This book completes a project that started in 1989 and that is closely related to the Fall of the Berlin Wall in that year.

At that time in 1989, and in fact from 1982-1991, I was employed as a ‘economic scientific researcher’ at the Dutch Central Planning Bureau (CPB), which institute can be compared to the US Council of Economic Advisers. The CPB provides the executive branch with economic projections and with evaluations of policy proposals. In 1989 I was involved in test runs for a study of the economy for the long run till 2015, later published as the CPB (1992a&b) “Netherlands in Triplo” and “Scanning the future”. The test runs showed continued economic problems, and this caused me to consider some points. If the Bureau would publish bad weather projections, then these might cause the government to enact economic reforms that would self-unfulfill the projections. Secondly, my CPB colleagues Van Schaaijk (1983) and Bakhoven (1988) had presented a solution approach to unemployment that did not get the attention that it deserved. Thirdly, when the Wall fell, it was obvious that continued unemployment in Western Europe would be detrimental to economic recovery in the East, and this suddenly made unemployment much more important than it had been before. So in November I wrote an internal memo Colignatus (1989) proposing various economic reforms that might be considered as research projects not only for the final version of the long run study but also for the medium run.

Then, in December, in deciding on the annual pay rises, the CPB directorate withheld part of the normal raise for me, and my section chief informed me that it would have been better if I had not written that memo. Apart from the bizar sensation that a hundred billion dollar invention was being punished instead of rewarded, I also experienced the sensation that comes when the dime drops or when the pieces of a puzzle fall together. I could not escape the conclusion that I was confronted with a particular piece of evidence of stagnation in policy making, and that improper means were being used to influence scientific discourse. Taking stock: my career position was blemished, my creative contribution was branded as weird instead of simply creative, and I was apparently supposed to no longer judge ideas on their own value but on some line that was decided by the directorate. If these methods were used, I could understand why colleagues Van Schaaijk and Bakhoven had become silent on their important contributions to the solution approach, or had left the Bureau altogether.

So in December 1989 I easily envisaged a book that would explain both the solution to the current mass unemployment in OECD countries and the stagnation in policy making that causes it. It was my perception at that time that under normal conditions it might take ten years before this analysis would be accepted by ‘the relevant circles’, i.e. some years to write the book, some years to allow my fellow economists to digest it, and some years for the percolation into public and political discourse.

But life is not such that if a scientist decides that a book should be written, that his environment will let him do it. Instead, there was the pressing need to find a proper answer to the abuse inflicted on me, and to collect and safeguard the evidence of that abuse. Given the triad of Voice, Exit or Compliance (‘compliance’ since ‘loyalty’ is the precondition - and the Exit and Compliance options already used by my two colleages) I decided to Voice. I filed an appeal, and started writing a paper where I clearly stated my conclusion as a scientist that the return to full employment could be much speedier if Parliament would have an enquiry in the policy making process. Not quite to my surprise, I saw myself moved to a separate room in April 1990, and my paper was blocked from circulation. Only after some trouble it was allowed to appear as an internal note Colignatus (1990ac), but was further blocked from internal discussion and eventual publication. And I was finally fired in October 1991. And neither quite to my surprise, the courts allowed the directorate to do all this. The court deemed it an abuse of power that the directorate had moved me to a separate room, but the dismissal was deemed acceptable. The legal position of a scientist within the government is not that strong, the popular stories to the contrary.

These lines clarify that this book has not been written under the conditions that benefit science. I have been mauled by the bureaucracy, I have been on the run from one short temporary job to another, always job hunting, a longer while unemployed and in dire financial straights. But I was happy that I had kept my integrity, and it was a joy to occasionally read some economics again and to write a piece of the analysis. I published a collection in 1992 and another collection in 1994. I discovered Mathematica, January 1993, and there was hope again. The internet became accessible to me, and I was able to enter my papers in the Economics Working Papers Archive (EconWPA) at the Washington University in St. Louis.

One factor that caused a shift in the plan of the book was that I no longer had the resources of the CPB at my disposal. No database, no model, no easy access to the literature, no participation in professional discussion, and no professional position that would give easier access to the other research institutes and organisations like the OECD, World Bank or IMF. It was curious, to say the least, not to have access to the model that I had helped designing and that I in fact normally maintained and had sitting at my computer. My situation caused me to rethink methodology. What could I prove, if I did not have the means that I had grown accustomed to ? But by 1991 I had solved that problem and life became a bit more agreeable. But of course, it took longer, much longer, to work it all out.

Please be aware that it was not all misery and gloom. Over these 15 years I could go to 7 Dutch economics ‘research days’, visit 3 European Economic Association congresses and visit the occasional colleague and professor. There are also nice events that happen when you approach people with some novel ideas. I still enjoy the tour of Cambridge that Richard Layard gave to Assar Lindbeck and me; this was in 1991 when Layard, Nickell & Jackman (1991), “Unemployment”, had just appeared. Mr. Emile van Lennep, former head of the OECD, then retired as Minister of State but still at the Dutch Treasury, agreed to talk to me, and afterwards helped me to get an interview at the US Treasury in the Summer of 1993: but to no avail, the person that I talked to was too absorbed by the Clinton Health Plan, and said something like ‘Well, if Europe wants to adapt its constitution, be my guest’. It also appeared that the OECD did not have information on tax exemption in the member states. It was worth a try, and fun to do. I also have had great fun developing my “Economics Pack”, applications for Mathematica. It is good software, it brings me in contact with interesting economists all over the world, and of course it includes, amongst other projects, also some of the material of this book - which should do something for the spread of the ideas as well.

So now the book is here. It collects and combines the various articles written since 1989, and gives the final twists that come from integration.

Note that I as a researcher claim ‘novel results’, while I at the same time say, at the risk of an inconsistency, that ‘either governments already knew how to solve unemployment and then neglected human suffering, or they could find out how to do it and then at least failed in co-ordination’. ‘Novelty’ and ‘it was known’ are at risk of being inconsistent. I have removed this risk (a) by making the novel results available since 1990, which was 10 years ago at the first edition of this book in 2000 and now in 2005 is 15 years ago, (b) by gathering information about the abuse afflicted on myself, and making this information available to others, and (c) by showing that important parts of the whole analysis (without my contributions) were already known before. Cohen Stuart in 1889, and policy makers in the 1950s already knew that tax exemption should be at the subsistence level. One does not really need a CWIRU concept to see that. While this was known, my novel contribution then has become to analyse the ‘loss’ of this information as an institutional and Public Choice problem - or bad co-ordination between the Treasury and the Ministry of Labour. As a ‘novel contribution’ it has its limits - though in the 1980s it took me a decade of eliminating other causes before I discovered, and indeed with surprise, how dumb and insensitive these bureaucrats can be. But other novel insights have a more enduring character, and that is a relief.

Yes, some friends have advised not to tell all of this, others have advised to do so. I once entertained the thought to skip my Dutch examples, and concentrate on, say, the US. This might enhance the argument, since readers would be less inclined to think that I am partial to the argument. I hesitated doing that, since (a) I am not partial anyway, and (b) it would eliminate that very example of the current structural deficiencies in economic policy making.

‘New’ is taken here in comparison to others, and thus includes points also made in my earlier publications on this analysis. New is:

1)      clarification that if you don’t index subsistence for average income, then you create poverty

2)      clarification that minimum ‘income’ is not an ‘income’ but a mechanism (with multiplier)

3)      the concept of the Tax Void

4)      the dynamic marginal tax rate, and its relation to labour supply and macro-economics

5)      these explanations for the shift of the Phillipscurve:

a)       by the minimum wage and tax void, or poverty

i)        directly, and caused by differential indexation of exemption and subsistence

ii)       indirectly, by the crowding out effect, shifting of the tax burden etc.

b)      by misguided macro-economic policy (not understanding taxes, fighting inflation with the wrong means)

6)      clarification that ‘there is no poverty trap’

7)      suggestion for a simple nonlinear tax function, clarification for households

8)      suggestion of a possibly ‘dromedary shaped’ labour supply

9)      clarification on the concept of a ‘free lunch’

10)   proper definitions of risk and uncertainty

11)   clarification for the impact of the minimum wage (tax void) on sheltered and exposed sectors

12)   clarification on the Definition & Reality methodology

13)   the theorem on the possibility of full employment, via the reduced form

14)   integration of deontic logic with preference theory

15)   the proper interpretation of Arrow’s Theorem

16)   the Borda Fixed Point method

17)   the theorem on the possibility of co-ordination, via the reduced form

18)   description of actual bureaucratic processes on these subjects, so that we better understand how the Great Stagflation came about (comes about)

19)   the concept of the Economic Supreme Court, in its political and historical relation to both the Trias Politica and economic science, and a draft constitutional amendment to start thinking about

20)   clarification of the moral imperative with regards to Russia and Eastern Europe

21)   positioning this analysis with respect to a standard small macro model and the work of other authors.

The prime conclusion of this book is that Western democracies are well-advised to install an Economic Supreme Court. This volume includes a draft constitutional amendment that shows that such a measure can indeed enhance democracy.

The fundamental structure for current policy making in a democracy is Montesquieu’s model of the separation of powers, i.e. the Legislative, Executive and Judicial branches that form the “Trias Politica”. It appears that this structure still allows room for economic policy making that is detrimental to the life and liberty of the citizens of the state. The key issue appears to be that there is no independent protection of the quality of information. With all the social, economic and political interests involved, the current process of economic policy making allows the current constitutional powers too much room for distortion of the information. Economic theory then suggests the creation of an Economic Supreme Court as a separate constitutional power with the task of the scientific management of information. The legislative and executive branches would still decide on policy targets and policy execution, but they would lose the power to interfere with the scientific handling of information. This argument can be developed purely theoretically. The economic experience of the last century shows that the argument is also practically relevant.

Political Economy as a science has the general objective of explaining and advising the management of the state. Two hallmark reference points exist in the General Theory by Keynes (1936) and the analysis by Tinbergen (1956) on the principles and design of economic policy making. These studies show that the state can be subject to long periods of economic recession and even depression if not properly managed. Since the end of World War II, application of these ideas has allowed spectacular economic growth while depression has been prevented indeed. However, the economic record especially since the 1970s is mixed, with issues like stagflation, problems with the welfare state and continued poverty and also with the issue of sustainable development and protection of the environment. It can be shown beyond reasonable doubt that economic policy has been detrimental to the life and liberty of many of its citizens while this came about by mismanagement of the available information.

An element of self-reference arises when economic policy uses economic theory itself, so that theory should include theory. Increasingly over the years, economic theory has gotten a role in the management of the state, and developments in the real economy cannot be properly understood without reference to the economic ideas adopted for national policy. Since economic theories give conflicting advice, part of the management problem of the state is the selection of the appropriate theory, and this selection is more and more the key management problem. At the next higher level of abstraction, the process of selection becomes the focus of attention. The problem then becomes what that process is, what criteria of transparancy and fairness it satisfies, and how the process itself affects the economy. The current structure gives too much room for political elites and bureaucrats to neglect the basic rights of the population at large. The criterion to judge an optimal improvement in the structure of economic policy making is not just economic growth but can be taken in the concept of democracy itself and the citizen’s right to be properly informed.

Keynes’s General Theory can be generalised even further by the inclusion of endogenous government in the model, and in particular economic policy making itself as that is guided by economic theory. Keynes clearly anticipated this line of thinking, where he wrote: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.” (GT:383) The new point now is that this does not only concern “practical men” but economists themselves too, and the whole institutional framework for economic advice. When economic policy making itself is part of the model, economic stagnation can be explained as stagnation in that realm, and the solution for economic stagnation can be found there too.

OECD nations had full employment in the 1950-1970 period, and Japan and Sweden had it much longer. So it would seem that full employment at least is feasible. However, after the period of full employment, all nations showed the phenomenon of stagflation, which is a worsening trade-off between inflation and unemployment (represented as the shift of the Phillipscurve), frequently associated with stagnating growth. Instead of full employment and a steady growth of welfare, OECD nations suffered a long period of insecurity from 1970-2005.

This volume analyses the different periods and finds the likely cause. The fundamental cause is the common Trias Politica structure of economic decision making that all OECD nations share over time and space. At an operational level, stagflation can be explained by the tax policy that OECD nations have in common as well.

The common tax policy is based upon a particular economic theory that has become the conventional economic view of our time. This conventional theory sees tax as a penalty on work effort and holds that statutory marginal rates have major disincentive effects. Marginal tax rates are a useful penalty on (inflationary) wage claims in wage-bargaining, but the conventional view is that the disincentive effect dominates. Following this theory, policy has been to reduce marginal rates at the cost of lower exemption. Another measure was to switch from the income tax to a Value Added Tax (VAT) that has no exemption at all.

The common tax policy has static and dynamic components. Statically, exemption is low. Dynamically, there is the tendency of reducing exemption even further. The low and ever lower exemption causes rising tax levels and hence either poverty or higher labour costs in the lower wage brackets, causing unemployment, and causing higher taxes to pay for the benefits. What is crucially wrong about current policies is the phenomenon of differential indexation. Exemption is indexed on inflation, while subsistence, by social psychological causes, rises with inflation and real income. This differential indexation causes ever increasing problems with poverty and unemployment.

The OECD countries have been pursueing this policy now for more than three decades, and rather little is being achieved. It is time to seriously wonder whether policy is on the right track. This book shows where the conventional theory goes wrong.

A first feature is the tax void. The tax void is the region of productivity and income between the net minimum wage and the gross minimum wage. The difference between net and gross is normally called a ‘tax wedge’, but this term is inadequate since a wedge is commonly thought to apply at a particular level while the void is a range. The income range between the net and gross minimum wage is a void since there are official tax statutes for that range but  no true revenues. People are not allowed to work below the gross minimum and thus cannot pay taxes there (that is, for full timers). Ideally, as in the 1950s, the net minimum should be equal to the gross minimum so that the void is zero, and so that such workers can start earning their own living without paying taxes. Because of the current practices for tax indexation, the tax void has grown over time so that the gross minimum wage has risen much more than the net minimum wage. By result, more and more low wage workers are subject to that excessively high gross minimum and are effectively removed from the labour market. The shift of the Phillipscurve can be explained partly by this growing component of minimum wage unemployment. This analysis also points to a solution. For the tax void, no taxes are collected (on full timers), thus abolishing such void taxes will not cost anything. The argument is not quite that lowering the minimum wage will create new job opportunities, but rather that not raising the gross wage costs so excesssively would not have destroyed the opportunities that already existed. This argument designs an experiment at no cost.

The tax void causes needless unemployment for millions of people all over the world and its plain bureaucratic stupidity is a blow to naive ideas about democracy (that the current democratic structure would be adequate and provide adequate information).

The second feature in the new analysis concerns the dynamic marginal tax rate. Marginal tax rates are important - since economic theory indeed assumes optimising economic agents - but these marginal rates should be properly computed. This analysis not only considers the partial effect, assuming other things constant, but rather considers the total effect that includes all simultaneous changes. A change in a marginal tax rate is usually accompanied by a change in exemption, and both generally happen at the same time, either annually or in computer policy simulations. Private and national income change at the same time too. Individuals are frequently aware that their own fortunes are linked to the fortunes of the national economy and they will be sensitive to their relative position in the distribution of income. Work incentives may be more guided by the average tax rate rather than the statutory marginal tax rate. Hence, ‘incentives’ may not be a convincing argument against higher marginal tax rates, even though policy makers have been advancing that argument forcefully. That, in fact, the converse is true, fits perfectly with the experience of the last decades. The reduction of the statutory marginal rates, as the policy was, appears to have had little incentive effects, since the true incentive effect depends more on the average tax over time, and this average has remained high due to the problems of unemployment, poverty and lower growth.

This book concludes that macro-economic policies in OECD nations have not countered stagflation but have actually increased it. Current policies add to labour costs, reduce incentives, fuel forward shifting of the tax burden, and worsen the trade-off between inflation and unemployment.

The new analysis points directly to a policy that will be successful and that will allow a return to full employment under stable prices like in the the 1950s. If exemption is put at subsistence, then jobs can be created at the low end of the labour market, which would save benefits and reduce average taxes, which again would increase incentives. The alternative structure and policy would also be beneficial for inflation. If low productivity labour has a stronger position in the labour market, then the risk of unemployment is spread more evenly, and trend-setting high productivity labour will be cautious about wage claims.

A welfare state is defined as a state that doesn’t let people die and thus provides benefits for the lowly productive anyway. The welfare state can be run more efficiently by using those resources, instead of going into benefits, to instead reduce labour costs and to price the lowly productive into jobs. The analysis on inflation and unemployment thus results into the proposition that, since the present situation is inefficient, an improvement is possible from which everybody can benefit.

This book provides theorems in mathematical economics to prove its points. The central questions in the political economy of employment in the welfare state are: can one solve unemployment, does one know how, and does one want to ? The book presents a model that satisfies the stylized facts and thus serves theoretical and empirical uses.

·         The first result is a possibility theorem (can) that there are two regimes of either full employment or unemployment.

·         The second theorem explains the choice by know and want causes. Full employment results from conscious choice or chance (while lacking knowledge). Unemployment results from conscious choice or wrong co-ordination (where a Pareto optimising change is blocked only by lack of knowledge - and a lack of knowledge not by the economists but by the incompetent or insensitive policy makers).

The analysis shows mathematically that democratic goals indeed can be blocked by special interests or neglect, for example within the bureaucracy. A policy conclusion is to improve informational (planning) procedures.

The discussion of taxes, unemployment and inflation is basically just a minor point of the book. The major point of the book concerns the co-ordination problem. Western democracies apparently allow long periods like the Great Depression or the Great Stagflation that are detrimental to the economic well-being and security of large sections of their populations. Ideas of economists that point the way to recovery are only slowly accepted. Key examples are the ideas of Tinbergen and Keynes: for them it took World War II before they got listened to. Eventually, the political powers of that time accepted that they had to redesign the structure of economic policy making, and they gave more room to the scientists, but did not dare to give up their ultimate power to meddle with the information. Currently, the world faces the challenge of the growth of the world population from 6 billion people around 2000 to likely around 8 billion people around 2025. To manage this process, mankind would benefit from a structure of economic decision making that is both democratic and that respects the citizen’s right to know.

EWP references are to the Economics Working Papers Archive at the Washington University at St. Louis: http://econwpa.wustl.edu. See also http://www.dataweb.nl/~cool.

Note: Colignatus is the name of Thomas Cool in science. Some archives may not recognize that name.

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Colignatus (1995e), “Economics programs written in Mathematica”, ewp-prog/9508001

Colignatus (1996a), “Unemployment solved ! A breakthrough in economic analysis”, ewp-get/9604002

Colignatus (1996b), “A constitutional amendment for an Economic Supreme Court”, ewp-get/9604003

Colignatus (1996c), “Enable Russia to help itself”, econwpa get/9604004

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Colignatus (1996e), “Dynamic curvature of the tax wedge”, ewp-pe/9604001

Colignatus (1996f), “On the nature and significance of a free lunch”, ewp-get/9607003

Colignatus (1996g), “Differential impact of the minimum wage on exposed and sheltered sectors”, ewp-get/9608001

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