Destabilizing an Unstable Economy - The Market Failures Issue

Challenge, Nov-Dec, 2002 by Charles Whalen, Jeffrey Wenger

As Figure 2 indicates, AFDC and TANF expenditures as a percentage of GDP have declined sharply and rather steadily since the 1970s, from a high of 0.65 percent of GDP 1975 to 0.24 percent of GDP in 1998. Thus, even prior to the advent of the TANF block grants, welfare's role as a countercyclical measure was waning. The block grants take this effect even further by leaving states responsible for coming up with additional welfare funds during a recession.

The Minimum Wage

The minimum wage was established during the Great Depression. With so many people out of work, downward pressure on wages was severe. Minimum wages were designed to preserve some purchasing power (effective demand) during a time when workers are likely to sell their labor at ever declining prices. The minimum wage puts a floor on that income erosion, and thus helps stabilize the economy during recessions.

As Figure 3 shows, the real value of the minimum wage has fallen markedly since 1968. Today's minimum wage provides a real-wage floor at the same level as existed in 1955. That means its ability to prop up the bottom of the labor market has eroded considerably in recent decades--only a severe recession is likely to find the current minimum-wage floor binding.

Making the System More Stable

Structuring the economy to best handle future expansions and contractions requires shoring up fiscal stabilizers. The tax system should be structured so revenues are sensitive to, and move inversely with, changes in income and prices. The need to incorporate stabilizing elements into the economy "argues for having a progression of tax brackets and rates over incomes in the middle ranges," wrote Minsky (1986, 308). In contrast, the yet-to-be-phased-in tax cuts of 2001 pull the system in the opposite direction.

Unemployment insurance needs to be reformed so the program reaches more people and provides more adequate benefits. Among the needed reforms: A state's extended-benefits program should start when its insured unemployment rate reaches 4 percent, as was the case before 1981. Also, workers laid off from part-time jobs should be eligible for jobless benefits.

Welfare and the minimum wage also require adjustment. The country's current welfare spending program, TANF, needs changes that will trigger more federal spending during recessions, and that will encourage states to create "rainy day" funds. Similarly, welfare time limits should be extended for individuals when macroeconomic contractions occur (Peterson 2002, 436-37). The minimum wage needs to be raised and automatically adjusted for inflation.

Another way to add stability to the economy is to establish the government as employer of last resort (ELR). Policymakers and academics have discussed this idea at least since the Great Depression, but Minsky was one of its strongest advocates in the 1980s and early 1990s. More recently, L. Randall Wray and Mathew Forstater have been at the forefront of efforts to develop the intellectual foundation and policy framework for guaranteeing a public-sector job to anyone not able to find private-sector work (Wray 1998; Forstater 1998).