Yes, this description corresponds to the essentials of a free-market, competitive economy. And the single most important factor in driving such a social system is personal incentives.
WE ALL KNOW that a high level of investment spending is crucial to keeping the economy in high gear. Investment incentives are those that propel the businessman to acquire machinery, land, a work force and working capital in anticipation of earning a
profit. But this is rarely undertaken without risk. How skillful he is in assessing the expected profits – and especially the risk of a venture and in managing it – will largely determine its success.
In a nutshell, profits that count depend on sales, costs and taxes. Risk of profits depends on variability of sales and the types of taxes and their rates which are, of course, usually unknown when the investment is undertaken. Assessing the risk of sales and costs is daunting in itself, but the tax risk only amplifies the total risk of the venture by a large multiple.
When the White House constantly threatens to raise taxes on those who are most likely to undertake investment spending, the perceived risk of ventures entertained by innovators mounts rapidly.
On March 3, President Obama is quoted to have said that “the well-off …aren’t contributing to growth, aren’t contributing to our economy.” Not only is this statement patently false – one wonders where his economic advisers acquired their training – but if he would stop threatening to raise their taxes and slow the issuance of government regulations, their incentives to invest in risky opportunities would mount appreciably, leading to a truly robust economy.
People who are well-off are, after all, the geese that lay the golden eggs, and extracting the last tax dollar from them might leave nothing to tax the next time around. Both incentives and the wherewithal to invest and pay taxes are thoughtlessly diminished.
THIS REMINDS US that another huge hindrance to investment incentives is government regulation. We have, especially during the past 50 years, burdened ourselves with literally thousands of costly regulatory constraints that dampen these incentives. Such restrictions contradict basic freedoms of a free-enterprise economy, contributing immensely to the recent disappointing gross domestic product and employment growth. They cost businesses billions of dollars a year, which, even though they may, to some degree, ultimately be paid by the hapless consumer.
Labor should have incentives to be productively employed. When all who are willing to work at mutually agreeable wages are employed, GDP and personal freedom likely are high, and our standard of living is at its zenith.
Isn’t that obvious? Not when you consider all the obstacles society places in front of the worker in the form of attractive alternatives. Instead, society provides incentives for labor to be nonproductively occupied. Higher amounts of unemployment compensation and longer periods of eligibility for such compensation vie for his attention. Eligibility for food stamps, for disability benefits, for aid to dependent children, for student loan programs and so on are a strong attraction to the alternative of gainful employment. By making these programs available and attractive, we incentivize potential workers to be eligible for them.
At some combination of benefits, however, many workers, especially the young, reach a point where they prefer not to offer their productive services – i.e., not to work. For example, to a substantial number of young adults, the federal student loan program is an option to working. Why work when the borrow/default path is always open for a comfortable, if temporary, way of life? Attending school might lead to more knowledge. But knowledge and experience can be acquired by working, too.
PUT ANOTHER way: By offering attractive social programs, welfare agencies in effect attempt to outbid all other sectors (including the private sector) for welfare clients, and by offering higher wages the private sector tries to outbid them for manpower. This is indeed an ironic outcome.
But, you say, these social benefits address important societal needs. Historically, our politicians have done a tragically poor job of suggesting and evaluating alternative methods for addressing these problems. Compensation for social programs must be set so as not to destroy the incentive to work. Aid to the verified extra needy should be handled through special programs, not by unemployment compensation, aid to needy
children or other general programs.
Politicians support minimum-wage laws not only because of their alleged social benefits but also because their entire direct costs are borne by employers. They also are aware that, as overwhelmingly established by economists, employment of young, unskilled workers – especially black teenagers – will be markedly depressed. Yes, as expressed in legal parlance, the minimum wage has a “disparate impact” on black teenage employment, which puts it in conflict with the Civil Rights Act of 1965.
But never mind – politicians will vote for increases in unemployment compensation and the extension of benefit periods to compensate those adversely affected. This is inhuman because the principal benefits teenagers gain from private employment is not the amount of the wage, but the uplifting experiences and discipline acquired from employment – the acquisition of values along with incentives that helps sustain them as adults, and a sense of pride, personal responsibility and independence. More teenage employment can lead to more stable families, more stay-at-home fathers. But minimum-wage induced unemployment prompts needless delays in teenagers acquiring necessary skills for working careers.
IT IS RAW UNION political power that drives the minimum-wage laws. Is there a viable alternative to such laws, such as rendering workers more valuable to their employers, or increasing their productivity, without these dismal and mean effects on unskilled teenagers?
Incentives drive the economy. They are needed by unskilled teenagers and by the most sophisticated, risk-taking venture capitalists. We should be keenly aware of that, and not worry about overemphasizing incentives.
(The writer is a professor emeritus of financial economics at the University of Georgia. He lives in Aiken, S.C.)