When Protecting Jobs Only Destroys Them

by Charles Wheelan

Wednesday, June 7, 2006

I like France. The language is beautiful. The food is inspiring. And I appreciate topless beaches as much as the next guy. Still, I sometimes wonder if eating snails doesn't somehow dull one's ability to make sensible economic policy.

I promised that in this column, I would debunk one of the most pernicious economic ideas of the left. (In my last column, I skewered one from the right: See "Debunking One of the Worst Ideas in Economics".) I've chosen the "lump of labor" fallacy, which is the mistaken notion that the world has a fixed number of jobs and that therefore the best way to make workers better off is by protecting those jobs. The French are not the only people who subscribe to this erroneous view of a modern economy, but they seem to cling to it more tenaciously than most.

For example, the French government passed a law in 2000 mandating a 35-hour work week for most workers while paying them for 39 hours. The primary intent was not to make life better for the affected workers but rather to create jobs for the unemployed. The French unemployment rate at the time was over 10 percent.

The supposed economic logic was that restricting the number of hours worked by the employed would generate new demand for workers to take over the remaining hours. In short, the architects of the policy reckoned that if I cut my work week from 39 hours to 35, and others are required to do the same, then new folks will be hired to do the other four hours of work.

Smaller Slices Aren't the Solution

Like most bad economic ideas that persist over time, the notion of a "lump of labor" has a certain intuitive appeal. The French policy assumes that the amount of work to be done in a modern economy is fixed, like a pie, and that cutting that work into smaller pieces -- fewer hours per week -- will provide slices for more people. If you've got six pieces of maple pecan pie to feed 12 people at Thanksgiving, then just cut each slice in half, right?

Not exactly. Requiring 39 hours of pay for 35 hours on the job makes workers more expensive relative to what they produce -- not unlike raising the minimum wage in the U.S. If workers become more expensive, firms will hire fewer of them, not more. French unemployment remains near 10%, roughly twice the rate in the U.S.

More recently, French students took to the streets to protest a policy that would make it easier to fire young workers. In the U.S., we take it for granted that firms can shed workers who aren't needed or aren't getting the job done. In France, workers who are hired full time are granted the employment equivalent of tenure.

To its credit, the government was seeking to introduce a two-year probationary period for workers under age 26, during which time there would be more flexible rules for termination. Young people -- and lots of sympathetic older people -- took to the streets to protest the policy, and the government backed off. Once again, the supposed logic was rooted in the idea of a "lump of labor" -- if you've got an unemployment problem, why make it easier to fire people?

Productivity: The Key to Job Creation

The problem is that fighting unemployment by making it harder to fire people is the equivalent of a department store deciding that profits would be higher if customers could no longer return merchandise. That logic ignores the important fact that if you can't return those pink Bermuda shorts from Nordstrom, you will be far more cautious about buying them in the first place.

The more fundamental point is that thinking about the economy as a zero-sum situation, in which every job gain must be someone else's loss and vice versa, is not only wrong but likely to lead to policies that produce more unemployment, not less. The number of jobs to be done in a modern economy is not fixed. The entire software industry didn't exist 25 years ago. Where did those jobs come from?

Instead, the key to creating both jobs and wealth is a concept that economists refer to as productivity. As productivity goes up, as it has steadily in the U.S. for 200 years, we're able to make more and better things as a society. In other words, we get richer.

To get your mind around the concept of productivity, imagine a small, insular farming village in which all of the good land is being farmed and every household grows or makes whatever it uses -- from food to the house itself. Further suppose that a stranger walks into town looking for work.

If you subscribe to the "lump of labor" theory, then this guy is out of luck. The only way he could go to work would be by farming part of someone else's land. If he eats more, someone else must eat less.

But that's not how the world works. Suppose the guy who walks into town has figured out how to build a more effective plow. He can sell his plows to farmers, who will pay for them with a share of their more bountiful harvests. Not only will our stranger have a job, but the farmers will be growing and eating more -- even after paying for their new plows.

We can do it again: A second stranger walks into town and offers to set up a school -- or make clothes, or build houses, or design irrigation ditches, or do anything that frees up the farmers to spend more time cultivating their crops. Again, crop yields go up. And again, we've created another job.

A third stranger could open up a medical clinic, which may not increase crop yields directly but will still make the village better off as farmers willingly trade some of their crops for better health. That's another job. (And two if there's a receptionist).

We can do the same exercise over and over again until our village has artists, yoga instructors, child-care centers, professional sports teams, dog walkers, and everything else you see going on around you. These jobs don't necessarily have to be created by strangers arriving in town -- farmers can always sell their land and launch an entrepreneurial venture. The key is that new ideas and better ways of doing things make the village continually more productive.

Self-Defeating Policies

What are the keys to raising productivity in a modern economy? Innovation, education, specialization, sensible tax and regulatory policies, and so on. The problem with the French policies I described -- and most other labor policies rooted in the lump of labor fallacy -- is that they discourage innovation and productivity. Firms are less likely to take a risk on an employee -- or expansion in general -- if they can't fire their mistakes. Meanwhile, requiring employers to pay 39 hours worth of wages for 35 hours of work makes automation or outsourcing that much more attractive.

When it comes to bad policy, France has good company. India still has a policy on its books requiring that firms with more than 100 workers receive government permission before laying off workers (which the government rarely deigns to grant). The logic is that a country with so much poverty and unemployment should protect every job it has.

The result: China has grabbed a disproportionate share of low-skill manufacturing because it's an easier place to set up large factories. India's thriving high-tech sector is the exception that proves the rule -- it's exempt from the most onerous labor regulations.

And Ross Perot enlivened the 1992 presidential election with his prediction that the North American Free Trade Agreement (NAFTA) would cause a "giant sucking sound" as jobs fled the U.S. for Mexico. His supposed logic was that what's good for low-wage workers in Mexico must be bad for workers in the U.S. If you haven't got enough pie to feed your own hungry family, don't start giving away pieces to the neighbors -- particularly really hungry neighbors.

The result: Ross Perot was the one blowing (rather than sucking) hot air. Ten years of data have confirmed what economists predicted at the time -- NAFTA gave a large boost to the Mexican economy and had a small positive effect on the U.S. economy. Trade allows countries to focus on what they do best, making all parties more productive in the process.

There's a crucial caveat to all this, illustrated best by going back to our fictitious farming village. Suppose the stranger walking into town has no high school diploma and no other skills to speak of. In that case, there really is no job for him. Therein lies the most important policy lesson: The key to growing the economy is making potential workers more productive, not trying to ration the amount of work that gets done.