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Larry Summers (whose name you may have heard recently — he is head of Obama’s National Economic Council, once published a paper on the causes of unemployment, and part of it is below:

Another cause of long-term unemployment is unionization. High union wages that exceed the competitive market rate are likely to cause job losses in the unionized sector of the economy. Also, those who lose high-wage union jobs are often reluctant to accept alternative low-wage employment. Between 1970 and 1985, for example, a state with a 20 percent unionization rate, approximately the average for the fifty states and the District of Columbia, experienced an unemployment rate that was 1.2 percentage points higher than that of a hypothetical state that had no unions.

Barack Obama, on the other hand, had this response regarding unions and unemployment:

On the economy, President Barack Obama signaled once again the ground is shifting — this time with regard to unions.

With his signature on three executive orders, President Barack Obama expanded workers rights and reversed Bush administration orders that were seen as anti-union.

Then, the president said something that hasn’t been heard in the Oval Office for a long time. “I do not view the labor movement as part of the problem, to me it’s part of the solution,” said President Obama.

[HT: Harvard economist Greg Mankiw]

I think I take it for granted that people don’t understand the distinct differences between the two. People in the news, as well as people in everyday speech, seem to use the terms interchangeably to refer to the same thing. But they are indeed different.

Fiscal policy is the policy made by federal, state, and local governments to spend on so-called “government services.” It includes both the taxing and the spending of the taxes.

Monetary policy, on the other hand, is made by the Federal Reserve (the central bank of the United States). For the sake of simplicity, I don’t want to get into the nitty gritty of how this is done, but by buying and selling government bonds, the Federal Reserve adjusts the supply of money in the economy as well as influences loan interest rates.

What are the implications of these two types of policy?

Keynesian economics (named after British economist John Maynard Keynes — economists who follow Keynes are often called Keynesians) emphasizes government expenditures to give stimulation to the economy in the short run during economic depressions (the term recession is simply a euphemism). The total wealth of a country (its GDP) is a combination of factors, including what individuals, businesses, and government spend on consumption goods, services and investments. If taxes are reduced, people will be inclined to spend more on goods, services, and investments, so GDP should rise. Another option is for government to increase its spending, as government expenditures also trickle into the economy and boost the GDP.

Monetarists (Milton Friedman is probably one of the most famous in this group) emphasize expansionary monetary policy during depressions. By “pumping money into the economy,” interest rates are lowered and loans are more easily made. People can borrow now and pay back later when the economy recovers (as it always eventually does). In fact, as people borrow to spend on goods, services, and investments, this increases GDP in the short run and gets the country out of the funk it was in.

Although the exact causes of the Great Depression are still being debated to this day, most economists agree (at the very least) that a combination of several New Deal policies and abysmal Federal Reserve policy direction exacerbated and lengthened the problems we encountered.

Something must be noted about both the views of Keynesians and monetarists: both “solutions” only work in the short term. There is an optimal or equilibrium point that GDP naturally moves toward. Otherwise, economists could continually manipulate fiscal and monetary policy to achieve “super” rates of GDP growth. More importantly, both forms of “temporary stimulation” take the attitude of “borrow now, pay back… some day.”

Like an organic being, the economy can suffer many blows and recover naturally on its own. Anytime a foreign substance — a medicine (or in the case of the economy, economic stimuli) — is introduced into the being, good things, as well as unintended consequences, can occur. The unintended consequence of economic stimuli is that by unnaturally fixing the economy, it sets it up for bigger problems later on. The “boom and bust” business cycle is not a natural occurrence, but a byproduct of economic policies which artificially prop up failing or aged parts of the economy. Just like an occasional fire in the woods is a good, natural part of life, allowing new undergrowth to burgeon and expand, an economic depression shuts down floundering enterprises and replaces them with new entities.

After nearly a century of Federal Reserve monetary policy and more than a century of legislative bodies fixing fiscal policies, it is no wonder that we are facing such difficult economic times.

The hopeful part is that, like an organic being, the economy is a very strong and robust creature, able to withstand much. In time, this bust will again turn into a boom.

Or should we replace that with the pervasive mantra of most conservatives/Republicans?: Get the hell out of my country.

It’s strange to me that Lady Liberty, “From her beacon-hand Glows world-wide welcome,” yet a majority of people want to shut out all the would-be immigrants.

I recently started reading The Myth of the Rational Voter by Bryan Caplan, economist at George Mason University. I highly recommend the book, as well as checking out the blog he co-manages, EconLog. A couple-chapter-excerpt from the book can be found at The Cato Institute website, but seriously, just buy it.

Professor Caplan discusses “Antiforeign bias,” and I found one particular passage particularly interesting. With so much theoretical and empirical evidence showing the benefits from dealings with foreigners, why could anyone (especially a so-called “free market” conservative) favor restrictive foreign trade and immigration policies?

I’ve been wanting to write about this topic for a while, so I’m glad I found something so well-written. Why reinvent the wheel?

From The Myth of the Rational Voter:

Popular metaphors equate foreign trade with racing and warfare, so you might say that anti-foreign views are embedded in our language. Perhaps foreigners are sneakier, craftier, or greedier. Whatever the reason, they supposedly have a special power to exploit us.

Alan Blinder laments that People around the world scapegoat foreigners:

When jobs are scarce, the instinct for self-preservation is strong, and the temptation to blame foreign competitors is all but irresistible. It was not only in the United States that the bunker mentality took hold. That most economists branded the effort to save jobs by protectionism shortsighted and self-defeating was beside the point. Legislators are out to win votes, not intellectual kudos.

The Survey of Americans and Economists on the Economy (SAEE) amply confirms Blinder’s point. Respondents rated the severity of the economic harm caused by the fact that “companies are sending jobs overseas.”

Economists are especially critical of the anti-foreign outlook because it does not just happen to be wrong; it conflicts with elementary economics. Textbooks teach that total output increases if producers specialize and trade. On an individual level, who could deny it? Imagine how much time it would take to grow your own food, when a few hours’ wages spent at the grocery store feed you for weeks. Analogies between individual and social behavior are at times misleading, but this is not one of those times.

The law of comparative advantage, one of the most fascinating theorems in economics, shows that mutually beneficial international trade is possible even if one nation is less productive in every way. Suppose an American can make 10 cars or 5 bushels of wheat, and a Mexican can make 1 car or 2 bushels of wheat. Though the Americans are better at both tasks, specialization and trade increase production. If one American switches from wheat to cars, and three Mexicans switch from cars to wheat, world output goes up by two cars plus one bushel of wheat.

How can anyone overlook trade’s remarkable benefits? Adam Smith, along with many 18th- and 19th-century economists, identifies the root error as misidentification of money and wealth: “A rich country, in the same manner as a rich man, is supposed to be a country abounding in money; and to heap up gold and silver in any country is supposed to be the best way to enrich it.” It follows that trade is zerosum, since the only way for a country to make its balance more favorable is to make another country’s balance less favorable.

Even in Smith’s day, however, his story was probably too clever by half. The root error behind 18th-century mercantilism was an unreasonable distrust of foreigners. Otherwise, why would people focus on money draining out of “the nation,” but not “the region,” “the city,” “the village,” or “the family”? In practice, human beings then and now commit the balance of trade fallacy only when other countries enter the picture. No one loses sleep about the trade balance between California and Nevada, or me and my grocer. The fallacy is not treating all purchases as a cost, but treating foreign purchases as a cost.

Modern conditions do make anti-foreign bias easier to spot. To take one prominent example, immigration is far more of an issue now than it was in Smith’s time. In theory, trade in labor is roughly the same as trade in goods. Specialization and exchange raise output— for instance, by letting skilled American moms return to work by hiring Mexican nannies. The SAEE confirms that the public is quick to see great dangers in this process— and economists and the enlightened public to minimize them.

In terms of the balance of payments, immigration is a nonissue. If an immigrant moves from Mexico City to New York and spends all his earnings in his new homeland, the balance of trade does not change. Yet the public still looks on immigration as a bald misfortune: jobs lost, wages reduced, public services consumed. Many see a larger trade deficit as a fair price to pay for reduced immigration. One peculiar pro-NAFTA argument is that if we admit more Mexican goods, we will have fewer Mexicans. It should be evident, then, that the general public sees immigration as a distinct danger—independent of, and more frightening than, an unfavorable balance of trade. People feel all the more vulnerable when they reflect that these foreigners are not just selling us their products. They live among us.

Calm reflection on the international economy reveals much to be thankful for, and little to fear. On this point, economists past and present agree. But an important proviso lurks beneath the surface. Yes, there is little to fear about the international economy itself. But modern researchers—unlike economists of the past and teachers of the present—rarely mention that attitudes about the international economy are another story. Paul Krugman hits the nail on the head: “The conflict among nations that so many policy intellectuals imagine prevails is an illusion; but it is an illusion that can destroy the reality of mutual gains from trade.”

That’s what over 100 economists are saying. Is this a surprise to anyone? Not me. Among those listed are five Nobel Prize winners, two of which are professors at GMU: Vernon Smith and James Buchanan.

By the way, I got this story from Greg Mankiw’s blog. Mankiw is a macroeconomist at Harvard, and though his name doesn’t appear on the list of supporters for the above-mentioned statement, he did state that he doesn’t like Obama’s proposed plan either; he merely didn’t sign because it was a “tad too hyperbolic for my tastes.” Makes me wonder how many more economists would have signed if the statement were merely “Obama’s plan is bad,” rather than “Obama’s plan is absolutely terrible.”