Defining Ideas

The Economic Fantasies Of Robert Reich

Monday, October 12, 2015

The United States has seen better days. The political and economic fabric of the country is unraveling, yet there is little agreement about how best to move the country forward. My own position has long been that the culprits of slow growth and social discontent are the increased levels of taxation and regulation that suck the productive lifeblood out of society. That position today is in the minority. A vocal group of progressive thinkers are plumping for the opposite course—and prominent among them is Robert Reich, former Secretary of Labor for Bill Clinton. In his new book Saving Capitalism: For the Many, Not the Few, he argues for a set of policies that would cripple the American economy. A better title for his book would be Dooming Capitalism, For Everybody.

Reich makes no bones about his central contention, which is to support “an activist government that raises taxes on the wealthy, invests the proceeds in excellent schools and other means people need to get ahead and redistributes to the needy.” In his view, only with these reforms and by “other means,” most of which are left unspecified, can we return to the glory days of his father, when union members could afford to give a good life to their children, which cannot be done today. Reich offers no explanation for why the decline has taken place, but contents himself with denouncing the “myth of the free market” and the idea that the government should not “intrude” into the business of its citizens.

More concretely, Reich starts by insisting that it is a fantasy to assume that there can be a free market without government to create property rights, control monopoly, and enforce contracts. But he fails to note that this exact list of tasks is what classical liberals like myself assign to government as well. In fact, his list is too short. First, he ignores the role of government in controlling crime and pollution. Second, he does not discuss the limits that should be imposed on the subsidy of some businesses by others. Third, he leaves to one side the difficult questions about the organization and financing of public infrastructure and the management of public resources. A good government is ironically a lot larger than Reich seems to understand.

The real differences between progressives like Reich and classical liberals like myself come then not in the proposition that markets depend in multiple ways on public support. Rather, the disagreement is over the means chosen to generate social improvements. It is here that Reich repeatedly misfires. In dealing with property rights, it’s nice that Reich comes out against slavery—but it is troublesome how he dismisses the right of all persons to determine what job offers to accept for work in the open market. The issue comes to center stage on the question of the minimum wage, where Reich takes the sunny view that the huge increase of the minimum wage to $15 per hour from its current level of $7.25 will largely be a transfer of wealth from rich CEOs and their shareholders to workers, who can use the money in question to get off of public assistance.

Dream on! Reich is in serious denial when he assumes that hard pressed firms in competitive markets won’t make serious changes in how they do business when labor costs move sharply higher. If the minimum wage shoots up, it will start to make more economic sense for these firms to replace low-skilled labor with machines and technologies that can do the same work. The employees that do remain will be, by and large, more skilled, shutting out the poor further. For example, Reich never considers the exceedingly high levels of unemployment among minority teenagers, whom regulation has shut out of the labor market.

The unintended consequences of regulations count. The early returns on the minimum wage increases in Seattle are a loss of 1,000 restaurant jobs in the city compared to an increase of 2,300 restaurant jobs in the rest of the state. And this is only for the first round of minimum wage increases. It is unlikely that Reich knows more about the restaurant business than the businesses themselves who will likely turn to customer self-order kiosks and other adjustments to offset rising labor costs. It is just foolish to project that the relatively small declines in employment levels from small increases in minimum wages will carry over when they increase the wedge between the market and the minimum wage.

Reich takes an even odder view in his discussion about the control of monopoly power. There is no classical liberal who looks with indifference on the creation or toleration of cartels or monopolies, especially when propped up by state power. But the same cannot be said of Reich. In his discussion of labor unions, he starts from the fantasy that employers in competitive markets can “dictate” the wages that they pay their employees. The obvious rejoinder is that workers will play one employer against another, so that competitive wages will rise in times of high demand, and fall in times of slack demand. Reich then fails to acknowledge that the entire fabric of labor law since the passage of the 1935 National Labor Relations Act has conferred government-backed monopoly power on unions who, when recognized, have the exclusive bargaining rights to all workers within the appropriate bargaining unit.

The exercise of this monopoly power is far more dangerous than the power held by firms, because it can lead to the imposition of grotesque work rules, while increasing the risk that strikes and lockouts will shut down essential services when the two sides butt heads. The system also tends to collapse under its own weight as new nonunionized firms, both domestic and foreign, can deliver better goods at lower prices, to low income families, than firms hobbled with onerous union contracts. It is no wonder that the percentage of union membership in the private sector has dropped from a high of about 35 percent in 1954 to about 6.6 percent in 2014.

It is only the rise of public union membership, which now stands at about 35 percent that keeps overall union membership at around 11 percent today. Many of those public employee union members are teachers who exact a heavy toll in their nonstop efforts to maintain a public school monopoly in the United States. Reich wants to invest the proceeds from higher taxation into education, but at no point does he discuss the dangers teacher unions pose to that mission. Nor does he mention the possible role that nonunion charter schools play in improving education. There is no doubt that charter school kids in New York, for example, decisively outperform non-charter public school students—which is why parents are clamoring to get their kids into charter schools. There is a stark choice here. Does Reich think that a commitment to unions should take priority over educational excellence?

Next there is the question of how to fund Reich’s ambitious, if misconceived, program of income redistribution. Reich is silent on the question of what programs advance growth, and his prescription for higher taxes on the wealthy for ordinary income and for capital gains only makes matters worse. He gets no quarrel from me on the proposal to tax unrealized gains (i.e. those from unsold stock) at the time of death, and, similarly for allowing deductions for unrealized losses. These have been part of the classical liberal agenda for ages, given that any exemption of large quantities of income from the tax system casts extra burdens on others, which slows down the rate of capital formation and voluntary exchange.

Yet his call for progressivity that targets the top one-percent will backfire. He cannot grow the economy by fleecing the most productive members of the workforce or on investment income from a low-growth economy. Reich laments the inordinate power of the nameless rich, but never explains how that amorphous group contrived in 2012 to pay roughly 38 percent of the taxes on 21.9 percent of income, when the bottom 50 percent paid about 2.8 percent.

Nor does he consider the risk that higher levels of taxation on ordinary income will tend to dull the incentive to work, inclining people to retire sooner or pass up on second jobs. Likewise, he is oblivious to the risk that high capital gains rates make investors reluctant to dump low performing stocks which would then allow them to invest in more productive companies—the very mistake that Hillary Clinton made in her problematic proposal to increase short-term capital gains rates.

Reich is also not alert to the dangers of subsidies to certain well-connected political groups. The ever-expanding subsidies for wind and solar energy that he recommends are ill-advised. If these forms of power can make it in the marketplace, no one should block them. But if they cannot compete with fossil fuels without the subsidy, then so be it. They should be allowed to languish. The basic point is subject to the simple caveat that fossil fuel subsidies are inappropriate as well, and that all forms of energy should have to take into account whatever externalities they create, be it from polluting the air or killing endangered birds. The same judgment applies most emphatically to lavish ethanol subsidies, which manage to distort both energy and food markets in one ill-conceived program.

There is a large point that comes out of Reich’s social agenda. Notwithstanding his long service in government, he seems to have no understanding of the enormous slip that takes place between an ambitious program for social reform and its successful implementation. I have spent most of my academic life in the weeds, looking at the specific operations of government action as it applies to pharmaceuticals, to the environment, to housing, to securities, to education, to employment, banking, insurance, and other social institutions.

In all of these areas, I have come to the conclusion that the modern progressive state has wrought untold damage for two very simple reasons. First, it has no sense as to when government should intervene and when it should stay its hand. The regulation of competitive labor markets is almost always a loser, and the ever-heavy hand of government in this area does much to explain the decline in working class incomes.

Second, the government has no sense of which means work and which do not. If the risk is monopoly, control it with an antitrust law that is limited to monopoly. But don’t wreck competitive industries, and by all means don’t use government power to prop up monopolies, as in labor markets.

But Reich is blind to all this. There is not a single proposal for deregulation in his disjointed book. Unfortunately Saving Capitalism won’t help the many as it promises to. If its policies are implemented, it will wreak economic and social mayhem on everyone.