The episodes of fiscal deficit and monetization of debt were to be offset by balancing fiscal surpluses and monetary restraint during periods of prosperity. In this way, economic policy-makers supposedly could act to counter the excesses of the business cycle and achieve stable growth.

The latter half of the 1930s saw a heavy dose of deficit spending and debt monetization without the attainment of stable economic growth. World War Ii injected the motive of patriotism to spur economic output of war goods. The ills of the economy were submerged in the effort to win the war. As the war drew to a close, though, the fear of a return to depressed business conditions dominated the economic policy debate.

Support for the Employment Act of 1946 was generated by those sympathetic with more government control of the economy. Henry Wallace, Vice President under Franklin Roosevelt in the 1941-45 term, vigorously backed legislation committing the government to a more active role in the economy in order to achieve full employment. As Wallace saw it, the high unemployment of the 1930s was the result of the “planlessness” of the U.S. economy.[1] The New Republic gave editorial support citing, with great admiration, the Soviet Union’s constitutional guarantee of a job for every citizen.[2]

While the more mainstream members of Congress did not necessarily buy the entire case for the planned or socialized economy, they did enact the Employment Bill. Falsely blaming laissez faire for the Great Depression, this law made the federal government responsible for creating and maintaining the conditions for full employment. It established the President’s Council of Economic Advisers to furnish the expertise that was supposedly needed to anticipate and avoid future recessions.

The Act provided that full employment was to be maintained by “compensatory spending.” That is, the government was to make up for “inadequate” private sector spending by running budget deficits and spending money it created. This anti-recessionary program was to be put into effect when the President’s economic advisers foresaw a decline in the business sector. That these advisers could do a better job of forecasting than the numerous participants in the marketplace was assumed without evidence.

Whether economic fluctuations have been avoided and whether this has been because of, or in spite of, the increasing government intervention in the economy over the last 40 years are the crucial issues in evaluating the Employment Act. Defenders of government intervention eagerly point out that the nation hasn’t seen a repeat of the Great Depression since the Act. This seems impressive until one recalls that until the Great Depression the nation had not seen as devastating an economic decline. The 150 years of U.S. history prior to the Great Depression were generally laissez faire when compared to the 50 years following this period. The policy of heavy government intervention would have to weather another 100 years without producing a Great Depression before we could even pretend to congratulate ourselves for discovering a key to perpetual prosperity.

Are We Better Off?

Even though the post World War II era has not produced another Great Depression, this alone does not tell us whether we are better or worse off for governmental attempts to manage the economy. From the outset, critics of such management pointed to timing, information, and political problems that would thwart government efforts to engineer prosperity. Since there is a lag between the initiation of fiscal or monetary stimulation and their impact on employment, timing is critical. Government experts must anticipate fluctuations in the economy and take action prior to the anticipated events. If predicting the future course of the economy were a science, then all economists would be fabulously wealthy. That they are not is ample evidence that there is considerable difficulty in making accurate forecasts.

Obtaining the economic information with which to make forecasts is time-consuming and costly. By the time data are gathered and analyzed they most likely are obsolete. To speed up this process or to make it more comprehensive is expensive. This raises the prospect that the cost of the information may be more than it is worth. Of course, in the final analysis, factual data are only inputs to a fundamentally judgmental process.

Using sophisticated computers to plot and project the future course of the economy based on past information misses the essential nature of the forecasting task. The future is unknown. It will not be a simple replication of current trends or past cycles. If the future were routinely predictable there wouldn’t be so many forecasting errors. The trick in forecasting is to anticipate when and how the future inevitably will differ from the past and present. This requires judgment.

Judgment can be cultivated through learning and experience. On the micro level—where we try to comprehend and deal with developments in our own family finances, businesses, and in-dustries-this is not an insurmountable task. Economic decision-makers, whether businessmen, employees, or consumers, can have some success in understanding the conditions and requirements of their particular circumstances. Determining what to sell, where to work, or whether to buy requires detailed knowledge of specific needs and capacities.

At the macro level, however, where government planners try to comprehend and anticipate the course of the entire economy, detailed specific knowledge doesn’t exist. The aggregate statistics which are available do not reveal the many ways in which economic expansions and contractions may occur simultaneously in different products and different markets. Since the purpose of production is the creation of specific products for specific uses, how particular resources are used is critically important. The Keynesian macro-management premise that merely maintaining aggregate demand—no matter what is produced—is sufficient to assure full employment is hopelessly in error. The government, lacking the necessary information, cannot efficiently deploy resources for the betterment of the economy.

To the impediments of improper timing and insufficient information, government intervention adds political manipulation. Even if the government’s experts agreed on the data and timing for prospective interventions, political factors would distort policy. Keynesian macro-management calls for a balanced program of deficits during recessions and surpluses during booms. Strangely, though, the surpluses over the last 40 years have been small and infrequent. In contrast, the federal government’s deficits have been huge and repetitive.

Macro-management has degenerated into an excuse for excessive Federal spending. When the economy is in recession, politicians can rely upon the Keynesian prescription for stimulative spending. When the economy is strong, politicians are encouraged to spend more because we can afford it. So, no matter what condition the economy is in, politics opts for more spending.

The penchant for spending has far outrun the inflation it has spawned over the last 40 years. As might be expected, a Keynesian program ofdeficits and money creation has pushed price indexes up by over 400 per cent since 1946. At the same time, nondefense spending by all levels of government has risen by over 3,000 per cent. This diversion of private resources to government use has imposed large and mostly hidden costs on our nation’s economy.

Consider that funds can be employed productively or nonproductively. In the private sector, it makes a difference to the economic decision-maker which outcome or use results. In the public sector, however, the attitude is more casual. Unlike entrepreneurs who must employ funds productively to stay in business, government bureaucrats rarely concern themselves with the return on their use of resources. Many in government pridefully assert that the public sector’s indifference to profits assures a more socially useful deployment of resources. However, this attitude miscontrues the meaning of profit and leads to policies that waste the funds appropriated from the taxpayer.

The Role of Profit

The creation of profit indicates that value has been enhanced by the undertaking earning the profit. The maker of profit has accurately identified needs and efficiently fulfilled them. The resulting profit is the difference between value and cost as determined by the marketplace. The larger the profit, the greater the social gain in value over cost. Accumulation of gains like this enables the economy to grow to meet even wider needs in the future.

For example, an enterprise that made a consistent 10 per cent profit on its investment year after year would be able to expand 45-fold over a 40-year period. In contrast, an enterprise that consistently lost 10 per cent each year would shrink to less than 11/2 per cent of its original value after 40 years. The assets available to society from these contrasting results are significantly different. Assume that each enterprise started with a million dollars. After 40 years, the enterprise making the 10 per cent annual profit would have grown to $45 million in assets. The enterprise losing 10 per cent per year would have shrunk to $15,000.

Obviously, it does matter how resources are employed. The notion of spending funds on make-work schemes to sustain aggregate demand has a devastating impact on the economy over time. Clearly, a business with $45 million in assets can employ more workers than a business with $15,000 in assets. Yet, government spending has been transferring resources from profitable enterprises for the past 40 years. Indeed, the long-term impact of growing government spending has been the destruction rather than the creation of jobs. Far from being the friend of the working man, big-spending politicians have pursued programs that have dramatically restrained opportunities and compensation in the U.S. economy.

What Might Have Happened?

The magnitude of the negative impact on employment from excessive government spending can only be estimated. We can’t really know what specific options were sacrificed by this spendthrift era, but we can make a crude approximation. For this purpose, let us imagine that in 1946, instead of committing the government to a wastrel course, politicians at all levels determined to hold government spending constant with respect to population and the purchasing power of the dollar. What might have happened?

The accompanying graph tracks actual expenditures by all levels of government versus a hypothetical inflation-proof, population-growth adjusted budget. This hypothetical budget as sumes that the government would have maintained the same real (inflation-adjusted) per capita expenditures that prevailed in 1947 (the first year after the Employment Act). These budget comparisons omit defense outlays. Rather than debate over whether defense outlays of the magnitude experienced were necessary due to forces (hostile nations) outside the U.S.’s control, these expenditures were excluded from both the actual and inflation-adjusted budgets.

Over the 40-year period, the inflation-proof, growth-adjusted budget grew from $33 billion to $272 billion: a 700 per cent increase. Actual government outlays grew from $33 billion to $1.1 trillion: a 3,200 per cent increase. The cumulative excess of spending over that needed to maintain real per capita government services was nearly $8.1 trillion. Current government spending is now over $800 billion higher than the inflation-adjusted budget would have required.

If the excessive spending had not occurred and if the funds had been left in the private sector through reductions in corporate, business, and income taxes, a considerable amount of additional capital could have been created. Using the rather modest rates of return earned by companies comprising the Dow Jones Indus-thais, we calculate that an additional $22 trillion in assets could have been accumulated. Inasmuch as the actual estimated corporate assets of the U.S. economy approximate $13 trillion, the impact of excessive government spending is clearly substantial. The failure of public policy to allow the economy to compound profits in this fashion over the past 40 years has significantly reduced job opportunities and real wages—the goods and services an individual’s wages can buy.

It must be remembered that this little exercise is hypothetical. We have not measured the impact of excessive government spending so much as we have gained some insight into the magnitude of the real, long-term burden placed on the economy. One can’t really measure the size of a growth that did not occur.

Many defenders of government spending are quick to allege that these outlays “create” jobs. While it is true that some specific jobs would not now exist if the spending binge had been contained, it is difficult to see how a net gain from this consumption of resources can be claimed.

Transfer Programs Grow

The largest growth in government spending has been in income transfer programs. There is no doubt that these programs have created jobs for many bureaucrats. However, this is hardly a net gain in employment. A similar amount of money spent on goods and services by consumers and businesses would likely employ a comparable number of people, albeit at different kinds of jobs.

In addition, transfer payments discourage people from working. As Charles Murray points out in Losing Ground, the more generous the benefits are for being poor or unemployed, the greater the temptation to be poor or unemployed. The loss of the output of large numbers of discouraged and unmotivated individuals clearly reduces the wealth of the society. Less wealth means fewer employment opportunities and lower real wages.

Public funds also are used to provide services that lose money. Whether it be the construction of dams and canals that produce fewer benefits than costs or the operation of deficit-ridden transit systems, almost every government-produced service generates less value than it cost. As a result, capital is consumed and society’s wealth declines.

Capital also is consumed by government regulations. Some people, of course, may argue that regulations provide jobs for clerks, statisticians, administrators, lawyers, and the like. But at the same time, the resources consumed in pursuing or defending against litigation are resources unavailable for research, new equipment, training, or other more productive uses. The ultimate result of litigation is a transfer, not a creation, of wealth. The more time and energy diverted to such efforts to transfer wealth, the less that can be invested in adding to wealth. This also has a negative effect on employment.

The crushing burden of taxation and government debt necessary to finance the explosion in spending also contributes to lower levels of employment. On the one hand, taxing profits and wages reduces the rewards for generating valuable output. The motivation to work hard and risk money in investments is diluted by high rates of taxation. On the other hand, the mushrooming public debt has crowded out many private sector ventures, while raising the cost of financing others. At the same time, Federal Reserve monetization of Federal debt has inflated the money supply, eroded the value of the dollar, and penalized savers. Excessive government taxing and borrowing have battered down both the incentives and the means of accumulating wealth. This also negatively effects employment.

Examination of the 40 years since the Employment Act of 1946 does not produce evidence for the success of government intervention aimed at promoting employment. Instead, our economy has suffered the loss of a significant opportunity to have improved the wealth and well-being of working people. While we cannot retrieve the sunk costs of 40 years of government waste, we can try to go forward to reduce and eventually eliminate this profligacy. Whether the government can be broken of the habit of excessive spending is the crucial question.


1.   G. J. Santoni, “The Employment Act of 1946: Some History Notes,” Review (Federal Reserve Bank of St. Louis, November 1986), pp. 5-16.

2.   George Soule, “The Full Employment Bill,” The New Republic (August 6, 1945), pp. 154-156.

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October 1987

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