Saturday, August 20, 2011

Long-Term Unemployment: A Modigliani-Miller Approach

Mark Perry of Carpe Diem (Via Don Boudreaux of Café Hayek):

The first principle of economics is that we live in a world of scarcity, and the second principle of economics is that individuals have unlimited wants and desires. 

Therefore, the second principle of economics: unlimited wants and desires, rules out any long-term problems of unemployment. [emphasis original]

I like this: stark and unrealistic.

Stark is a good way to move the discussion forward, particularly if it yields something unrealistic: because this means that what is included in the stark viewpoint must be relaxed to get something realistic. And the points that are relaxed tell us something about the real world.

The academic finance version of this is the Modigliani-Miller theorem. In short, it states that under certain conditions, the value of a firm is indifferent to the way it is financed. This is unrealistic, so it must be a relaxation of those conditions that leads to finance creating value.

I view Perry’s point in the same way: if long-term unemployment is a problem, it must be because either the problem of scarcity has been mitigated, or the problem of wants has been mitigated.

But … the latter is precisely what governments strive to do. They don’t really get rid of wants, but they clearly spend a lot of time trying to suppress them.

Think about this in terms of something like broadening the taxation of  internet transactions. This won’t actually reduce wants, but it will keep people from expressing them quite as freely … you know … by buying stuff. And that will certainly reduce the propensity of employers to hire additional workers, and perhaps lead to more long-term unemployment.

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