Friday, October 25, 2013

The Issue of Unemployment - Part 3 (What Phillips Said)

As earlier mentioned, Alban William Phillips  came up with a relationship  of the percentage change in money wages and the level of unemployment.  He argued that since a particular level of unemployment in the economy will imply a particular rate of wage increase, the aim of low unemployment and a low rate of inflation may be inconsistent. This idea presented as the Phillips Curve posed a real dilemma. If Phillips is right, fiscal management will have to be taken with great precaution if a good balance between inflation and employment is s to be achieved. Moreover, it is possible that massive unemployment may be persistent  and the concerned government(s) may not be helpless about it.

Keynesian economists do not believe  the claim of A.W. Phillips.  According to them, if the government will spend more money for productive activities , the new money injected into the system will accrue to the benefit of those who were previously unemployed and  will not just flood the market with an oversupply of money (which is the cause of inflation).  There is a Keynesian  belief that any economy will naturally have unemployment because the economy itself operates naturally in a state of disequilibrium. There will always be a situation wherein those who are willing to work exceeds the number of jobs available and at the same time, firms are unable to sell all the goods they would like to sell. The disequilibrium is caused by these oversupply of goods and labor. The solution is for the government(s) to spend on public infrastructure, for instance, to utilize the excess labor and make them productive, give them a source of income, so that they may consume the excess goods. The premise of the Keynesian solution is that there is a natural state of unemployment. If the economy  tends towards  full employment as believed by classical economists (by virtue of the concept of “the invisible hand” by Adam Smith), the new money injected by the government to create employment will really just have an inflationary effect. A policy to create employment in a full employment scenario is ,of course, absurd if not stupid.

A full summary about  the main difference between the two point of views may now be drawn. The Keynesian view is that there is unemployment in the natural state, while on the other hand, the classical view is that the economy will always tend to the full employment level  if left alone. Because there is a natural unemployment level in the Keynesian point of view,  fiscal policies geared towards involving more people in the productive activities, is rational. On the other side of the coin, because there is already a tendency towards full employment in the classical point of view, anti-inflationary measures can be made as the focus of policies.

Clearly, the two schools of thought are in the opposing ends of the pole, and the whole span of difference is articulated by the Phillips  Curve. In the theoretical arena, the opposing views can be in an eternal stand-off, again because their arguments and notions are based on situations where some factors which add to the complexities, albeit real, are held constant. But that is not what is needed in the tangible world. In practice, realistic solutions must be drawn to combat realistic problems.

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