Geithner and other advocates of free markets don’t understand free markets.

Geithner says he does not want the U.S. financial sector reduced in size. Well, having spent his working life in this sector and with so many friends in this sector he wouldn’t would he?

But more seriously, his main reason for not wanting this sector reduced in size is that there are opportunities for the sector because of the rapidly expanding middle class in developing countries. There are two flaws in this argument.

First, whence the assumption that it will be AMERICAN banks rather than NATIVE banks that will provide developing countries with the financial services they need? Given that American banks are run by clots, idiots, and crooks, I’d probably prefer a native bank to an American one if I were a developing country citizen.

Second, the size of the financial sector in a properly functioning free market would be determined by the same factors as determine the size of any other sector: supply and demand for the products concerned. Supply and demand based, that is, on genuinely free market prices.

Now the price of credit or loans is one of the main elements here, and the price of credit (i.e. interest rates) are anything but FREE: the price is rigged by central banks, and is currently at record lows! My guess is that this artificially expands the size of the financial sector (though that depends on the elasticity of supply and demand for credit).

Geither clearly thinks “bigger is better”. The notion “optimum size” is perhaps too abstruse for him.


Britain’s CEOs are frustrated train drivers.

In similar vein in a letter to the Financial Times, a long list of Britain’s CEOs want Britain’s rail system improved because this will “create capacity” in the rail system. Plus it will “improve connections between airports” and “help commuter services”.

What are they going to tell us next? That investment in the plastics industry will result in more or better plastics products? Or perhaps they’ll tell us that building more blast furnaces will result in the production of more steel?!?*!!

The optimum size of….. Oh dear - there goes that “abstruse” word again. Anyway, the optimum size of the transport industry should be determined (as in the case of the financial sector) by supply and demand, that is, supply and demand at market prices. The only exception comes where someone can demonstrate that social or environmental factors should override market forces.

Can a central bank go bust?

Note dated 10th Feb 2011. I’ve completely changed and re-drafted the article below, partially as a result of what I learned from Winterspeak’s article on the possibility of central banks going bust (26th Feb 2011). That’s the beauty of blogging: what you learn. (Thanks to Tom Hickey for alerting me to Winterspeak's article.)

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Yves Smith and Willem Buiter claim that when winding down QE, a central bank (CB) might make a large loss because the value of the relevant securities has dropped. Moreover, the loss might be so large that the CB will not be able to escape the problem by printing more money if inflation looms: any such money printing operation would simply exacerbate the inflation.

The latter claim is wrong by 180 degrees and for the following reasons.

Any loss made by a CB is profit in the hands of the private sector, the effect of which is likely to be stimulatory and/or inflationary. In this scenario, what the CB needs, far from being more printed money, is the opposite: that is, some form of “money mopping up” tool or deflationary tool.

The traditional deflationary tool used by CBs is interest rate increases – effected by selling government bonds. But what if the CB has taken QE as far as it can and sold ALL its government bonds? It is then in uncharted territory.

It could announce it was willing to borrow at above the going rate, and raise interest rates that way. I’m not an expert on the law governing CBs, but I imagine the law in some countries permits this ploy while others do not. Anyway, that’s a minor technical / legal problem.

The bigger problem is that it is debatable as to whether the latter ploy would be deflationary. Reason is that in order to pay the interest, the CB has to print money, and the net effect is to increase financial assets in the hands of the private sector, which does not sound desperately deflationary to me.

Put another way, private sector entities do not do deals with CBs unless those private sector entities think there is profit in the deal. And making a profit is liable to result in stimulation and/or inflation.

In this situation, the CB could be in a bind or “bust” in the sense that it would need to go cap in hand to the government or Treasury and ask it to collect extra taxes to fund the latter interest payments. After all, there is a big difference between, first, offering the private sector higher interest payments where the money for those payments has been confiscated from the private sector, and second, offering higher interest payments with printed money.

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If Mervyn King strayed into the political arena, it was because of the illogical division of responsibilities as between central bank and government.

Mervyn King expressed support for the UK government’s policy of front loading government spending cuts. Paul Krugman and Ed Balls (the U.K. Labour Party’s shadow finance minister) accuse Mervyn King of straying into political territory.

Neither Balls nor Krugman offered anything that that might be called a “reason” for their opinions.

This “political territory” problem arises from time to time because of the illogical division of responsibilities as between the Bank of England (and indeed most central banks) one the one hand, and governments on the other. That is, both institutions have a say in factors that influence aggregate demand (AD), which is a nonsense. You might as well have a car controlled by two steering wheels, each controlled by different people.

Central banks are normally responsible for interest rate adjustments, which in turn influence AD and hence employment levels. Thus it can be argued that Mervyn King was in order to pass comment on ANYTHING that influences AD or employment in the aggregate.

On the other hand it could be argued that he was not in order in that he passed comment on the “steering wheel adjustments” being made by government.

A more logical division of responsibility would involve central banks having sole discretion over ALL factors that influence AD: i.e. interest rates PLUS the budget deficit (or surplus). These are very much technical, rather than political questions.

In contrast, government (i.e. political parties) would have responsibility for the much more political questions like the MAKE UP of government spending and what proportion of GDP should be devoted to the public rather than private sector.


Modern Monetary Theory (aka Functional Finance).

The above points about division of responsibility is of particular relevance for Functional Finance (FF), and for the following reasons.

In an FF regime (at least as I see it), interest rate changes are not the main AD adjustment tool. The main tool is Abba Lerner’s so called “money pump”. That is, if more AD is needed, government just creates more money and spends it. And conversely, if inflation looms, government does the opposite, that is reins in money (via raised taxes) and “unprints” or extinguishes money.

This raises the question as to who controls the pump. And the answer is “the central bank”. Central banks are better qualified than politicians to pass judgement on whether AD needs adjusting so as to optimise the inflation / unemployment relationship. In contrast, as pointed out above, the question as to what proportion of GDP should be devoted to the public sector, and the make-up of that spending is very much a political question, and should be the responsibility of political parties.

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The crucial importance of foreign bond holders in relation to the U.K.’s deficit and austerity.

According to the Financial Times, Mervyn King in a speech in Newcastle said “households would have to accept a period of austerity because of the need to raise consumption taxes and cut spending to bring the deficit under control.”

Mervyn King actually said nothing of the sort. But then our so called quality broadsheet newspapers have never been vastly more reliable sources of news than Playboy magazine or Asian Babes.

However a large majority of OTHER economics commentators ARE saying something similar to what Mervyn King allegedly said, namely that cutting the deficit requires increased taxes and/or government spending cuts, which allegedly brings austerity.

This is nonsense. I’ve been banging on about this myth for best part of a year now. For the umpteenth time here is the flaw in the flaw in this “austerity” argument.

Reducing the deficit simply involves getting taxpayers to fund a portion of government spending rather than lenders (i.e. those who buy government bonds). And there is no more reason for this to be deflationary, or to involve austerity than switching the tax burden from income tax to a sales tax. (As opposed to tax increases, public spending cuts can play a part, of course.)

A slight problem with this “switch” is that might seem to involve switching the tax burden from the rich onto the poor. But this “problem” can always to dealt with by altering income tax and/or other wealth based taxes.


Foreign bond holders.

There is however a reason why reducing a deficit MIGHT involve austerity. If the portion of national debt held by foreigners has been rising in recent years, that is an effective subsidy of living standards in the country concerned. And if that subsidy were to suddenly stop, that would cause what might be called a standard of living hit or “austerity”. But does ceasing to live on an ever expanding overdraft really constitute “austerity”? Isn’t it more realistic to call this “facing reality”?

This foreign bond holding point is significant for the U.K. The U.K.’s national debt has been rising at a rate that equates to about 6.6% of GDP a year. See here and here.

While the proportion of this held by foreigners has risen by about 50% in the last three years or so (from 20% to 30%).

And those numbers are significant. They equate to a standard of living subsidy amounting to about 2% according to my highly questionable calculations. ((6.6/5) x (30/20) = 2))

But ceasing to rely on foreigners funding an ever expanding national debt is no reason for job cuts or increased unemployment. The only reason to cut employment levels is the threat of excess inflation. That has nothing to do with the deficit.

Moreover, the U.K. seems to have got used to “austerity” so far as living standards go. As Mervyn King said in the above speech “….in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.”

An introduction to Modern Monetary Theory.

Note. Introducing Modern Monetary Theory in less than 2,000 words or so is not easy. I tried here some time ago here. The article below is another attempt. This summary hopefully reflects the views of most MMT advocates, but it should not be taken as necessarily being an accurate reflection of their views. It’s “MMT as I see it”.

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MMT consists essentially of a simple solution to a series of complex economic problems. These are the problems which economists and politicians are currently grappling with: deficits, national debts, inflation, unemployment and so on. Or to be more accurate, MMT is a step forward in solving those problems.

But MMT itself has a big problem: it is so simple that at first sight, it is often rejected precisely because it is so simple. But then E=MC2 is a simple formula. That doesn’t stop Einstein’s theory solving dozens of problems in physics and astronomy.

Anyway, MMT says basically that given excess unemployment, the government / central bank machine should just create more money and spend it. And conversely, given excess inflation, government should do the opposite, that is rein in money (e.g. via increased tax) and “unprint” or extinguish money.

Also, MMT claims that government borrowing is largely a waste of time. That is, the traditional Keynsian policy of having government borrow and spend more in a recession is defective. So in a recession, governments should simply spend more – and forget about borrowing.(For more on the nonsense that is government borrowing, see here.)



Inflation.

Now the knee jerk reaction of 99% of population to the money creation idea is entirely predictable: “inflation”.

However the fact of creating new money does not, repeat not, cause inflation. For example if someone prints a million tons of $100 bills and hides them down a disused mine shaft, there’d be no effect. It’s only when that money is SPENT, that there is an effect, and the effect is to raise demand, which is exactly what is needed in a recession (as long as the increase in demand is not excessive).

As regards inflation, employers do not raise prices unless they find demand for their products EXCEEDS their ability to supply. And if an economy has spare capacity, particularly excess unemployment, then employers CAN meet the extra demand. Thus little inflation is caused by a “print money and spend it” policy in a recession, as long as the amount printed or created is not excessive.

As distinct from the short term, it is possible that the additional money will EVENTUALLY lead to inflation. Well the answer to that was spelled out above, namely that if inflation DOES loom, then the “money printing” process can be put into reverse. Plus there are other and more conventional anti inflationary measures government can take: raised interest rates for example.


Public v. private sectors.

A second possible objection to the above money creation idea is that it increases the proportion of GDP taken by the public sector. That’s a fair point. And there is a simple solution. This is to use part of the new money to reduce taxes, i.e. just leave peoples’ hard earned money in their pockets. Some of that money will then be spent on private sector goods.

As to evidence that households really do spend a significant proportion of windfalls deriving from tax reductions and other sources, see here, here, here and here.

Having dealt with the objections to MMT, I’ll now explain a few more of the advantages.


Crowding out.

First, the total AMOUNT of new money that needs to be created to bring about a given reduction in unemployment is guaranteed to be less (and could be VASTLY less) than the amount of borrowing needed under the conventional “borrow and spend” policy. The reason is that government borrowing increases interest rates which in turn crowds out private sector economic activity.

There is much argument as to the EXTENT of this crowding out, but it is just possible that the above borrow and spend policy has no effect whatsoever as far as reducing unemployment goes, because the crowding out is total.

Or possibly the crowding out is say 90%, in which case government needs to borrow and spend about NINE dollars for every ONE DOLLAR increase in GDP: a complete farce. Noticed the HUGE increase in government borrowing over the last two years combined with a less than dramatic reduction in unemployment?

Of course (and here comes the real farce), governments don’t actually let interest rates rise in a recession. That is, they buy back government debt, i.e. they engage in quantitative easing, or “money printing” of a sort. So the REALITY is that governments are currently implementing MMT, but in an illogical and incoherent manner.

So what exactly are the illogical aspects of our current “MMT on the sly” policies that need to be removed to make it more logical?

Well let’s consider the BASIC purpose of the economy. It’s to provide what the consumer wants, isn’t it? Thus MMT implemented in a logical way simply consists of enabling consumers to purchase more, and that is easily done, as mentioned above, by leaving money in household pockets, rather than confiscating such money via tax. And that can be done for example via a payroll tax reduction and various other measures. (Plus, as mentioned above, public sector spending can be increased.)

In contrast it is very hard to be sure who are the main beneficiaries under a traditional Keynsian “borrow and spend” policy. Under this policy, government borrows money, then spends it, plus it issues bonds to those it has borrowed from. Then it buys back some of the bonds, i.e does some QE. Who benefits from this process? Just try working it out yourself. You’ll probably never get to the bottom of it. Certainly a major effect of Q.E. is to boost asset prices, the stock market in particular. And the main beneficiaries here are the wealthy.

Also, politicians have recently channelled new money into the pockets of Wall Street, rather than Main Street. After all, if you are a politician and some banker has funded your election campaign, you have to pay them back, don’t you?


Is MMT better than interest rate adjustments?

For decades the main tool for adjusting demand has been interest rate adjustments. Thus it is valid to ask why MMT is better. There several reasons. Here are just a few.

First, interest rate adjustments are distortionary: they bring sudden and temporary windfalls for people and business heavily reliant on borrowing, while for others there is little or no benefit. Indeed, savers actually LOSE income as a result of rate reductions.

Second, several studies into interest rates have concluded they are an ineffective way of influencing demand. For example the Radcliffe Report on monetary policy in the U.K. published in 1960 concluded that ‘there can be no reliance on interest rate policy as a major short-term stabiliser of demand’.

Third, the interest rate, that is the price of borrowed money, should be determined the same way as everything else: by market forces. Having government tinker with the price of something is justified given some very good explanation, and assuming there is no alternative to “tinkering”. But there is an alternative to tinkering with interest rates: it’s called MMT.

To summarise, where a government needs to stimulate an economy (or do the opposite – damp down economic activity), there is a way of doing so which is much simpler than existing policies. This simple alternative is MMT. Moreover, governments are already implementing MMT, but in a chaotic and illogical manner.

MMT would make national debts obsolete. MMT would cut out a lot of nonsense, bureaucratic expense, subsidies for the rich, and so on: the list is quite long.


The history of MMT.

Given that the first “M” in MMT stands for “modern” you might think MMT is a new idea. Actually it is several decades old, which makes the title “Modern Monetary Theory” not entirely appropriate.

There is actually an alternative name: “Functional Finance”, but the name “MMT” seems to have gained the upperhand. The word “functional” is very appropriate. The idea behind this word is that there is no reason why government spending needs to equal the total of government income from tax and from borrowing. That is, the purpose of government income and spending should be “functional” in the sense that the only important consideration is the effect of such income and spending on unemployment and inflation.

Keynes was well aware of the essentials of MMT, while a contemporary of Keynes’s, Abba Lerner, advocated MMT in a more open and blunt manner than Keynes. Also, Milton Friedman advocated what amounts to MMT here.


Thomas Edison.

But perhaps pride of place should go to Thomas Edison, the inventor, who tumbled to a couple of the essential ideas behind MMT in 1921. Edison certainly gets the idea, mentioned above, that government borrowing is a nonsense. Plus he gets the idea that any new money should be the property of the people, not of bankers, the rich, or any other group.

Alternatively, see the original New York Times article where Edison sets out his ideas. See the two paras near the end starting “It is absurd to say..”. (Incidentally, Edison in this article also spots the basic flaw in the gold standard! Not bad for a non-economist. But then he was a genius, as we all know.)

Some people just don’t know when they’ve got someone else over a barrel.

There is an old saying which goes something like, “When you owe the bank a little money, you’ve got a problem. But when you owe the bank A LOT OF MONEY, the bank has a problem.”

Many Americans think that the large amount they owe China and other foreigners is a US problem. I suggest that if the US played its cards right, it would become a severe headache for foreigners and a source of profit for the US.

The US, instead of providing its economy with enough stimulus has allowed China and others to come to it’s “rescue” with billions (that the US could perfectly well have printed itself).

What the US should do is create enough new money to bring employment back to where it was, or near where it was prior to the crunch. Maybe it would even be an idea to print a bit MORE money than is really needed so as to bring about an inflation rate of 4% or so.

That would mean the debt to foreigners would decline in real terms at 4% a year: headache No 1 for foreigners.

As to the interest rate offered by the US to those wanting Treasuries, this should be a miserable 1% or so. In fact the Fed could have a big notice over its front door: “We’ll borrow just as much as you are able to lend us, you suckers. We’re open for business 24/7”.

Of course, the reaction of foreigners would be to seek out other borrowers. But if a significant portion of other sovereign borrowers adopted the same policy, the lenders would have nowhere to go.

A possible catch with the above policy is that the Chinese government is not as stupid as the US government.

That is, the best policy for the Chinese to adopt in reaction to the above “1% Treasury” idea would be to cease lending: that is gradually sell off their Treasuries and use the money to buy US goods and services and ship those products back to China. That constitutes a REAL repayment of debt. I.e. the debt is repaid in the form of real goods and services. And that would involve a temporary standard of living hit for US citizens.

Alternatively, foreigners might use the money to invest in US industry. That would involve no standard of living hit for US citizens.

But the Chinese have a phobia about imports. They are determined to export as much as possible, and build up stocks of other countries’ sovereign debt. So there is a good chance they wouldn’t go for the latter rational policy. That is, there is a good chance they’d just plonk their surplus dollars in U.S. banks, who wouldn’t have much use for the money, and who would thus offer a rate of interest even more miserable than the above 1%.

As long as someone behaves irrationally, there is money to be made out of them. Someone somewhere ought to have them over a barrel.

Note added 21st March 2011: Nice to see someone else tumbling to the fact that borrowing money from other countries so as to get out of a recession is totally unnecessary, since the U.S. can print its own dollars. See fourth para here.

“Make work”, the Job Guarantee, WPA, etc: should they be limited to the public sector?

Summary.

Make work schemes, like the WPA in the U.S. in the 1930s do not make sense. However they involve temporary subsidised work for the unemployed. And temporary subsidised work for the unemployed with EXISTING employers, as distinct from “specially set up employers” like make work schemes, DOES make sense. Plus there is no reason to confine this sort of work to the public sector.

Temporary subsidised work with existing employers actually amounts to something very similar to a totally free labour market, that is a labour market with no artificial interferences like minimum wage laws. While the price that employers pay for such labour can be “free market price”, i.e. very low, obviously the take home pay of the relevant employees must be up to socially acceptable levels.

If you find this article hard going, don’t worry. I estimate the number of people on planet Earth with enough brain and enough genuine interest in the subject to understand the article to be about three!


Introduction.

The idea that there are an almost infinite number of useful jobs the unemployed could do is as old as the stars. Pericles in Ancient Greece 2,500 years ago had the unemployed work on public sector construction projects. And more recently in the U.S. in the 1930s millions were employed on schemes of this sort: the “WPA” for example (which stood for Work Progress Administration).

And then there is the particular form of “make work” currently advocated by some Modern Monetary Theory enthusiasts, namely the so called “Job Guarantee”.

In principle, unemployment can be reduced to zero at the flick of a switch by schemes of this sort. For a very crude illustration, we could tell the unemployed their benefits are henceforth conditional on walking round their neighbourhood keeping it free of litter. Those accepting the work would be deemed to be employed. And those refusing would be deemed to have turned down work, and are therefore not unemployed. Hey Presto: unemployment vanishes.

Incidentally, I’ll refer to WPA, Job Guarantee, and similar schemes below as “make work”, for want of a better phrase.


Limit make work to the public sector?

The advocates of make work normally see it as being limited or largely limited to the public sector.

The reason (normally not set out too clearly by make work advocates) is that no additional demand is required. But there is a catch here, as follows.

Labour employed on make work can be employed alongside other factors of production (OFP) like permanent skilled labour, equipment, materials, etc. Or, secondly, such labour can be employed with little or no OFP. But if OFP IS employed, it has to be ordered up from the rest of the economy. I.E. ADDITIONAL DEMAND IS REQUIRED! Now there is a problem here.

If the economy can take extra demand, there is no place for make work in that employment can be created simply by raising demand. That is, raising demand is a better way of raising employment than implementing or raising the numbers doing make work.

Alternatively if OFP is NOT used, then the only input on make work schemes will be temporary and not very skilled labour: output per head will be hopeless.

Incidentally, make work employees were described as “not very skilled” in the above para not because they don’t possess skills. The point is that people tend to become unemployed when, even if they DO possess skills, there is no demand for those skills locally. Thus any job a person gets, whether make work or not, is LIKELY to involve them working in a RELATIVELY UNSKILLED capacity.

And there is a further nonsense here in relation to OFP. If a make work scheme DOES involve levels of OFP that are up to near those that obtain with normal employers, then what’s the difference between such make work schemes and a normal employer? The answer is “none”.

This nonsense actually obtained, more or less, with some 1930s WPA construction projects, where the amount of construction equipment, matrials, skilled labour, etc was almost up the level normally found with private sector contractors.

To summarise, make work is stuck between a rock and a hard place: use no OFP and be condemned to inefficiency. Alternatively, employ significant amounts of OFP, and accept two bits of nonsense: first make work has an inflationary effect, because OFP has to be ordered up from the rest of the economy. Second, the relevant make work scheme comes to much the same thing as a normal employer.


Make work and inflation.

The above point about make work being inflationary can be summarised as follows. If unemployment is above the level at which labour shortages exacerbate inflation (which I’ll call NAIRU for want of a better phrase), then make work will not be inflationary. But in this scenario, there is no place for make work in that employment is best raised by a straight rise in demand (plus, presumably, an equivalent expansion in the public sector).

Moreover, on a like for like comparison, there is little difference as between the inflationary effect of public and private sector make work. To illustrate, take two make work schemes, both of which the same OFP to unskilled labour ratio. The private sector scheme will be inflationary because any extra demand at NAIRU is inflationary. While in the case of the PUBLIC sector schemes, government will have to increase net spending so as to order up the required OFP. There is not much difference between the two!


Existing employers provide a decent OFP to temporary labour ratio.

As explained above, the problem that really stymies traditional make work schemes is the OFP problem.

There is actually a very simple way, at least in theory, of employing make work labour efficiently with ABSOLUTELY NO NEED for additional OFP. This is to make the unemployed available at a subsidised rate to EXISTING EMPLOYERS (as opposed to “employers” in the sense of “specially set up make work projects”).

If the unemployed (i.e. low priced and relatively unskilled temporary labour) is supplied to EXISTING employers, those employers will be induced to raise the amount of labour employed RELATIVE to the amount of OFP employed. This is for exactly the same reason as if the cost of say computing (or any other input) declines, employers will employ more computing power relative to other inputs.

Note that, as is always the case in economics, it is not the AVERAGE price of an input (or anything else) that is important: it is the MARGINAL price. That is, make a few EXTRA OR MARGINAL employees available to employer at a lower price, and (to repeat) more labour will be employed relative to OFP.

Now we have a piece of magic here: little or no extra OFP is required, yet the “make work employee to OFP ratio” is almost up the standard that normally obtains with existing employers (because it is existing employers who do the employing!). To put that in plain English, it is better to have an unemployed teacher work in some sort of peripheral capacity in a school, than have them do typical “make work” type work, e.g. weeding the flower beds in the nearest public park.

Incidentally, I’ll continue to describe the employees involved as “make work”, despite the fact that from this stage in the argument the assumption is that they are allocated to EXISTING employers rather than to WPA make work type schemes.


Would supposedly marginal employees really be marginal?

How do we ensure that make employees really are “marginal”. That is, how do we ensure that they are the employees that each employer regards as the least productive or most peripheral?

It’s easy. Just limit the TIME that each make work employee stays with a given employer. Employers don’t mind losing employees who are genuinely of marginal use, but they very much DO mind losing their more productive employees. If an employer knows an employee will leave in the near future, the employer will not classify the employee as make work, or claim the make work subsidy in respect of the employee. (Obviously it would be necessary here to have some rules to prevent attempts to “fiddle” the system: for example there is an obvious temptation for employers to fire and immediately re-hire make work employees who have reached their time limit.)


Make work with existing employers = free market!

Astute readers will have noticed by now that the system advocated above amounts to much the same thing a totally free and perfectly functioning labour market (a bit of an unrealistic and theoretical construct, but never mind). That is, a labour market where there are no artificial interferences like minimum wage laws or state funded unemployment benefit systems. In this free (and brutal) market, many of those becoming unemployed just have to take any old job however low paid if they want to avoid starvation. They are likely to move on quite quickly to something better paid as soon as they find it.

The system advocated above comes to much the same thing: certainly the cost of the relevant labour to the employer would be ultra low (or even free). However, take home pay would be up to minimum socially acceptable levels.


No limit to the number of potential public sector make work employees?

An objection that advocates of public sector make work schemes will probably raise is that there is in principle no limit to the number of public sector make work jobs that can be created. This is an obvious and crude truism (pointed out in the first para above – picking up litter, etc).

Incidentally this point applies both to traditional WPA make work schemes AND to “make work with existing employers”.

However, the above truism does not get public sector make work very far, and for the following reason. The marginal product of labour (or any other input) declines with increased numbers employed. I.e. it is true that limitless numbers can be employed on public sector make work schemes, but the bigger the number, the more likely it is that marginal product of the relevant labour is around zero, or even negative, e.g. the collection of non-existent litter – to echo the example with which we started above.

Indeed, the PRIVATE sector is BETTER at employing relatively unskilled labour than the public sector. On that basis, and assuming we want to expand the number of make work people in both sectors to the point where the output of the marginal employee is any specified amount (including perhaps zero), then then MORE make work people would be employed in the private than in the public sector.


The declining marginal product of labour is caused by macro as well as micro factors.

It might seem that the point just above about the marginal product of labour is flawed in that this marginal product point is invariably set out in the text books as being a MICRO ECONOMIC phenomenon. (I.e. where a firm employs increasing numbers relative to a fixed input of capital equipment and materials, the output or “product” of each succeeding person hired will decline.)

In contrast, in the above para, the point is being applied to a MACROECONOMIC scenario.

The answer to this apparent flaw is that there are also MACROECNOMIC forces at work which result in the marginal product of labour declining as unemployment in the aggregate falls. These “forces” are very simple and common sense: first, as unemployment falls, it becomes increasingly difficult for the nation’s employers to find labour that is suitable for vacancies. Second, employers in the aggregate always employ the best labour first. That is, as unemployment falls, lower quality labour becomes employed.


And therein lies the reason why temporary low cost labour raises aggregate employment both in a free market and under the system advocated here.

Simply pointing to the fact that an employment system has similarities to the free market is not a bad argument, but it needs to be strengthened to explaining the reasons, in theory, why the result is an aggregate increase in employment. The reason is thus.

As pointed out above, as unemployment falls, employers have to take progressively poorer and poorer quality labour. When this decline becomes sufficiently serious, employers tend to resort to bidding up the price of an increasing number of skills, until excessive inflation ensues. However, if relatively unsuitable labour is available for free or at a much reduced price, employers will employ more of such labour, rather than bid up the price of more suitable labour. NAIRU is reduced.


Conclusion.

Hopefully the above paragraphs have demonstrated two points. The first it is that limiting make work to the public sector does not make sense. Second, there are strong arguments for allocating make work employees to EXISTING employers, rather than specially set up “employers” like the WPA. That is, it is better to allocate an unemployed teacher to a temporary and peripheral teaching post in a school (public OR private sector) than have the teacher pick up litter.

If the above arguments are fool proof, then there is NO case for “specially set up schemes” like the WPA. That is, ALL make work employees should be allocated to EXISTING employers, not specially set up schemes.

Possibly there are weaknesses in the above argument, which might result in it making sense to have WPA type schemes for a PROPORTION of make work employees, while allocating the rest to EXISTING employers.

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