Poly's Predictions on Employment Jude Wanniski October 27, 2003

Memo: To Bob Herbert, New York Times
From Jude Wanniski
Re: Fewer Jobs, Higher Wages

Your column today, "There's a Catch: Jobs," was clearly written before the news article on this morning's front page of the Times, , "Wage Increases Giving Economy Unexpected Lift: Gains in Most Pay Levels. The only thing wrong with your piece on the jobless recovery, Bob, is that it was based on old statistics, which underpinned the gloomy report you cited. The front-pager is based on new numbers about how at this stage of the expansion productivity increases are being shared with higher profits for capital and higher wages for labor. Back in July, we predicted this is exactly what would happen as a result of the cuts in tax rates on capital that Congress produced last spring.

In fact, we have been arguing all year that lower tax rates on capital would be even better for labor and that the process now underway would enable many households that rely on two incomes to get by with one breadwinner. We can make predictions like this -- as we have been doing for more than 25 years -- because we are in a supply-side framework that distinguishes between different kinds of monetary and fiscal policies. For months, I've been warning several of the Democratic presidential contenders that they should be expecting the economy to steadily improve, with the labor marketing eventually tightening in 2004, but every one of them is listening to an economist in a demand-side framework and promises to raise taxes!

Here is a client letter I sent out on July 14 of this year, which could not be clearer in its analysis of what to expect. Note I also pointed out back then that while President Bush would be in better shape on the economy in 2004, he would be in much worse shape on Iraq. Our analysis is not at all partisan, as I think you have been coming to appreciate.

FYI: A Sawtooth Climb on Wall Street
By Jude Wanniski Jul 14, 2003

I’ve mentioned a number of times during this mini-bull market that the advance will continue as long as there are no bolts from the blue – but that it would be a three-steps-forward-two-steps-back advance. My reasoning is that almost all the drag on the economy has to do with macro-economic errors made during the past few years. And most of the pull on the market and the economy is due to the change in the federal tax structure now solidly in place. In our distinctive supply-side model, nothing happens automatically because the system is composed of all the U.S. citizens who use dollars to operate in what is an exchange economy – and everyone else in the world who use their national monies to interact with our exchange economy. Remember there are no consumers in our supply model, only producers who exchange their surplus production with each other in the spot market or in the contract market.

The dramatic experience we had with monetary deflation from early 1997 ended when the dollar/gold price climbed back over $350 per ounce. But our economic system was savaged by the wild and deep swings in the national unit of account and has not yet repaired the damage. Tens of millions of businesses and households and 130 million men and women in the work force scrambled as best they could for survival, but I’d imagine very few escaped economic injury. The Enrons and Qualcomms in the system reaped the whirlwind when the conventional expectation of a “V-shaped” recession in 2001 never materialized because of the monetary deflation. There will always be stories of businessmen gone bad in an economic downturn when they juggle the books to keep their doors open. The fact that there is a high-profile scandal surfacing almost every other day can be easily explained by the unusual combination of deflation and contraction hitting the system simultaneously. Only real estate escaped the scythe, kept buoyant by the $1.4 trillion tax cut on capital gains, which was the parting gift of the Clinton Administration.

It may be years before there is complete adjustment to the deflation, through bankruptcies and rebirth of enterprise. But if we imagine the market as a serpent moving forward, it is shedding those problems at its tail end and chewing on the new opportunities going forward. This is not all automatic either, in the sense that we can expect expansion on a definite time line. In an exchange economy, someone will decide to build inventory in California on a Monday in anticipation of orders from Massachusetts that may come on Tuesday, but which might come on Thursday or Friday. The orders will come, given the superiority of the new, lighter taxation on capital, but the capital does not actually get recorded until the orders are placed. If the orders are placed sooner from Massachusetts, the dynamic may cause someone in Illinois to build inventory because of signals he sees that are under the radar scope of financial surveys that can only hit the high spots.

The work force is affected in different ways depending upon the kind of expansion underway. In an expansion from a trough, the official unemployment rate will lag with a demand-side push or a supply-side pull. With the dynamic we are experiencing now, there is more of a lag because of the additions to the capital stock. Employers can actually satisfy order demand with the same number of workers and those who were about to lay off all their workers need only lay off half, as the turnaround appears at the margin. The unemployment rate may continue to climb for awhile, but the only problem for the markets would be if the government decides to do something X, which would be negative, instead of a positive Y. The very best thing that could happen during the next few years would be a decline in the number of workers employed, but only for the reason that households can be managed with one breadwinner instead of two. For that to happen, one of the breadwinners has to be working in an enterprise where increased capital makes up for decreased labor. This goes back to the point that labor benefits most from a cut in capital taxation.

The Democrats, looking for issues to bring down the Bush Administration or at least cut into the GOP lead going into 2004, are making all the usual errors in focusing on unemployment. At the slow but steady rate the market value of capital is expanding, the reported jobless rate will be declining just in time for the elections next year. On the other hand, the Republicans are also putting aside any further discussions of supply-side adjustments in tax policy this year and fiddling around with back-door cuts in state and local sales taxes. The idea is to allow individuals to deduct some of their sales tax payments from federal income tax, which was a gimmick introduced in the Depression and repealed in the Reagan years. There are many less “expensive” ways to adjust tax policy that would produce greater efficiencies in the exchange economy. If there were even one Democrat with a growth agenda, the White House would have to respond with a serious counter of its own. Without a partisan push, the Bush Administration is content to collect election issues for 2004 instead of presenting them with any realistic chance of enactment this year or next.

If there were a bolt from the blue to mess up Wall Street, it would almost certainly come from disturbances in foreign policy. President George W. Bush still seems unperturbed by the escalating criticism of how he “misled the nation” in taking it to war against Iraq. It is a more serious problem than he may now imagine it is, because there was considerable manipulation of intelligence to promote the war. The President himself is probably out of impeachment’s reach in that he probably told the truth as he saw it. His weakness, though, is in the argument that he did not have the wisdom or experience to see how his top team was stacking the deck against a diplomatic solution. This will get much worse, I think, when the congressional hearings get underway, and probably should lead to resignations at the Cabinet level, for the sake of the President and the GOP.

In 1991, I warned President George Bush that the only way he could survive in ’92 would be to fire his Treasury Secretary, Nick Brady, who was instrumental in getting Bush to break his “read my lips, no new taxes” promise. This President Bush has done just fine in replacing his economic team with a much better one, but may become undone by sticking too long with a national security team that has made a mess of Iraq. In any case, these difficulties should not have much impact on the financial markets, which may actually be pleased with developments that are lessening the chance of more pre-emptive wars by the Pentagon’s hawks.