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In December 1985, Congress passed a law-which it has since ignored-mandating a balanced budget by 1991. Is a zero deficit an appropriate target for fiscal policy?

The basic principles certainly do not lead to this conclusion. Instead, they point to the desirability of budget deficits when private demand, C + 1+(X - IM), is too weak and budget surpluses when private demand is too strong. The budget control should be done and the budget should be balanced, according to these principles, only when C + I + G + (X - IM) under a balanced-budget policy approximately equals full-employment levels of output. This may sometimes occur, but it will not necessarily be the norm.

In brief, according to this approach, the focus of fiscal policy should be on balancing aggregate supply and aggregate demand, not on balancing the budget. But why do these two criteria differ? The reason should be clear from our earlier discussion of stabilization policy.

Consider the fiscal policy that would be followed if we lived under an effective balanced-budget law. If private spending sagged for some reason, the multiplier would pull GNP down. Since personal and corporate tax receipts fall sharply when GNP declines, the budget would swing into the red. That would require either lower spending or higher taxes-exactly the opposite of the appropriate policy response. Thus:

Attempts to balance the budget-as done, say, by President Herbert Hoover during the Great Depression-will prolong and deepen recessions.

Budget balancing can also lead to inappropriate fiscal policy under boom conditions. If rising tax receipts induce a budget-balancing government to spend more or cut taxes, fiscal policy will “boom the boom”-with disastrous inflationary consequences. Fortunately, believers in budget balancing usually are not alarmed by surpluses.

Actually, the issue is even more complicated than we have indicated so far. Fiscal policy is not the only way the government affects aggregate demand. The government also influences aggregate demand through its monetary policy. For this reason:

The appropriate fiscal policy depends, among other things, on the stance of monetary policy. While a balanced budget may be appropriate under one monetary fund policy, a deficit or a surplus may be appropriate under another monetary policy.

An example will illustrate the point. Suppose Congress and the president believe that the aggregate supply and demand curves will intersect approximately at full employment if the budget is balanced. Then a balanced budget would seem to be the appropriate fiscal policy.

From the time Karl Marx began to write about economics in 1843 until about 1858 (roughly a decade before Capital was published), he devoted a significant portion of his writing to a phenomenon he called alienation. Very little on the subject was published by him during his lifetime. Thus we do not know whether Marx really considered it important and would have included it in the portions of Capital published after his death, or whether he purposely did not publish it because he changed his mind and decided it was a false direction.

It was not until the middle of the twentieth century, when the Soviet Union began to publish some of Marx’s accumulated notes and manuscripts, that the materials on alienation became available to the public. But once the idea was made public, it attracted a great deal of attention among Marxist scholars, particularly among those who specialized in political science and sociology. And while the concept of alienation seems to hold less appeal for economists, it is useful for helping us reconstruct some of what Marx was after.

Actually, alienation seems to refer to at least two different concepts. The first, which has most intrigued noneconomists, describes the psychological state of workers in relation to the capitalist production process. According to Marx, capitalism, by replacing artisanship with mass-production techniques, by putting workers on assembly lines where their functions are reduced to repetitive detail rather than concern with the quality of the whole product, and by treating workers (or, rather, their labor power) as mere commodities that are bought and sold as part of the profitmaking process, causes workers to lose any sense of satisfaction from their labor and any means for identifying with their output. In short, modern workers are alienated from the production process in ways that the medieval artisans were not.

What… constitutes the alienation of labour? First… that in his work… he does not… feel content but unhappy, does not develop freely his physical and mental energy but mortifies his body and ruins his mind…. Lastly, the external [alien] character of labour for the worker appears in the fact that it is not his own, but someone else’s… that in it he belongs, not to himself, but to another.”

The second concept of alienation, which has more relevance to our present discussion, describes the connection between the accumulation process and the produced means of production that are made available to the economy. According to Marx, such items as plant and equipment are as much the product of labor as are any other commodities. However, in industrial economies, the worker’s job depends on the availability of factories and machinery. Thus, after she has labored to make these particular products and product management, the worker must confront them again, this time as domineering, alien objects that hold the power to determine whether she will remain employed. The very items that the worker has made with her own hands become the means by which capitalists can control her.

Aside from the domination to which the worker is subjected by the alienated products of her own making, this form of alienation is significant because it has an inherent tendency to escalate. Accumulation, by its very nature, builds up the economy’s stock of productive equipment. As this happens, workers become increasingly dependent on more and more equipment in order to remain employed. And as time passes, their dependence on the alienated products of their labor continues to grow proportionally with the economy.

In the early stages of capitalism, workers could easily find employment on their own in industries that utilized relatively few machines. But as capitalism matures, workers more and more are forced into automated factories with all the frustration and alienation that attends such work places. Here we have the seeds of the class antagonism that Marx predicted would contribute to the demise of capitalism. In other words, here we have a law of motion of capitalism.

If this interpretation of alienation is valid (and it is not entirely clear from Marx’s unfinished writing on the subject), it is a problem that lies at the heart of the dynamics of capitalism as Marx saw them. The very mechanism that produces surplus value and capital accumulation must aggravate alienation, and through it, we are told, capitalism does indeed sow the seeds of its own destruction.

Thus, Marx felt that a revolution spurred by worker alienation might be one way that capitalism would die. Another would be through a spasmodic business cycle.

The first step in financial planning is gathering the necessary data, and the data management. This information must be sufficient to obtain a clear picture and pattern of the client’s current situation. In turn, the value of this process will be directly related to the accuracy and completeness of the information obtained.

Data gathering is often a painstaking process because clients either may not see the significance of certain information or may not wish to reveal everything. It is especially important to be aware of any essential hidden facts. If the planning is for a couple or a family, planners must verify the objectives of each person involved and clarify important discrepancies before proceeding to the analysis stage.

To facilitate data gathering and analysis, it is essential to use a data intake form or questionnaire. The questionnaire should be as brief as possible while obtaining all necessary information. Few people appreciate a 40-page document which, realistically, could be condensed to a dozen pages. Specialized questionnaires may be used to handle specific needs such as business planning.

An important and integral segment of financial planning is knowing where a client’s money goes. This is really very fundamental, because spending habits cannot be approved or changed without this knowledge. Who enjoys tracking their expenses? Probably no one. But it is very difficult to make good decisions on future investments, retirement goals, or major purchases without going through this process.

One purpose of cash-flow management is to determine the amount of discretionary income. In this context, it is not up to financial planners to specifically determine how clients should spend their money. Nor should they impose their value judgments on the lifestyles or spending habits of their clients. Rather, the role of a planner is to point out aspects of spending patterns that positively or negatively affect financial objectives. It is up to individual clients to determine whether they will continue in a wrong direction or seek to change.

Assisting clients in determining whether their cash-flow management is aligned with their objectives is the first step. To begin, planners will note when income is received and when it is disbursed. Timing is critical. A client could have a significant sum in a low-interest or no-interest account until the expenses are paid.
For example, if Sarah sold stock in a taxable transaction, how long does she have before the taxes are due? During this time, she should earn the highest rate, not leave the funds in a low-yielding savings account. Consistently managing income in this manner will produce significant benefits over time.

Some people constantly borrow from the future to cover current living expenses. Most commonly, they borrow against future job salaries increase or bonuses to pay for daily spending. If this is happening, planners must intervene and help the client recognize the impact of this behavior on his or her financial objectives. In this situation, the client’s values must be clarified before any further decisions can be made.

In sum, if clients are living beyond their means, what will encourage them to change this pattern? The answer lies in their values, such as fear of bankruptcy. Clients must not become so attached to borrowing that they feel borrowed money belongs to them. Money borrowed is meant to be paid back.

We have observed that the federal government’s annual budget debt and deficits have been extremely large under Presidents Reagan and Bush. The budget deficit ballooned from $79 billion in fiscal year 1981 to $208 billion by fiscal year 1983-setting a record which was subsequently eclipsed in both 1985 and 1986. The budget for fiscal year 1990, which ended just as this edition went to press, is expected to show a deficit of $138 billion. These are enormous, even mind-boggling, numbers. But what do they mean? How are they to be interpreted?

The Structural Deficit

First, it is important to understand that the same fiscal program can lead to a large or small deficit, depending on the state of the economy. Failure to appreciate this point has led many people to assume that a larger deficit always signifies a more expansionary fiscal policy. But that is not always true.

Think, for example, about what happens to the budget when the economy experiences a recession and GNP falls. The government’s most important sources of tax revenue-income taxes, corporate taxes, and payroll taxes-all shrink because firms and people pay lower taxes when they earn less. Similarly, some types of government spending, notably transfer payments like unemployment benefits, rise when GNP falls because more people are out of work.

Remember that the deficit is the difference between government expenditures and tax receipts:

Since a falling GNP means higher expenditures and lower tax receipts:

The deficit rises in a recession and falls in a boom, even with no change in fiscal policy.

The government’s fiscal program is summarized by the two red lines. The horizontal line labeled G indicates that federal purchases of goods and services are approximately unaffected by GNP. The rising line labeled “Taxes minus Transfers” indicates that taxes rise and transfer payments fall as GNP rises. Notice that the same fiscal policy (that is, the same two red lines) can lead to a large deficit if GNP is Y1, a small deficit if GNP is Y2, a balanced budget if GNP is Y3, or even a surplus if GNP is as high as Y4. Clearly, the deficit itself cannot be a good measure of the government’s fiscal policy.

For this reason, many economists pay less attention to the actual deficit or surplus and more attention to what is called the structural deficit or surplus. This is a hypothetical construct that replaces both the spending and taxes in the actual budget by estimates of how much the government would be spending and receiving, given current tax rates and expenditure rules, if the economy were operating at some fixed high-employment level.

Because it is based on the spending and taxing the government would be doing at some fixed level of GNP, rather than on actual expenditures and receipts, the structural deficit is insensitive to the state of the economy. It changes only when policy changes. That is why most economists view it as a better measure of the thrust of fiscal policy than the actual deficit.

This new concept helps us understand the changing nature of the large budget deficits of the 1980s. Because of the deep recession of 1982-1983, the difference between the two budgets was quite large in the early 1980s. But it has been negligible in recent years. The numbers in the last column show that the structural deficit was actually larger in fiscal 1989 than in 1983-despite years of budget “stringency.” It is the failure of the structural deficit to decline that most alarms keen students of the federal budget.

The opposite end of the spectrum from ignoring interdependence is for all the firms in an oligopoly to recognize their interdependence and agree to a peace treaty under which they collude overtly with one another, thereby transforming the industry into a giant monopoly.

A notable example of the formation of a cartel is the Organization of Petroleum Exporting Countries (OPEC), which first began to make decisions in unison in the 1970s. For a while, OPEC was one of the most spectacularly successful cartels in history. By restricting output, the member nations managed to quadruple the price of oil in 1973-1974. Then, unlike most cartels, which come apart in internal bickering or for other reasons, OPEC held together through two worldwide recessions and a variety of unsettling political events, and struck again with huge price increases in 1979-1980. Only in the mid-1980s did it run into trouble.

But the story of OPEC is not the norm. Cartels arc not easy to organize and are even more difficult to preserve. Firms find it hard to agree on such things as the amount by which each will reduce its price and output in order to help push up the price. For a cartel to survive, each member must agree to produce no more than the level of output that has been assigned to it by the group. Yet once price is driven up and profitability is increased, it becomes tempting for each seller to offer secret discounts in order to lure some of the profitable business away from other members of the cartel. Indeed, some of this happened to OPEC in the 1980s. When this happens, or is even suspected by cartel members, it is often the beginning of the end of the collusive arrangement. Each member begins suspecting the others and is tempted to cut price first, before the others beat it to the punch.

Cartels, therefore, usually adopt elaborate policing arrangements, in effect spying on each member firm to make sure it does not sell more than it is supposed to or shave the price below that chosen by the cartel. This means that cartels are unlikely to succeed or to last very long if the firms sell many varied products whose prices are difficult to compare and whose outputs are difficult to keep track of. In addition, if prices are frequently negotiated on a customer-by-customer basis, and special discounts are common, a cartel may be almost impossible to arrange.

Many economists consider cartels to be one of the least desirable forms of market organization. If a cartel is successful, it may end up charging the monopoly price and obtaining monopoly profits. But because the firms do not actually combine their operations but continue to produce separately, the cartel offers the public no offsetting benefits in the form of economics of large-scale production. For these and other reasons, open collusion among firms is illegal in the United States, and outright cartel arrangements are rarely found. (However, in many other countries cartels are common.) There is only one major exception in the United States. The government has sometimes forced regulated industries such as telecommunications and gas pipeline transportation to behave as a cartel would, by prohibiting them from undercutting the prices set by the regulatory agency.

Many observers are concerned that the antitrust laws are often used by inefficient firms to protect themselves from the competition of more-efficient rivals. When they are unable to win out in the marketplace, the argument goes, they simply start a lawsuit against their competitors, claiming that those rivals have achieved success by means that violate the antitrust laws. Not only do they seek the protection of the courts against what they describe as “unfair competition” or “predatory practices,” but they often sue for compensation which, under the law, can sometimes be three times as large as the damages they have suffered. Moreover, even if the defendant is found to be innocent, it must normally pay the very high costs of the litigation itself. Aside from the enormous waste that such suits entail, observers worry that this is a perversion of the antitrust laws, which were, after all, designed to promote competition, not to prevent it. Three examples, one very old and two very recent, illustrate the nature of such litigation.’ These three cases also show that the courts are often sufficiently wise to throw out such attempts to use the antitrust laws to prevent competition.

The Schoolmaster Case. In 1410, two Gloucester schoolmasters brought suit charging a third schoolmaster with trespass, on the ground that the latter had entered into business in competition against themselves in the same town, and in the process offered a per-pupil fee some 70 percent lower than their own. The claim was rejected by the court, and one of the judges commented “…though another equally competent with the plaintiffs comes to teach the children, this is a virtuous and charitable thing, and an ease to the people, for which he cannot be punished by our law.” (Court of Common Pleas [1410]).

AMI versus IBM. Allen-Myland Inc. (AMI) is a small firm specializing in the upgrading of computers, in which it had obtained handsome profits, in a period when expansion of a computer’s capacity was very laborious. However, technological progress by IBM had reduced a labor-intensive task to the simple installation of a small and highly reliable part that took several minutes of essentially unskilled labor, thus rendering obsolete many of the services offered by AML AMI sued IBM, seeking to persuade the court to impose an artificial and expensive market niche for upgrading services, with AMI permanently protected from competitive pressures. The court’s decision completely rejected AMI’s position (Eastern District of Pennsylvania [1988]). The decision is now under appeal.

Sewell Plastics versus Coca-Cola, Southeastern Container et al. The Sewell Plastics Company had a preponderant share in the manufacture of plastic soft-drink bottles in the United States. At one time, it sold two-liter bottles at a price somewhat above 30 cents per bottle. A group of CocaCola bottlers in the Southeast considered the price too high, and formed a cooperative firm, “Southeastern Container,” to manufacture plastic bottles for themselves. Within five years Southeastern had reduced its cost below 14 cents per bottle, and real retail prices of soft drinks also fell. Despite rising national sales and profits, Sewell decided to sue Southeastern, explicitly admitting that it was seeking to persuade the court to force a sale of Southeastern to itself or, as a possible alternative, to force Southeastern’s customers to sign exclusive purchasing contracts with Sewell. In the spring of 1989 the judge dismissed Sewell’s claims (U.S. District Court, Western District, North Carolina [April, 1989]).

From the preceding discussion it may seem that measuring a nation’s balance of payments position is a simple task: we simply count up the private demand for and supply of its currency and subtract quantity supplied from quantity demanded. It has to do with the demand management.

Conceptually, this is all there is to it. But in practice, the difficulties are great because we never observe directly the number of dollars demanded and supplied.

If we look at actual market transactions, we will see that the number of U.S. dollars actually purchased and the number of U.S. dollars actually sold arc identical. Unless someone has made a bookkeeping error, this must always be so. How, then, can we recognize a balance of payments surplus or deficit ? Easy, you say. Just look at the transactions of the central bank, whose purchases or sales must make up the difference between private demand and private supply. If the Federal Reserve is buying dollars, its purchases measure our balance of payments deficit. If it is selling, its sales represent our balance of payments surplus.

Thus the suggestion is to measure the balance of payments by excluding official transactions among governments. This is roughly how the balance of payments surplus or deficit is defined today, though, for a variety of complicated reasons, the U.S. government decided long ago to stop publishing any official statistic called “the balance of payments deficit.” Instead, all foreign transactions are listed, and readers are invited to define the balance of payments in any way they wish. Let us now see just what data are published in these official accounts.

However, of course, there is not one labor market but many-each with its own supply and demand curves and its own equilibrium wage. We all know that certain groups in our society (the young, the black, the uneducated) earn relatively low

wages, and that some of our most severe social ills (poverty, crime, drug addiction) are related to this fact. But why are some wages so low while others are so high?

Supply-and-demand analysis at once tells us everything and nothing about this question. It implies that wages are relatively high in markets where demand is great and supply is small, while wages are comparatively low in markets where demand is weak and supply is high. This can hardly be considered startling news. But to make the analysis useful, we need to breathe some life into the supply and demand cost curves.

We begin our discussion on the demand side. Why is the demand for labor greater in some markets than in others? The marginal productivity principle teaches us that there are two types of influences to be considered. Since a worker’s marginal revenue product depends both on his marginal physical product and on the price of the product that he produces, variables that influence either of these will influence his wage.

The determinants of the prices of commodities were discussed at some length in earlier chapters, and there is no need to repeat the analysis here. It is sufficient to remember that because the demand for labor is a derived demand, anything that raises or lowers the demand for a particular product will tend to raise or lower the wages of the workers that produce that product.

A worker’s marginal physical product depends on several things, including of course, his own abilities and degree of effort on the job. But sometimes these characteristics are less important than the other factors of production that he has to work with. Workers in American industry are more productive than workers in many other countries because they have generous supplies of machinery, natural resources, and technical know-how to work with. As a consequence, they earn high wages.

Turning next to differences in the supply of labor to different areas, industries, or occupations, it is clear that the size of the available working population relative to the magnitude of industrial activity in a given area is of major importance. This helps explain why wages rose so high in sparsely populated Alaska when the Alaskan pipeline created many new jobs, and why wages have been and remain so low in Appalachia, where industry is dormant.

Second, it is clear that the nonmonetary attractiveness of any job will also influence the supply of workers to it. (The monetary attractiveness is the wage itself, which governs movements along the supply curve.) Jobs that people find pleasant and satisfying-such as teaching-will attract a large supply of labor, and will consequently pay a low wage. In contrast, a premium will have to be paid to attract workers to jobs that are onerous, disagreeable, or dangerous-such as washing the windows of skyscrapers.

Finally, the amount of ability and training needed to enter a particular job or profession is relevant to its supply of labor. Brain surgeons and professional football quarterbacks earn generous incomes because there are few people as highly skilled as they, and because it is time consuming and expensive to acquire these skills even for those who have the ability. In addition to all of the above, it is important to recognize that adjustments in the labor market are slow in comparison with those in the markets for other inputs and commodities. Workers, for example, will be reluctant to move, even from lowwage geographic areas to high-wage areas; so wage differentials often persist longer than price differentials. In the labor markets, long-run equilibrium takes a long time to attain, particularly where substantial retraining and relocation is required to eliminate differences in wages among jobs.

Our discussion suggests the most obvious determinant of the position of the aggregate supply curve: the money wage rate. Wages are the major element of cost in the aggregate economy, accounting for about 70 percent of all expenses. Since higher wages mean higher costs, they spell lower profits at any given prices.

Let us return to our example and consider what would happen to a gadget producer if the money wage rose to $8.75 per hour while the price of a gadget remained $9. Profit per unit would decline from:

$9-$8=$i

to:

$9 - $8.75 = $0.25.

With profits squeezed, the firm would probably cut back on production.

This is the typical reaction of firms in our economy to a rise in wages. Therefore, a wage increase leads to a decrease in aggregate quantity supplied at current prices. Graphically, the aggregate supply curve shifts to the left (or inward), as shown in Figure 10-2. In this diagram, when wages are low, firms are willing to supply $4400 billion in goods and services at a price level of 100 (point A). After wages increase, however, these same firms are willing to supply only $4000 billion at this price level (point B). By similar reasoning, the aggregate supply curve will shift to the right (or outward) if wages fall. Thus:

A rise in the money wage rate causes the aggregate supply curve to shift inward, meaning that the quantity supplied at any price level declines. A fall in the money wage rate causes the aggregate supply curve to shift outward, meaning that the quantity supplied at any price level increases.