The Eurozone is both a spectacular failure and a spectacular success

One of the ways I judge whether an economy is working is whether it is able to provide enough work for those who desire it (both in number of jobs and hours of work). That is, an economy that generates purely frictional unemployment with underemployment eliminated. I know that there are many that think that emphasis is old-fashioned but those opinions are mostly provided by those that have secure, well-paid jobs. The latest Eurostat European Labour Force data, May 2012 shows that the policy framework in Europe is failing dramatically against my benchmark with the unemployment rate is now at its highest level in the Eurozone since the currency union began. I judge the Eurozone to be a failed “state”, in need of a dramatic change in policy approach. At the same time I consider it to be spectacularly successful. Time to explain …

Yesterday, I quoted Chicago economist Robert Lucas, Jnr who said that “At research seminars, people don’t take Keynesian theorising seriously any more; the audience starts to whisper and giggle at one another.”

Those who pronounce that unemployment is voluntary (a “preference for leisure”) or that youth unemployment is just a search process and the higher rates of unemployment just reflect that they are searching more intensively because they have less knowledge, and the rest of the sickenly false reasons that the mainstream elicit to defend their indefensible position are typically well-paid persons in secure employment with large superannuation balances and consulting income on top of their university income.

I have been researching unemployment for my entire career and I have yet to meet an unemployed person who prefers leisure any more than I do or most people. They are just the people who bear the brunt of deficient aggregate (effective) demand, which arises from poor policy choices from our governments.

There was a lovely retort from veteran Cambridge economist Frank Hahn’s 1982 book Money and Inflation (published by Blackwell), which is relevant to today’s blog and that observation. The book was a collection of lectures that Frank Hahn delivered at Birmingham University in 1981. to that

I don’t have the book near where I am working today but Tony Thirlwall quoted Hahn in a paper that he presented to a meeting at Cambridge a few years ago (that both Randy Wray and yours truly also gave papers). Frank Hahn was discussing the Lucasion (that is, Monetarist) denial of the concept of involuntary unemployment and Thirlwall quoted him as saying:

I wish he … [Robert Lucas] … would become involuntarily unemployed and then he would know what the concept is all about.

As an aside, Frank Hahn was not one Keynes’ inside coterie. He was critical of Keynes for his lack of technical skills and exposition.

In the Preface (Pages x-xi) to his 1982 book – Money and Inflation – Hahn wrote that while he was extremely critical of the Monetarist theoretical position, he also didn’t think much of Keynes. He wrote:

It is of course true that the Keynesian orthodoxy was also flimsily based and that its practitioners also dealt in unwarranted certainties. I do not wish to defend this. But bygones are bygones, and these economists are not now stridently to the forefront. However, I ought to lay my cards on the table. I consider that Keynes had no real grasp of formal economic theorizing (and also disliked it), and he consequently left many gaping holes in his theory. I nonetheless hold that his insights were several orders more profound and realistic than those of his recent critics.

When Hyman Minsky reviewed Hahn’s book in 1984 (Reference ‘Hahn’s “Money and Inflation”: A Review Article’, Journal of Post Keynesian Economics, 6(3), 449-457) he said that:

Hahn’s attack on Monetarist expectations is consistent with the Post Keynesian critique. But Han is not a closet Post Keynesian. He “believes” that Arrow-Debreu can be used as a basis, a “scaffolding”, for useful theory. Post Keynesians accept the logic of arguments such as those in Hahn’s critique and work at developing a monetary theory that fully recognizes the complex institutional structure of modern capitalism. It is sad but Hahn, for all his talent and power, doesn’t even try to understand our economy.

Anyway, lets progress.

The latest European Labour Force data, May 2012 – published this week (July 2, 2012) by Eurostat show that the Euro area unemployment rate is now at 11.1 per cent, the highest level since the Eurozone was formed.

The first graph shows the aggregate unemployment rate at the Eurozone level and for selected peripheral Eurozone nations. The jobless rate is spiralling upwards and all the summits and bailout plans have not changed that pattern – and can be judged to have failed.

There is a host of Eurostat data conveniently arranged at the Youth Dashboard and the following graph is taken from data available there.

It shows the unemployment rate for Eurozone youth (15-24 years of age) from 1995 to 2011. The situation has of-course deteriorated further into 2012.

The latest data shows that youth unemployment in the Eurozone is 22.6 per cent, for Spain and Greece 52.1 per cent; Portugal 36.4 per cent; for Italy 28.5 per cent, and for Ireland 28.5 per cent.

I tweeted yesterday when I saw the data release that this is a lost generation being created in Europe.

The long-term damage that arises from excluding the youth from the labour market is life-long and then some. Just as this cohort will carry the disadvantage throughout their lives and typically endure unstable and low-paid work interspersed with lengthy periods of unemployment when the business cycle turns down.

But even more damaging is that they will find it harder to form stable relationships and if they do their children will inherit this disadvantage arising from the exclusion at this time of their parent(s).

It is unfathomable why this is not an absolute policy priority and the Euro leaders announce immediate job creation programs through the Eurozone targetted at youth, if they cannot bring themselves to introduce an unconditional job guarantee for all workers.

The costs of this folly are so large and so enduring that there is no fiscal justification that can be mounted to not introduce such a plan.

The next graph from the same database shows the ratio of Long-term unemployment (12 months or more) to Total unemployment for the Euro area and selected nations from 1995 to 2011.

This is a familiar pattern during drawn-out recessions. The pool of long-term unemployed expands as new entrants come intot th elabour markte and are seen as being more attractive relative to those who have been unemployed for some time.

This pattern also provides another argument by the neo-liberals to justify austerity. They claim that rising long-term unemployment is structural in nature and needs to be addressed via training rather than aggregate demand expansion. I have done a lot of work in this area in my earlier research.

Economists employ classification frameworks to help us make sense of the labour force data. For example, in terms of types of unemployment (with implicit causes attached), there is a distinction made between demand-deficient and structural unemployment.

Demand-deficient unemployment occurs when the number of people wanting gainful employment exceeds the number of vacancies being offered. The composition of the unemployed relative to the skills demanded is not the binding constraint.

Structural unemployment is said to arise when there are imbalances in the supply of, and demand for, labour in a disaggregated context. A simple case arises which highlights the difference as to which constraint is promoting the unemployment. If at the aggregate level the number of unemployed is equal to the number of vacancies then (abstracting from seasonal and frictional influences) this unemployment would be termed structural.

Structuralists suggest that structural imbalances can originate from both the demand and supply sides of the economy. Technological changes, changes in the pattern of consumption, compositional movements in the labour force and welfare programme distortions are among the pot-pourri of influences listed as promoting the structural shifts.

The distinction between demand deficient and structural unemployment is usually considered important at the policy level. Macro policy will alleviate demand deficient unemployment, while micro policies are needed to redress the demand and supply mismatching characteristic of structural unemployment. In the latter case, macro expansion may be futile and inflationary.

The Monetarist notions of the NAIRU are tied in closely with the concept of structural unemployment and has been used to justify the ridicule that Robert Lucas refers to in the opening quote.

By the mid-1970s, Keynesian remedies proposed to reduce unemployment – that is, demand expansion – were met with derision from the bulk of the profession who had embraced the natural rate (NAIRU) approach and its policy implications even though there was very little evidence presented to substantiate these effects in any economy in the world.

The NAIRU approach reinstated the early classical idea of a rigid natural level of output and employment. Essentially, it asserted that in the long-run there was no trade-off between inflation and unemployment, because the economy would always tend back to a given natural rate of unemployment, no matter what had happened to the economy over the course of time.

The natural rate (or NAIRU) reflected structural characteristics (you guessed it – minimum wages, welfare payments, etc) and so only microeconomic changes – that is, deregulation, welfare retrenchment, abandonment of minimum wages – could lower it. Accordingly, the policy debate became increasingly concentrated on deregulation, privatisation, and reductions in the provisions of the Welfare State – one of the defining characteristics of the neo-liberal era.

But if structural changes are, in fact, cyclical in nature a prolonged recession may create conditions in the labour market which mimic structural imbalance but which can be redressed through aggregate policy without fuelling inflation.

This was, in part, one of the investigations I undertook as part of my PhD studies. As a graduate student I considered that the NAIRU concept was merely a standard (logical) prediction from the orthodox competitive model, which lacked empirical substance. There were also internal inconsistencies in the theory.

It was not difficult to find empirical evidence which was contrary to the edicts of the NAIRU approach – for example, the quits are pro-cyclical not counter-cyclical. Please read my blog – Even the most simple facts contradict the neo-liberal arguments – for more discussion on this point.

In the real world, booms in activity stimulates on-the-job training opportunities and raises potential output above the level that would have persisted had the economy remained at low levels of activity. Alternatively, as activity falls due to demand failure, both training opportunities decline and actual skills are lost, as workers lie idle. The potential capacity level falls as a result.

To learn more about that research please read my blog – The structural mismatch propaganda is spreading … again!.

The point is that the NAIRU concept does not stack up theoretically or empirically. It is well established that changing labour market imbalances reflect cyclical adjustment processes which render any estimated macroequilibrium unemployment rate to be cyclically sensitive and therefore not the basis of an inflation constraint.

The NAIRU hypothesis suggests that any aggregate policy attempt to permanently reduce the unemployment rate below the current natural rate inevitably is futile and leads to ever-accelerating inflation.

However, the empirical world supports the notion that imbalances reverse when aggregate demand regains strength. The last thing we should be doing at present is to abandon job creation policies and start relying, exclusively, on training programs and worker-attitude-correction strategies to reduce long-term unemployment in Europe or anywhere.

I have provided this quote from Michael Piore (1979: 10) previously, but it is worth repeating:

Presumably, there is an irreducible residual level of unemployment composed of people who don’t want to work, who are moving between jobs, or who are unqualified. If there is in fact some such residual level of unemployment, it is not one we have encountered in the United States. Never in the post war period has the government been unsuccessful when it has made a sustained effort to reduce unemployment. (emphasis in original) [Unemployment and Inflation, Institutionalist and Structuralist Views, M.E. Sharpe, Inc., White Plains]

So why would anyone think that the Eurozone has been a success?

I read an interesting article by American investigative journalist Greg Palast recently (June 26, 2012) – Robert Mundell, evil genius of the euro – where he argued that the Euro had succeeded in spectacular fashion.

His argument was that:

The idea that the euro has “failed” is dangerously naive. The euro is doing exactly what its progenitor – and the wealthy 1%-ers who adopted it – predicted and planned for it to do.

That progenitor is former University of Chicago economist Robert Mundell … [who] … intended to do something about it: come up with a weapon that would blow away government rules and labor regulations …

The euro would really do its work when crises hit, Mundell explained. Removing a government’s control over currency would prevent nasty little elected officials from using Keynesian monetary and fiscal juice to pull a nation out of recession.

I agreed with everything he wrote and have commented before that fiscal austerity really has nothing to do with a belief that financial markets are dominant and that if the ECB funded all the stimulus necessary to regenerate economic growth there would be hyperinflation. It is clear that the Euro leaders, infested with neo-liberal zeal, want to finish off the agenda that was rudely interrupted by the crisis that that agenda actually caused.

They want to tilt the balance towards capital, undermine real wages growth and welfare benefits and return economies to states that existed before trade unions, inconveniently provided a modicum of industrial justice to the workers.

So why do I also say the Eurozone has failed? Well it is because I prefer to evaluate it from the perspective of decency rather than the ambitions of the neo-liberal elites. As noted in the opening – if a society cannot provide enough work for those who desire it then it is clearly also not lifting the fortunes of the poorest members in that society. That is my definition of a failed state.

What can be done about it? I have been invited to speak at the upcoming European Commission Employment Policy Conference (“Jobs for Europe”) in Brussels on September 6-7, 2012. At that meeting I hope to articulate a comprehensive strategy which will link in to the work already being done by the EC – see Commission presents new measures and identifies key opportunities for EU job-rich recovery – but challenge the notion that direct job creation is to be avoided.

I will obviously report more on that work nearer to the day.

But there was an article in the UK Guardian (July 3, 2012) by US economist Dean Baker – Why Americans should work less – the way Germans do – which proposed a solution to US unemployment.

Dean Baker says:

There is a solution to unemployment: if we worked the same shorter hours as Germany, we’d eliminate joblessness overnight

I don’t consider the proposal presented to be a viable solution. Rather, I characterise these proposals, however well intentioned, to be conceding ground to the neo-liberals and trying to work around the artificial constraints that the latter place on economic (and hence employment) growth.

Dean Baker notes that “on average German workers put in 20% fewer hours a year than Americans – and German unemployment has fallen during the post-2007 downturn”.

He continues:

The most important point to realize is that the problem facing wealthy countries at the moment is not that we are poor, as the stern proponents of austerity insist. The problem is that we are wealthy. We have tens of millions of people unemployed precisely because we can meet current demand without needing their labor.

This was the incredible absurdity of the misery that we and other countries endured during the Great Depression, and which Keynes sought to explain in The General Theory. The world did not suddenly turn poor in 1929, following the collapse of the stock market. Our workers had the ability to produce just as many goods and services the day after the collapse as the day before; the problem was that after the crash, there was a lack of demand for these goods and services.

I totally agree with that proposition. It reminded me of the way Norwegian economist described the situation during the Great Depression.

Jans Andvig quoted Frisch in his 1992 book – Ragnar Frisch and the Great Depression – A Study in the Inter-war History of Macroeconomics Theory and Policy (published by the Norwegian Institute of International Affairs, Oslo. page 287):

One has to understand that the ongoing crisis is not a crisis of real poverty, but an organizational crisis. The world is like a ship loaded by the goods of life, where the crew starves because it cannot find out how the goods should be distributed. Since the depression is not a real poverty crisis, but one of organization, the remedy should also be sought through effective organizational work inside the apparatus of production and distribution. The great defect of the private capitalist system of production as it is today is its lack of planning, that is, planning at the social level. This cardinal point cannot be disputed.

Frisch was concerned about income distribution as much as the level of aggregate demand. He was also an antagonist to Keynes, because the latter eschewed the value of econometric modelling as a tool to aid interventionist policy. I will write about Frisch in detail another day because he is a very interesting character with some very original policy ideas.

The question that arises then, is what policies are required to ensure these “organisational problems” are resolved.

Dean Baker acknowledges that the “result of this lack of demand was a decade of double-digit unemployment in the United States” during the 1930s and that the “spending programs of the New Deal helped to alleviate the impact of the downturn”.

He also says that this “is the same story we face today”. I agree totally.

But he then claims that governments:

… can also employ people by encouraging employers to divide work among more workers. There is nothing natural about the length of the average work week or work year and there are, in fact, large variations across countries. The average worker in Germany and the Netherlands puts in 20% fewer hours in a year than the average worker in the United States. This means that if the US adopted Germany’s work patterns tomorrow, it would immediately eliminate unemployment.

He wants the “lost wages will be made up by subsidies from the government” because he understands that “the problem is too little demand, not too much”.

Let me say that I support shorter working weeks to give workers more time to spend with the families, friends and otherwise. Productivity growth should allow real wages to rise and the working week to fall.

But relying on shorter working hours to solve the unemployment problem will not eliminate that evil.

It is clear that aggregate demand has to grow for output and employment growth to occur, unless governments introduce a Job Guarantee scheme and simultaneously engineer a transfer of workers into that pool from existing employment.

That is, a JG scheme does not necessarily require aggregate demand to grow. A government would be perverse if it adopted fiscal austerity and suppressed demand while at the same time introduced a JG.

So the solution at present has to include an increase in the budget deficits in nations that are enduring high unemployment. That is recognised by Dean Baker, when he notes that the German response to the crisis was to ration hours of work and the state would pick up the tab to ensure incomes of workers on shortened hours would not fall by much.

I considered the German approach in some detail in this blog – Shorter hours or layoffs? – and concluded that the German case provides a better option relative to laying off workers. But the comparison between Germany and the US is fraught given the radically different welfare support levels in place in each nation. US has no safety net at all.

There are several arguments advanced in favour of using shorter hours. First, it allegedly allows the burden of recession to be shared instead of a small relative percentage of workers bearing the costs in the form of unemployment. However, given that recession does not impact evenly on sales and across firms (that is, some industries and therefore firms are more vulnerable) this “sharing” is not possible. Some firms cannot survive even with shorter hours while others do not need to cut hours at all.

Second, unemployment requires some workers to lose all their pay whereas sharing hours would proportionately reduce pay for all workers. While there is some merit to this argument, it doesn’t help those workers who are on the margin of solvency with respect to their nominal contractual commitments (for example, mortgage payments). Further, given that wage income is a significant component of final demand – a widespread cut in pay (via less hours) would see aggregate demand fall and unemployment worsen. Some proponents of short working weeks argue that the pay issue can be overcome if the government pays workers a portion (might be 100 per cent) of the difference they earn from the firm and what they would have earned by working a full week. This is of-course the solution that is followed, to some extent, in countries such as Germany (see below). However, it is problematic if there is significant casualisation in the workforce. What is the standard working week that the subsidy would be based on? This would be particularly difficult in Australia, where like the fools we are, we have allowed underemployment to skyrocket.

Other suggestions to the pay dilemma include the provision of tax credits to firms to cover paid time off. So a government subsidy in another guise. Whether this is the best use of government spending is moot given the opportunity that it provides private firms to abuse the system.

Third, some argue that sharing hours is good because it frees up more time for leisure and families. It does that by definition but while that might benefit some it may also disadvantage others, especially lower paid workers. Leisure and income tend to be complementary in this consumer age and a loss of pay may reduce the capacity to enjoy leisure.

Fourth, less congestion on roads makes for higher standards of living. Sure enough. Flexible hours would spread the traffic usage across a broader spectrum of available hours. But why not just petition for better public transport and improved bicycle paths? We don’t need schemes that cut workers pay to improve transport systems. What we need is a commitment by the Government to build high quality public infrastructure. If they saw the recession as an opportunity to accelerate the construction of public spaces (including bike paths and better transport) then a lot of the need to cut hours would disappear as the net government spending underwrote aggregate demand and jobs.

The same logic underlying Dean Baker’s proposal was used by the French when they brought in a statutory 35-hour working week in February 2000. It was seen as a way of “spreading the work” and reducing their persistently high unemployment rates.

The facts that emerged were that employers did not hire new workers in any great quantity and unemployment remained largely unchanged (as a consequence of this move). The evidence is that the workers who kept their jobs enjoyed longer weekends which created a real estate and sports-centre cum golf boom in the 100km radius of Paris (for example). But the bosses just increased intensity of work and so 5 days work was performed in 4 days.

The problem is that while it has improved the lives of many of those in employment it did virtually nothing for the unemployed.

So the plan to spread the work failed. I imagine Dean Baker will say that to get the subsidy the firm has to shuffle the hours. But what incentive is there for the firms to do that if it not going to sell more goods and services and may add to their labour costs?

There are also many within-firm issues which add costs. In all but the lowest skill jobs, the act of hiring is costly. Further, workers are not perfect substitutes and so work-sharing can be difficult to organise. The inflexibility it introduces when a matching worker is not available increase employer costs. The administrative burden of adding to the payroll etc add costs. There are also spatial (regional) matching issues. So where is the incentive for the employer?

Workers have other commitments/obligations which are not necessarily as flexible – such as child care arrangements. If the boss can tell the worker to take a holiday (employer chooses remember) this might not align with these other responsibilities. While flexibility for the worker in terms of hours might seem like a good idea, in many cases it becomes a poisoned chalice.

Further, who determines where the flexibility will occur? Dean Baker’s Centre (CEPR) has proposed this before and placed the so-called flexibility in the proposal at the behest of the employer! SHE gets to decide how the worker will be rationed off into idleness.

Finally, given that the US government (or the ECB in the Eurozone) issues the currency it can easily ensure that aggregate demand is sufficient in the economy by stimulating employment rather than rationing it.

For Dean Baker’s proposal to get past the demand constraint government net spending has to rise anyway. That means it has to get past the current ideological constraint that is stopping that from happening.

Once that constraint is eliminated then rationing hours is not going to be the best way to solve unemployment.

Conclusion

I would rather see that stimulus initially be introduced via an employment guarantee with increased minimum wages (in the US). The limit of the guarantee and the last dollar that would have to be spent would be determined by the last unemployed worker who came through the Job Guarantee door wanting to work. A down-to-the-last-dollar automatic stabiliser you might say which eliminates all the complaints made by the mainstream about fiscal policy inefficiencies arising from timing lags.

The US government and any national government can always afford to introduce this sort of program. Shuffling workers around a highly constrained volume of working hours is not a progressive solution. It is a compliant surrender to the failure of the US government to realise its fiscal responsibilities.

Once that was in place, I would then undertake major public infrastructure projects to employ skilled labour and ensure public health and education was well funded (which means in the US context I would be funding states via federal transfers proportionate to population).

That is enough for today!

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