Wednesday, October 30, 2013

The Issue of Unemployment - Part 5 (Shall We All Abandon Keynes Now?)

Classical economics/monetarism is a  market-oriented point of view. It revolves around the assumption that macroeconomic growth will trickle down  to the masses via the market mechanism.  However, market economies are, of course, imperfect  and the trickle-down effect does not normally occur.  This means that equity issues are unlikely to be resolved under the classical/monetarist approach unless the market is near, if not fully, perfect.

On the other hand, direct employment of people is already a wealth (re)allocation measure which effects and ensures socio-economic equity, and this is something that can not be guaranteed in monetarism. 

Going back to GNP, the increase in that economic indicator  may  not necessarily mean that all or majority of the people  benefited from the growth of the economy. It is possible that,  under a monetarist system, rich will get richer and the poor, poorer and the income disparity between economic classes will continue to widen.

In addition to the above, it should be worth noting that when the shift towards monetarism was made by the above-cited governments, they ignored the structural problems which rendered Keynesian economics ineffective. For instance,  Australia, as a welfare state, provide welfare benefits to the unemployed which may cause apathy for people to get jobs.  The expectation that they will somehow still have a source of income make people indifferent towards earning their own money. The teenagers may even have the same notion such that more and more may probably be dropping out of school. According to the definition of  (un)employment by Baddock (1992) as presented earlier, this type of unemployment may not be included in the statistics because  the element of willingness to work is not present and therefore, must not be taken against Keynesian economics.

Another structural problem that should  have been contended with is the immobility of jobs and people. It is possible that there are oversupply of goods and labor in one area or region but a corresponding undersupply may   exist in other areas.  The immobility of people to seek jobs where there are available may be caused by transport disadvantages, rigidity of wages and hiring  systems and  erroneous land-use decisions.  This is where the role of planners may actually come in.

As cited by Kalachek (1973, in Rasmussen and Haworth, 1973), there were central cities in the United States in the mid-60s which experienced massive unemployment rates even though at that time, the overall demand for labor  was strong and hiring standards were consequently relaxed. “ Inferior quality of education, poor health, low motivation and racial discrimination (applicable to unemployed blacks) are traditional explanations” (Kalachek, 1973). However, an additional idea was advanced suggesting that the physical location of jobs and workers and the existing transportation network within labor markets may also play a culprit role. Kalachek (1973) further explained that this problem  was and is the result of the suburbanization of industries, primary reliance on privately-owned vehicles, and residential segregation. To this list, lack of information about job availability  and lack of  social support services  e.g. housing may  be added.

The cause of suburbanization are, among others, retail trade following customers outside the inner cities, technologies allowing manufacturers to operated in a more cost-effective manner in the fringes (Hall, 1991), and other reasons  which may be related to  deagglomeration  forces (McConnell, 1988).

Suburbanization itself, which created the  cross-commuting patterns of residents and workers, is not an impediment to employment. It is the mobility of the labor force that may inhibit them to be employed where job is available.

Note also that the whole problem of structural unemployment may actually be looked at in the regional development angle because the structural problems as mentioned by Kalachek (1973)  are the same employment-related problems which may impede regional development (BIE, 1994):

            “ In relation to market-based impediments,...the labor market adjustments may be  impaired  by a) lack of  information about employment and accommodation prospects in    different locations; and b) inadequate opportunities for training and retraining. “

Relatedly, the BIE (1994) further cited the Australian Industry commission’s 1993 Report which identified a large number of institutional and government-related impediments to regional adjustments, to cite, verbatim,  Australia’s existing wage fixing arrangements limit the scope for wage flexibility which constraints adjustment options available to regions with consequent adverse effects on employment opportunities; Greater flexibility in wages (enabling firms to pay “training wages”) and work practices would provide greater potential for training and retraining by employers. This would help increase the regional employment opportunities;  Social security arrangements in conjunction with the tax system are exacerbating problems of regional unemployment. Consideration needs to be given to policy options which deals with poverty traps and the employment disincentive effects of social security payments, particularly for those facing low wage alternatives; Current arrangements relating to superannuation guarantee charge for causal and itinerant employees impose high cost on employers of this type of labor;  The mobility of labor is adversely affected by a number of impediments including the use of stamp duties on conveyances as a state revenue raising measure, the use of public housing as a manner which ties disadvantaged groups to particular  locations, occupational licensing restrictions that limit people from undertaking employment in different states, and limitations on the portability of entitlements and superannuations;  Rigidities, inefficiencies  and lack of flexibility in land-use regulations covering land-use zoning, site clean-ups regulations, development approved processes and environmental regulations impact adversely on the adjustment capacities of regions; and inefficiencies in the pricing of public infrastructure  and the regulation of transport and communications increase the cost of these services and act as tax to regional development, in general, or disadvantage particular regions relative to others.

Well-structured  regional development policies can be  the answer to the structural problems mentioned above.  As regional development  is attained, structural defects in the economy may likewise  be straightened out, which means that  the Keynesian approach may be again  used effectively.          

The structural problems cannot be ignored by simply changing the macroeconomic approach. Keynesian or classical,  the structural problems of unemployment will have to be contended with  as it can be an economic time bomb.

The Issue of Unemployment - Part 4 (A Different Angle)

A neo-classical-monetarist in the person of Milton  Friedman believed that a real full employment, as advocated by the old classicists,  may not be attained and thus unemployment may actually exist (He temporarily agreed with Keynes, in this sense). He argued  that  the cause is due to structural factors in the economy rather than natural economic factors. With structural unemployment, Friedman posed that no matter how much money is injected by the government through  public expenditures, the labor market will fail to react because of the structural defects and hence, the new money will just cause inflation. A direct solution of job creation will be fruitless and even detrimental and therefore, it merits that solutions should be geared towards controlling inflation, instead

This view by Friedman is very crucial in the debate because it opened up a more realistic angle. According to him, the structural problems,  may include levels of benefits for the out-of-work, the ease with which workers can change jobs or the social (dis)acceptance of being out of work. Further, unemployment may just be voluntary, that is, anybody not working made a rational choice not to at the prevailing wage.

It may be the realistic touch of  Friedman’s monetarism that prompted many governments to use it in practice. As cited by Stillwell (1993), the governments of Great  Britain under Margaret Thatcher, the United States under Ronald Reagan and Australia has moved towards the monetarist approach  and away from the previous Keynesian approach.   The employment commitment was abandoned and  accepted the more classical notion that the problem is structural hence cannot be contended with.  Policies were then focused on combating inflation  thus tight monetary polices  were put in place.

The results were common among the three economies. Amidst a well-controlled inflation, unemployment went soaring. As reported (Stillwell, 1993)  it reached up to 12 percent in Great Britain..

The  common experience may  be taken as a clear example of what Phillips meant with the trade-off between inflation and employment. However,  it seems that the structural problems have likewise been forgotten when the Keynesian approach was abandoned.

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.

The Issue of Unemployment - Part 2 (The Opposing Views)

John Meynard Keynes was the main proponent of Keynesian Economics. Although educated under Alfred Marshall, a hard-line classical economist, Keynes did not agree with the classical point of view  advocated by Marshall, specially about the trade cycle.

It may be recalled that in the history of the United Kingdom,  there was a time in the inter-war period when unemployment was at  a very high level. The minimum recorded was 5 percent but the worst was a soaring 20 percent of the total labor force (Baddock, 1992).

In relation to this, according to classical economists (who  actually  are followers of Adam Smith’s and David Ricardo’s “market-driven economics”), when trade cycle experience a down turn, production decline hence the rise of unemployment levels. As demand for labor get  so low, wage rates  will have the tendency to fall likewise, as the  workers will lower their asking price as they compete among each other for jobs. Eventually, the wage levels will be so low that businessmen will  realize that a low cost in wages will enable them to  make profit again. They will start to reinvest, production will rise again and so will employment. The economy will begin to expand until such time that rising prices will bring about another down turn in the trade cycle (Baddock, 1992).

Given the above, the classical economists concluded that the failure of an economy to recover may be caused by the inflexibility of wage rates even in the face of massive unemployment. Their  recommendation was that the labor force must be willing to accept wage cuts to keep employment rising again.

Keynes did not agree with such classical notion. He argued that although wage cut policies may work in specific industries, a general cut in wage rates will, following the more basic macroeconomic theory, decrease the buying power of people and decrease consumption and further, will lead to the decrease in the aggregate demand and income. He held that with this chain of effects, the economic slump will be worsened.

Economists from the classical school , one of them was Arthur Pigou, did not agree with the above idea of Keynes (He was also educated under Alfred Marshall and followed  the  classical stance of his mentor) Pigou held that by lowering wages, the general price levels will  also be lowered, and therefore, money in the hands of the people will actually have more buying power and lead to higher demand and consumption. In other words, Pigou believed that wage cuts will control or lower inflation  and will cause the economic upturn. This phenomenon which came to be known as  the Pigou Effect  was said to be not fully proven, but Pigou insisted that  this can really be stimulated when businessmen start injecting new investments and expenditures because of the low  cost  they  have to pay for labor (Samuelson, 1982).

The Keynesian reaction to the Pigou Effect was that, if new money (investments) is what is necessary to create an upturn in the economy, then why should government not do so without necessarily cutting off wages.

From the above, a summary may be partially drawn. The Keynesian school of thought  advocates government expenditure to solve unemployment and trigger economic growth. Based on this notion,  Keynesian economists  are batting for expansionary fiscal policy to influence  aggregate demand and lower the unemployment levels.  On the other hand, classical economists are batting for a restrictive monetary policy (which may be in the form of government expenditure cutbacks)  to limit the money circulating in  the market  and thereby, control inflation.

The Issue of Unemployment - Part 1

In order to explain  clearly the concept of unemployment, it may first be necessary to define what full employment is.  Baddock  (1992) defined  full employment as a situation  in the economic sphere wherein “everyone in the labor force who is willing to work at the market rate for his type of job, has a job”. With the definition, Baddock emphasized the exception of those who are “switching from one job to another”.

 The above definition conveys the concept of “willingness to work”. That means, a person, as a member of  the labor force, must have the intent to find a job.  This separates those people who intend to be in the receiving end of welfare services of the government. The economic sphere that Baddock pertain to therefore does not  include abnormal economic behavior such as apathy towards being productive. In short, the economic sphere pertained to is market- oriented. The  definition likewise stresses that the market rate is the defining factor for the level of wages, which again, emphasizes a market orientation.

 Moreover, the definition  clarified that functional unemployment, a situation which occurs when people switch jobs, is not considered  as unemployment at all  because it is a temporary condition.

 At the macroeconomic level, employment is considered a major indicator of economic development and stability (Samuelson, 1982).  In fact, as macroeconomics is the study of economic systems aggregating over the functioning of individual economic units, it is primarily concerned with determination  of national income, prices and employment levels. Moreover , it is concerned with the roles of fiscal and monetary policies (Baddock, 1992).

The Gross National Product (GNP) is an aggregate indicator of development and included in its computation are all payments for the use of factors of production, including wages and salaries of labor (Samuelson, 1982).  In effect, a high level of employment can be directly translated to a high level of national income and high GNP.

It has been argued through time and again  that GNP may indicate economic growth but not growth with equity and thus it may not be a satisfactory indicator of development.  However, if the  increase in GNP  is attributable to the increase in employment rather other factors,  it actually can be interpreted as more people  benefiting from the growth. In effect, if high employment is the main factor which triggered the increase in GNP, then the trickle-down effect of growth to the masses is much more  observable. That is because, in reality, a high level of employment (or a low unemployment level), means that more people will have more buying power which can be translated (consistent with  the classical view)  as an increase in the propensity to consume and save, Further, it means a higher  demand for products in the market and greater capacity to invest.  As a reaction, the market will tend to expand production and hire more people. The chain of effects goes on in a cyclical fashion and the economy grows with it.

Economists  contend that if the rate of economic growth/expansion would  approximate the rate of growth of the population, then employment would be sustained, ceteris paribus.

The aim of this academic exercise is to critically review and analyze the opposing arguments and ideas held by Keynesian and classical economists as regards (un)employment and relate them with the subject argument in a very realistic light.