Unemployment Theory and Practice - Case Study Example

Microeconomics: Unemployment Theory and Practice Introduction This paper is about various theories of unemployment, and their effect upon policy. It will analyze government policies related to unemployment in several countries, and assess their success in improving long-term unemployment and overall employment of those in the active workforce. History of Unemployment Theory Theories of unemployment and employment began to gather important underpinnings before and during the Great Depression. John Maynard Keynes theorized in his “demand theory” of unemployment that overall changes in demand influenced the pace of economic growth (Keynes, 1936). In Keynes’ view, the rate of growth insured that there was full or less than full employment. If the rate of economic growth were less than that of the underlying rate of population growth, then unemployment increased; the converse was also true. Keynes posited that economic growth was due to demand increases. Demand for Keynes was defined as the total amount of resources devoted to buying goods; in his model, all demand was equal. If, for example, the private sphere increased personal consumption, that added to growth. The same was true for industry: if they increased investment or expenses, then their increases in spending promoted growth. During the Depression, Keynes proposed that increasing government spending would also increase growth—and therefore government provided an important counterbalance during times when private or industrial demand dipped. Although Keynes acknowledged that there may be long-term instabilities related to growth, he felt that those instabilities were less important than the need to keep employment (and therefore consumer demand) high. Keynes dismissed the longer-term consequences by famously saying “in the long run, we’re all dead.” From a microeconomic point of view, Keynes failed to acknowledge the impact of “rent,” which is the pernicious effect that increases in government spending have on growth in the rest of the economy. The government can decide to fund increases in spending through increasing borrowing, increasing taxes, or both. If borrowing goes up, private and industrial borrowers must pay more for their borrowed money, and they invest in fewer projects, houses and cars as a result. If the government chooses to increase tax revenues to pay for increased spending, the subsequent effect on consumer spending (regardless of whether the taxes come directly from consumers or industry) will be a decline. The amount of government “take” is less than the overall brake on the economy, as the negative effect at the margin—on the incremental ‘final dollar’ earned by workers and corporations, is greater than the value of that dollar to the government. The difference between the two—government take and private industriousness, is the ‘rent’ which government demands. Finally, Keynes felt that only 100% employment of every able-bodied worker was the right level. His analysis did not account for those who may be moving from one job to another, or who are abandoning one career in search of a higher-paying or more rewarding career. The ultimate result of Keynes’ 100% employment goal is inflation, as employees are enticed to stay at their current place of employment with ever-higher wages. Milton Friedman and Schumpeter Milton Friedman turned Keynes’ reasoning on its head. He said that the role of the state was to demand as little as possible. The State, in Friedman’s thinking, should assure that the money supply (M1 and M3—which includes velocity) should grow at a slow and predictable rate. He argued that trying to correct the money supply in order to assure full employment only fueled fears of inflation, and made companies less willing to invest. As did Keynes, Friedman felt that the best insurance of full employment was a growing economy. Unlike Keynes, Friedman predicated the growth in employment on a concomitant growth in productivity—faster productivity growth resulted in faster employment growth. Friedman’s theory was founded on Schumpeter’s notion of “creative destruction.” He posited that the best way to ensure continued growth in the economy as a whole was to allow the destruction of old companies and old industries (and by implication, old job classifications), and to allow the rise of new ones. Only by doing so, argued Schumpeter, could economic growth be assured and employment continue to be high. Schumpeter (and Friedman) would agree that the notion of “creative destruction” implied that the employee must be flexible (i.e. willing to move, willing to be retrained, willing to try new things) in wages, geography and industry choice. The French and German theories of unemployment have been different than the Schumpeter/Friedman theories which have predominated in the US in the past 40 years. France claimed, under Mitterand, that the problem of unemployment was caused by too many people working too many hours. If one reduced the number of hours worked to 35 from 40, said Mitterand, one would create a “vacuum” of 12.5% additional time that could be filled by other workers. Thus, in Mitterand’s economic thinking, France’s unemployment rate of over 10% could be nearly eradicated by removing 12.5% from everyone’s workweek. The implication was that everyone would also earn 12.5% less, but that portion was never implemented. The 35-hour workweek was implemented in France in the mid-1990’s, but France’s unemployment rate remained stubbornly higher than 10%, where it is today. The German theory was that if everyone was paid a high wage, regardless of source, the overall productivity and income of Germans would continue to be high. Rather than accept Schumpeter’s theory of creative destruction, the Germans supported old industries, such as steel, shipbuilding and lignite coal mining, to the point where each job maintained with public funds approached a per-worker cost of nearly $60,000 per year in the late 1990’s. In addition, Chancellor Kohl decided to create currency parity between East and West Germany at the time of reunification in 1990. This decision instantly made 2/3rds of East Germans uneconomic, as their productivity was significantly lower than their West German counterparts. The predictable result was that most East Germans lost their jobs; East German unemployment rates remain high to this day. The theory on unemployment under successive Labor governments in the 1950’s and 1960’s was that companies which were failing should be nationalized. Britain nationalized its steel and coal industries as they became too uneconomic to compete with less-expensive imports. It then nationalized the auto industry, combining several failing manufacturers (Rover, Jaguar, Austin, others) under British Leyland, a nationalized company which was the “British champion” in the increasingly competitive, increasingly global automobile industry. As we have seen in Germany, these policies of protecting employment through government subsidies result only in increased taxes and an ever-increasing cost to the taxpayer as the businesses become ever more uneconomic. The theory of creative destruction has played out particularly well in the United States since 1980. At that time, the US was emerging from a recession from the 1970’s when unemployment was at 7-8%, prime interest rates were at 12% and mortgage rates as high as 22%. Corporate taxes were a high 35%, and personal income taxes topped out at 70%, which provided a major disincentive for people to earn additional income through additional work. Ronald Reagan and Congress enacted a lowering of the top income tax rate to 35%, and corporate taxes to 25%. Capital gains taxes were significantly reduced. The reduction in taxes created a venture capital, IPO and new-investment boom which started a rate of new business formation which had not been seen in the past. From 1982 to 2000, the Fortune 1000 companies actually lost employees, while those companies under 100 employees added over 80% of the nearly 24 million new jobs created in the United States. During that same time, Europe added only 4 million jobs, of which most were government positions (BBC, 2002). The monetary policy in the US, led by Alan Greenspan, was to control for inflation and allow a gradual growth in the money supply; these moves assured the market that increases in inflation would not occur to reduce their overall returns. France, Germany and the US’ Policies towards Full Employment Thus the theory of unemployment practiced by the United States, Germany and France could be contrasted during the 1980’s and 1990’s. The result was that the unemployment rate in Germany and France averaged 10% or more during the period, while the US unemployment rate moved between 4 and 6 percent (Economist, 2007). As a result of this drastic difference in growth and unemployment, the US now has an average income per capita 30% higher than Germany and France in current currency exchange rates, while the PPP (purchasing power parity) income per capita in the US is nearly twice the levels in Germany and France. The US continues at an employment rate below 5%, while Germany ‘enjoys’ a lower than average rate of 8%, and France continues at 10%. The official unemployment figures can be deceptive. The US has an average of only 6-9 months of unemployment insurance payments, and those payments tend to replace less income than those unemployment insurance schemes in Germany and France. In the latter two countries, the unemployment insurance runs for two years at a much higher level compared to the average post-tax wages prevalent in those countries. One could argue that the US unemployment rate should therefore be higher than that in the European countries, as Americans have fewer months of coverage; in fact, Americans have a much lower rate of long-term unemployment than their continental European counterparts, perhaps due in part to the shorter period of subvention by the state. In addition, both France and Germany have longer-term programs which amount to welfare for unemployed workers. Called the “ABM” in Germany, nearly 5% of the working population partakes of this long-term support; these workers are not counted as actively seeking jobs because they are said to be in training programs. Thus the ‘true’ unemployment rate in Germany is between 12 and 15 percent. Another issue with unemployment comparisons is the rate of employed people as compared to the total amount of people within a certain age group. The US has a higher percentage of people working in the working-age groups than either France or Germany. Furthermore, US workers spend many more hours per year than their French and German counterparts. This higher rate of employment (as opposed to just lower rate of unemployment) results in a higher GDP per head, as more people are carrying the income burden. Which System is Better? Which system has the better long-term handle on keeping unemployment low and employment high? Both France and Germany have elected conservative governments to replace their socialist governments from a few years ago. Nicolas Sarkozy, France’s new President, claims that he will teach the French how to work hard again. He has stood up to the labor unions in his demands that they give up the most egregious pension and wage abuses and, most importantly, return to a 40-hour or greater workweek, in order to increase productivity and competitiveness with the rest of the world. The Germans have reversed their policy of high compensation for long periods of time with their unemployed workers, and started to push them to find jobs, even if lower-paying. Both countries are attempting to reduce their benefits costs and reduce the legal restrictions placed on employers in regards to hiring and firing employees. It is thought that tough restrictions on firing make it more costly for employers to hire new people. Conclusion In conclusion, the systems advanced by Schumpeter and Friedman trump those introduced and backed by Keynes and those who follow his “demand-side” theories. That doesn’t mean that government demand is not important, or that overall demand must remain high. It just means that there is a big difference to long-term economic growth if the fundamental causes are from private consumption, harder work, and industrial investment than if they come from increasing government debt, or increasing the rate of taxation. Bibliography BBC. (2002, March 5). EU unemployment stabilises. BBC News , p. n.p. Birch, D. L. (1987). MIT Program on Neighborhood and Regional Change. Cambridge: MIT Press. Economist. (2007). 2008 World Almanac. London: Economist. EU. (2005). New EU report shows active labour policy can increase employment rate despite low growth. Brussels: EU. Keynes, J. (1936). The General Theory of Employment, Interest and Money. Cambridge: Cambridge University Press. Read More