Mass unemployment is involuntary

I am now using Friday’s blog space to provide draft versions of the Modern Monetary Theory textbook that I am writing with my colleague and friend Randy Wray. We expect to complete the text by the end of this year. Comments are always welcome. Remember this is a textbook aimed at undergraduate students and so the writing will be different from my usual blog free-for-all. Note also that the text I post is just the work I am doing by way of the first draft so the material posted will not represent the complete text. Further it will change once the two of us have edited it.

This section continues the work on stylised facts that should be explained by any credible macroeconomic theory. In this part I deal with involuntary unemployment and its associated time series properties.

Unemployment

One of the stark facts about modern economies has been the way in which unemployment has evolved over the last three or more decades. While different nations have recorded varying experiences the common thread is that unemployment rates have risen overall and, in most cases, endured at higher levels for many years.

In Figure 1.x unemployment rates – the percentage of willing workers who are unable to find work – are shown for six nations. The time frame extends from 1948 for the US and less periods for the other nations – Australia (from the third-quarter 1959), Japan (from first-quarter 1953), Germany (first-quarter 1962), France fourth-quarter 1967) and Norway (from first quarter 1972). The samples used reflect the available comparable data. The sample of nations chosen include the two largest industrialised European nations (Germany and France), a Scandinavian exporting nation (Norway), a small open economy predominantly exporting primary commodities and with a relatively underdeveloped industrial base (Australia), and two large industrialised nations (Japan and the USA).

Figure 1.x Comparative unemployment rates (%)

Sources: OECD Main Economics Indicators, US Bureau of Labor Statistics, Statistics Japan, Statistics Norway. Data is seasonally adjusted.

The accompanying data in Table 1.x provides further information upon which to assess the historical behaviour of unemployment.

The data shows that unemployment rose in all nations shown during the 1970s and persisted at these high levels well into the first decade of the new Century. For some nations (Japan and Norway) the level of the unemployment rate has been significantly below that of the other nations shown.

The data also shows quite clear cyclical patterns. Take Australia as an example where cyclical patterns are pronounced. Unemployment was below 2 per cent for most of the Post-World War 2 period and then rose sharply in the mid-1970s and continued rising as the economy went into a deep recession in the early 1980s.

Economic growth in the second-half of the 1980s brought the rate down from its 1982 peak but never to the level that had been enjoyed in the 1950s, 1960s and early 1970s.

The 1991 recession then saw the unemployment rate jump up again very quickly and reach a peak higher than the 1982 peak. Once again, the unemployment rate started to fall again as growth ensued after the recession was officially over but it took many years to get back to levels prior to the 1991 downturn.

The unemployment rates tend to behave in an asymmetric pattern – they rise very sharply and quickly when the economy goes into a downturn in activity but then only gradually fall over a long period once growth returns.

Any credible macroeconomic model needs to provide convincing explanations for these movements. How were unemployment kept at low levels during the 1950s and 1960s? Why did unemployment rates rise in the 1970s and persist at the higher levels for several decades? What determines the cyclical pattern of the unemployment rates – that is, the asymmetry?

There is some agreement among macroeconomists that the persistently high unemployment in the late 1970s and beyond was consistent with the economists concept of involuntary unemployment. Involuntary unemployment is a fundamental concept in macroeconomics and indicates that individuals are constrained by the systemic failure of the economy to provide enough jobs and have little power to alter that circumstance and thus gain work.

In Chapters 10 and 11 you will be introduced to various classification frameworks that have been used by economists to categorise the concept of unemployment. You will learn that a significant number of economists consider unemployment to be a voluntary state, chosen by individuals upon the basis of their preferences for “leisure” against work.

The concept of voluntarism comes from the Classical economists (pre 1930s) who denied that there could ever be an enduring state where the system failed to provide enough work relative to the preferences of those who desired to work. They claimed that output (which drives the demand for labour) could never persist at which would be insufficient to generate a job for all those who desired one.

The Great Depression in the 1930s changed the debate because the notion of voluntary unemployment failed to accord with the observed reality. Millions of workers clearly desired to work but were forced onto the unemployment queue because employers were not willing to provide them with jobs. It was clear that the firms had no desire to expand employment at that time because they could not foresee any potential sales for the extra output that might have been produced.

In the 1930s, the British economist John Maynard Keynes realised that the existing body of macroeconomic theory was inadequate for explaining the mass unemployment that persisted throughout the decade as production levels fell in the face of a major slump in overall spending. He thus defined involuntary unemployment in this way:

Men are involuntarily unemployed, if, in the event of a small rise in the price of wage-goods relative to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. (Page 15, General Theory)

At this stage of your studies, that definition will appear to be difficult to understand. It was deliberately designed to challenge the existing British Treasury viewpoint which claimed that the unemployment during the early part of the 1930s was due to the real wage (the purchasing power equivalent of the money wage) being too high relative to productivity.

So Keynes said that if the real wage falls and workers still supply more labour to the increased quantity of jobs offered by the firms then those workers were unemployed against their will – that is, involuntarily unemployed.

You will learn more about that argument as this course develops. But the essential point that Keynes was aiming to instill into the debate was that mass unemployment of the type he saw in the 1930s was a demand rather than supply phenomenon. That is, it is total spending in the economy that impels firms to employ workers and produce goods and services. A firm will not employ if they cannot sell the goods and services that would be produced.

Building on that concept, Keynes introduced the idea of the unemployment equilibrium – that is, a state where the monetary economy could continue to operate at high levels of unemployment and firms realising their expected sales volumes. He argued that if the economy reaches this type of impasse, the only way out is to reduce unemployment by an injection of government spending, which stimulates demand and provokes firms to increase output and offer more jobs.

We will consider these ideas in more detail starting in Chapter 7.

The debate between Keynes and the Classical economists in the 1930s has resonated throughout the decades since. In the 1980s and beyond as unemployment persisted at high levels in many nations it was clear that firms wanted to increase output at the current real wage levels but were constrained by the aggregate spending available.

We need to understand how economies became trapped in an unemployment equilibrium long after Keynes first identified the tendency within the capitalist monetary system.

The Great Depression in the 1930s taught us that, without government intervention, capitalist economies are prone to lengthy periods of unemployment. The emphasis of macroeconomic policy in the period immediately following the Second World War was to promote full employment. Inflation control was not considered a major issue even though it was one of the stated policy targets of most governments.

In this period, the memories of the Great Depression still exerted an influence on the constituencies that elected the politicians. The experience of the Second World War showed governments that full employment could be maintained with appropriate use of budget deficits (national governments spending more than they were receiving in tax revenue).

The employment growth following the Great Depression was in direct response to the spending needs that accompanied the onset of the War rather than the failed Classical remedies (the British Treasury view) that had been tried during the 1930s. The problem that had to be addressed by governments at War’s end was to find a way to translate the fully employed War economy with extensive civil controls and loss of liberty into a fully employed peacetime model.

Governments all around the world endorsed the emerging Keynesian orthodoxy of the time and committed to the notion that unemployment was a systemic failure in aggregate demand (spending) and moved the focus away from an emphasis on the ascriptive characteristics of the unemployed (for example, whether they were lazy and avoiding work) and the prevailing wage levels.

Many leading economists in the immediate Post World War 2 period pronounced that it was the responsibility of the national government to ensure there was enough spending in the economy such that all the workers seeking jobs would be satisfied.

Full employment was the articulated macroeconomic goal and was expressed as the number of jobs that satisfied the desire of workers to work. It was recognised that at any point in time, some workers would be unemployed because they would be moving between jobs. Economists term this sort of unemployment frictional and consider it provides benefits to the economy because it helps to ensure workers are moving into positions where they are best suited.

Frictional unemployment is typically below 2 per cent of the available labour force and so full employment was defined in terms of this very low unemployment rate. You will learn more about these concepts in Chapter 10 when we discuss labour market measurement.

The result of these new understandings from the Great Depression was that from around 1945 until 1975, national governments manipulated fiscal and monetary policy to maintain levels of overall spending sufficient to generate employment growth in line with labour force growth. This was consistent with the view that mass unemployment reflected deficient aggregate demand which could be resolved through positive net government spending (budget deficits). Governments used a range of fiscal and monetary measures to stabilise the economy in the face of fluctuations in private sector spending and were typically in deficit.

As a consequence, in the period between 1945 through to the mid 1970s, most advanced Western nations maintained very low levels of unemployment, typically below 2 per cent.

In Figure 1.x the last part of that period is shown for most nations.

In Chapter 11 we will learn that the stability of this Post-War framework with the Government maintaining continuous full employment via policy interventions broke down in the 1970s.

Following the first OPEC oil price hike in 1974, which led to accelerating inflation in most countries, there was a resurgence of pre-Keynesian thinking. Inflationary impulses associated with the Vietnam War had earlier provided some economists, who had contested the desirability of full employment, with opportunities to attack activist macroeconomic policy in the United States.

Governments around the world reacted with contractionary policies to quell inflation and unemployment rose giving birth to the era of stagflation (the joint incidence of high unemployment and inflation).

From that time until the present day, many governments have not run large enough budget deficits to ensure that overall spending in the economy was sufficient to generate full employment. The result has been the persistently high unemployment in the 1980s and 1990s and again in the current period.

We will discuss the reasons why governments abandoned their commitment to full employment and what options the government has within a modern monetary system for maintaining low rates of unemployment. We will provide a theoretical and policy framework that contests the current orthodoxy which has downgraded the importance of low unemployment.

We will explain how the current debates are really the same as those fought during the Great Depression and the dominant view among policy makers now is really just a reintroduction of the so-called Say’s Law, which claimed that free markets guarantee full employment and that Keynesian attempts to reduce unemployment will ultimately be self-defeating and inflationary. This was the view that Keynes discredited when he demonstrated beyond doubt that spending creates income and output which drives employment growth.

While the current era is dominated by governments who have prioritised low inflation over low unemployment we will show that the idea that at nation with full employment will suffer accelerating inflation is not supported by an understanding of how the economy works.

Mass unemployment still represents a macroeconomic failure that can be addressed by expansionary fiscal and/or monetary policy. We will consider the design of an effective policy intervention in Chapters 13 to 18.

[NOTE: TWO OTHER STYLISED FACTS WILL BE INTRODUCED INTO THIS CHAPTER: (a) the growing gap between real wages and productivity after a long stable period of proportional co-incidental growth; and (b) the dramatic rise in private sector indebtedness in the last 20 or so years]

Saturday Quiz

The Saturday Quiz will be back again tomorrow. It will be of an appropriate order of difficulty (-:

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.