How to fix the gap

I’ve written about this before, but I thought I’d go a little more in depth on the subject. One way of understanding unemployment is by analyzing the difference between potential GDP and real GDP, GDP being the value of goods and services produced in our economy. When real GDP falls below potential GDP, we have unemployment. Why? Because potential GDP is the theoretical amount that could be produced if we had full employment. So it’s really in the definition. The picture here shows what a graph of real GDP versus potential GDP looks like now.

Looking at the picture, we can see that it’s really a simple matter of either raising real GDP faster than potential GDP, or lowering potential GDP, or a combination of both. Close the gap, and unemployment will decrease.

Only it’s not so easy to raise real GDP, except, perhaps, through government spending, which is one of the things the current government is doing. That’s what stimulus spending is supposed to do. In this way, we increase employment, which raises GDP, and makes the gap smaller. Only, the gap isn’t getting very much smaller, and unemployment remains high.

So, the other option is to make potential GDP decline. That’s easy, but the government doesn’t actually want to do that, or at least doesn’t want to say it wants to do that. In fact, the government is doing things that seem intended to keep potential GDP rising. Now, I’m not saying that increasing potential GDP is a bad thing; in fact, it's good. But, I think this demonstrates how government should really just butt out. The idea behind a market economy is that things eventually work out by themselves. But when the government intervenes, unintended results abound.

For example, the government is providing huge subsidies for education. PELL grants, subsidized student loans, and tax credits are some of the federal programs. These things raise potential GDP by increasing “human capital.” Theoretically, the more college graduates there are, the more human capital there is, and the higher potential GDP becomes.  But is it really working out that way?

I’ve written before about how government subsidies for education are resulting in a devaluation of education. Basically, by declaring that everyone has a “right” to higher education, and ensuring that no one misses out due to lack of money, our education system is busily herding people through the system, keeping failures to a minimum, and lowering the value of getting that education. A college diploma is quickly becoming a piece of paper that says “I was there,” and not much else.

So, if government action is devaluing higher education, then we can say that soon enough higher education will be mostly worthless. Potential GDP won’t be positively impacted by the higher number of college graduates, and the recessionary gap will narrow. The cost of this narrowing, though, is enormous. We, as taxpayers, are spending billions to keep up the charade.

As if the devaluing of education isn’t enough, long-term unemployment also serves to decrease the recessionary gap. The longer people are unemployed, the more their skills tend to atrophy. Most people don’t sit around studying, working to keep their skills sharpened, and waiting for the day that they’ll actually get to use those skills again. So, long-term unemployment serves to lower potential GDP, resulting, again, in a narrowing of the recessionary gap. Yay!

What else can the government do to close the recessionary gap? Oh yeah. They can keep signing free trade agreements. That will surely help, because then we’ll keep exporting our capital to increase productivity in countries where labor is cheaper than it is here. If we export our capital, it isn’t available for use here, resulting in a decline in potential GDP, and another narrowing of the recessionary gap. Go us!

In the end, it’s going to cost us trillions, and take an inordinately long time to close the recessionary gap in the U.S. if we continue to follow the current “plan.” In the meantime, there’s going to be a lot of unnecessary pain, and it will take years, even decades, to pay for all this foolishness. And we’ll have the pleasure of watching while we become the new third world country.  And it will be as if we never spent that money.

We’re already sliding compared to other countries in many areas, like education. The answer to our problems is not to get more people to graduate with college degrees; we need to improve on the quality of our graduates. We need to recognize that there is no real “free trade” in this world. Free trade doesn’t exist when currency manipulation is the norm. Being able to buy cheap foreign goods doesn’t do us any good when we’re unemployed.

So, yeah. The government needs to stop with the heavy subsidization of education. They need to stop looking for the next new source of cheap imports. Otherwise, we’ll become a nation of college graduates, flipping burgers at McDonalds, and barely skilled enough to tie our own shoes. But, we’ll all be employed.