Edited and written by David Gordon, senior fellow of the Mises Institute and author of four books and thousands of essays.

Rethinking Intervention

Fall 1999

Edmund S. Phelps
Harvard University Press, 1997, ix + 198 pgs.

Edmund S. Phelps is no right-wing extremist. Quite the contrary, he stands at the center of Keynesian orthodoxy in economics. Often termed an "economist's economist," he is most famous for his work on the natural rate of unemployment and for his structural account of business cycles.

In Rewarding Work, Mr. Phelps risks his reputation as a guardian of the establishment: he almost, but not quite, kicks over the dogmas of the welfare state. Fortunately for those of an Austrian bent, his proposals can easily be fixed so that they conform entirely to classical liberalism.

As free-market advocates see matters, the welfare state cripples market incentives. Why work, if you can get as much, or in some cases more, by idling on welfare? From Herbert Spencer and William Graham Sumner to Henry Hazlitt, classical liberals indict welfarism as a subsidy for voluntary unemployment.

The conventional wisdom brushes aside this view as extreme and hardhearted, but our author views things differently. "[T]he welfare programs that are not work-related, such as Medicaid and food stamps, devalue work and thus reduce job attachment. Means-testing intensifies the impact.... Wage earning and job holding are now dwarfed by the welfare system. Welfare pays more than work for the mothers eligible for Aid to Families With Dependent Children (AFDC) and the train of benefits that follow from it" (p. 99).

But, defenders of the present system will allege, what is so bad about this? Surely the United States is a rich society: can we not afford to provide for the less fortunate? Only reactionary ideologues could object. Do not such benighted figures as Mises and Rothbard, who condemn welfare, elevate property rights above human rights?

Mr. Phelps, amid a few disclaimers, allies himself with the reactionaries. Work is essential to a person's well-being: absent gainful employment, one's life is liable to be dreary and futile. "One of the most important rewards in most jobs is mental stimulation. They present a continual series of exercises in problem-solving.... Of course mastering the simplest jobs will generally be less of a learning experience than a career in the most complex and demanding jobs. Jobs do not all have to provide a mental workout, though, to sustain the main point.... The reflections of people in humble lines of work show that they learn much from their work and from its school of hard knocks" (p. 11). This passage, by the way, is an excellent short rebuttal of Marxist cant about "alienated labor."

To a classical liberal, the indicated course of action is simple-eliminate the welfare state. Then, those formerly on welfare will be able to attain the benefits of work which our author has so ably described. Absent a premium for idleness, what alternative do they have to the bracing discipline of employment?

No, says Mr. Phelps, people who argue in this fashion overlook a key point. You gain the advantages for living which a job provides only if the job pays adequate wages. Unless you have enough money to support yourself and your family in a decent manner, employment will not end the futility of your life. Precisely here arises the point at which Mr. Phelps dissents from the views of classical liberals.

Mr. Phelps holds that there is no reason to think that, in present circumstances, the free market will provide a living wage for unskilled workers. During the nineteenth century, land was readily available. "Labor was so scarce that all hands were of considerable value in gaining a foothold on the new land" (p. 2). But this fortunate situation no longer obtains, and the lot of the contemporary unskilled is not a happy one.

Our author offers a wide range of data to support his claim that the unskilled do not earn enough for a decent life. These data I shall lazily leave to readers to evaluate for themselves. But my failure to discuss this part of Mr. Phelps's case is not entirely due to laziness. Rather, as it seems to me, a crucial wrong assumption invalidates much of his argument.

Mr. Phelps purports to be arguing that unskilled workers do not earn enough for a decent life. But much of his discussion concerns whether the wages of the unskilled have kept pace with the pay of abler workers. To show that they have not does not suffice to establish what Mr. Phelps needs for his argument against the market. Inequality and lack of wages adequate for a decent life are two very different things.

But suppose that Mr. Phelps is right: what can be done? Our author is too good an economist to recommend an increase in minimum wages. An increase of the minimum wage to "a sufficiently high level is bound to decrease employment: all the affected workers would be priced out of the market. No economist I know of has suggested that wage rates of $4 an hour might be pushed up to $7 by means of a hike of the minimum wage without causing a major decline in employment among low-wage workers" (p. 146).

Although this argument is too deep for the likes of Robert Reich, it is of course elementary and hardly news. Much more significant, to my mind, is that Mr. Phelps also rejects governmentally sponsored job-training programs to "educate" the unskilled to a higher calling. "It shows a profound lack of understanding of capitalism to suppose that outsiders can anticipate the training that entrepreneurs can make use of before the entrepreneurs have decided what goods or services they will try to sell and what methods of production they will try. Decisions about most training are best made by the entrepreneurs" (p. 150).

So much for what Mr. Phelps thinks will not be successful. His own proposal has the merit of simplicity: he favors wage subsidies to employers who hire the unskilled.

At first glance, this sounds like just another interventionist panacea; but closer examination shows, I think, that our author's proposal may readily be taken in a way consistent with the free market. Mr. Phelps is perfectly willing to have the subsidy take the form of a remission of payroll taxes. Further, though he himself favors a graduated program of subsidies-the higher your wage before the subsidy, the lower your subsidy-he also thinks that subsidies for all workers would be beneficial. This cuts out governmental efforts to direct the proportion of skilled to unskilled work.

Translating this latter version of the proposal into a payroll tax remission, what our author says comes to this: if the government reduces taxes on wages, wages will tend to rise. Mr. Phelps has, with a roundaboutness that would do credit to Rube Goldberg, arrived at a free-market position.

It would, of course, not do to end on a note of praise for an economist who rejects laissez-faire. Let us note, then, that like John Rawls, whom he here follows, Mr. Phelps gives no argument for his view that fairness demands that the surplus generated by economic cooperation benefit the least well-off to the greatest extent possible.


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