General Theory of Employment - Essay Example

Question 2 When discussing John Keynes' theories on employment they must be placed in their historical context. Keynes was looking for a reason for and a way out of the situation of mass unemployment that was part and parcel of the Great Depression. His theory, when broached to the president of the United States at that time, Roosevelt, was referred to as to easy. But its simplicity does not detract from its viability. And a later president, Richard Nixon, stated that they, American government and business, were all Keynesian practitioners. Keynes, in his book The General Theory of Employment, Interest and Money (1936, Chapter 2), described involuntary unemployment this way: Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively 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. His definition of involuntary unemployment, based on response to an increase in aggregate demand led to his definition that full employment is "a situation in which aggregate employment is inelastic in response to an increase in effective demand for its output." (Chapter 3) In Keynesian theory capitalism has no machinery to guarantee full employment. Keynes assumes that when aggregate demand is outweighed by aggregate supply then output will serve as the self-adjusting mechanism. (Furstater, 2001, p. 4) There is "no self-adjusting mechanism which generates a level of effective or aggregate demand sufficient to ensure the full utilization of resources." (Pilling, 1986, p.5) This creates an environment where the possibility of unemployment always exists. This conclusion is repeated by Furstater (p. 10) who states that "capitalism is first and foremost a system that does not provide employment for every person willing and able to work." According to Keynes the level of employment is directly related to the level of output which fluctuates based upon the level of effective demand. The two key components of effective demand are consumption and investment. Consumption refers to the money spent by individuals on consumer goods. As income increases so does our demand for consumer goods, though not quite as much as our income, due to increased taxes and the possibility of our putting the money away in savings, and Keynes referred to this as the marginal propensity to consume. He developed an equation which expressed how much extra will be consumed with the each additional unit of additional income: Marginal propensity to consume= The amount consumption rises The amount income rises mpc (marginal propensity to consume) =dCw dYw (Rodda, p. 2) If savings are increased too much there is a chance that consumption will drop, leading to decreases in income. Keynes believed that if incomes rose the marginal propensity to consume would drop. "When income rose beyond a point where a level of sufficient comfort had been attained, marginal consumption would fall as a greater portion of income is saved." (p. 3) Investment refers to money spent by enterprises on investment goods. "Investment spendingis driven by expectations of future profits." (Taylor, 8) Profits are the revenue that remains after subtracting costs. So investment is based on projected revenue based on expectations of future costs. Whereas consumer spending is fairly predictable, investment spending is volatile. This led Keynes to note that economic downturns were due in part to "the uncontrollable and disobedient psychology of the business world." (Chapter 22) Output is made up of consumer goods and investment goods. The levels of consumption and investment directly affect the level of output. Any fluctuation in the level of effective demand directly, by affecting output levels, affects employment, with a fixed money wage. It must be remembered that the money generated by production is subject to three leakages: taxes, savings, and the purchase of imported goods. The leaked money might get spent in the home market or it might not, adding to the volatility of the situation. There is no guarantee that the government will spend all of the money they take in through taxes, or that the money they do spend will be spent at home. Saved money might be spent on business investment or it might not. And, foreign nations might spend the money they accrue on imports or they might spend it at home or save it. If the leakages are greater than the injections into the economy aggregate demand drops, affecting production and incomes, if the injections are larger than the leakages spending increase, but so do taxes, savings and imports, if leakages and injections are equal, then growth stops and the economy stabilises. In assuming that fluctuations in spending cause output fluctuations Keynesian theorists also assume that prices and wages are fairly rigid also. (Blinder, 2002, p.2) In fact, Keynes believed "that for institutional reasons money wages tend to be fairly rigid downward. (Furstater, p. 4) Keynes also assumes that the "'economic framework' of capitalism is fixed." (Pilling, p.8) The greatest short-run impact of these changes in aggregate demand is to the level of output and thereby to the level of employment. As the demand drops so does the level of employment. "Keynes said that workers were involuntarily unemployed if their willingness to accept a cut in wages would not solve the problem of general unemployment." (Steele, 1999, p.3) Since the reason for the unemployment is based on a lack of aggregate demand for output then a reduction in wages would serve little purpose. Kaufman notes that Keynes pointed out in his paper that "even if perfectly flexible" a change in wage rates cannot "ordinarily restore a balance between aggregate labor demand and supply, leaving open the possibility/probability of persistent involuntary unemployment and underutilized resources." (2002, p. 33) Bearing this thought in mind Furstater notes that "the market system on its own will only operate at full employment by chance." (p.3) If businesses lose their confidence in the future of the market then they stop making investments, slowing or stopping business growth, which leads to lower wages, which leads to less consumer spending, which in turn leads to the loss of jobs - these are called multiplier effects. They are dependent in the size of the leakages that are occurring. According to Solow (2004, p.2) Keynes claimed to have shown that an unmanaged capitalist economy could come into equilibrium with involuntary unemployment, and have no way of extricating itself." Keynes proposed that the unemployment problem could be remedied by the government's increasing its own aggregate spending as a boost to the economy; this would be an upward multiplier. This spending must be financed through borrowing not a tax increase, or it would be defeating the purpose. "The goal should be to keep the total level of private investment plus public investment high enough to maintain full employment." (Taylor, 12) The government could also approach it from another direction which would be to keep the level of spending the same but decrease taxes. Monetary policy could also be used to stimulate demand, by the central bank allowing money to grow at an accelerated rate. This could lead to lower interest rates and stimulate spending on both the consumer and investment fronts. Or the central bank could reduce inflation by increasing the interest rates by slowing down the supply of money. But, Blinder notes that "anticipated monetary policy (that is policies that people expect in advance) can produce real effects on output and unemployment only if some prices are rigid - if nominal wages (wages in dollars, not in real purchasing power), for example, do not adjust instantly." (p. 1-2) .One of the biggest differences between Keynesianism and the neoclassical approach is their differing opinions on government spending. Keynes felt that governments were not only supposed to enforce private contracts, maintain a stable monetary system, and provide public goods, which the neo-classicists believed, but that the government was "also responsible for maintaining high levels of economic growth, low levels of unemployment and a less equitable distribution of income than would result from market forces alone." (p. 16) This divide between the two economic philosophies among others could have split economists completely. But, "Keynes had not asked his felloe economists to toss out all or even most of their theoriesNeoclassical economics could coexist with Keynesianism as long as it was recognized as a special theory which was applicable under conditions of full employment while Keynes would supply a general theory that was capable of explaining the lapses from full employment." (p. 17) Though Keynes' theories were thought simplistic, and are not perfect especially in our technologically advanced world they have a proven record in the real world. Keynes' theories have been born out in the United States. "Before World War II, eight U.S. recessions worsened into depressions (as happened in 1807, 1837, 1873, 1882, 1893, 1920, 1933, and 1937). Since World War II, under Keynesian policies, there have been nine recessions (1945-46, 1949, 1954, 1956, 1960-61, 1970, 1973-75, 1980-83, 1990-92), and not one has turned into a depression." (Kangas, p. 2) References Blinder, Alan (1990) Keynesian Economics [Online]. [accessed 19 August 2006]. Available: http://www.econlib.org/library/Enc/KeynesianEconomics.html>. Furstater, M. (2001) Unemployment in Capitalist Economies: A History of Thought for Thinking About Policy [Online]. [accessed 20 August 2006]. Available: http://www.cfeps.org/pubs/wp/wp16.html>. Kangas, S. A Review of Keynesian Theory [Online]. [accessed 19 August 2006] Available: < http://www.huppi.com/kangaroo/Keynesianism.htm>. Kaufman, B. (2002) On the Neoclassical Tradition in Labor Economics [Online]. [accessed 19 August 2006]. Available: http://www.iza.org/iza/en/papers/kaufman210502.pdf#search=%22Keyne%2Bmacroeconomics%2Bequilibrium%20involuntary%20unemployment%22>. .Keynes, J. (1936) The General Theory of Employment, Interest and Money [Online]. [cited 22 August 2006] [accessed 19 August 2006]. Available: http://www.marxists.org/reference/subject/economics/keynes/general-theory/index.htm>. Krugman, P. (2006) Introduction by Paul Krugman to The General Theory of Employment, Interest, and Money, by John Maynard Keynes [Online]. [accessed 19 August 2006]. Available: . Pilling, G. (1986) The Crisis of Keynesian Economics [Online}. [cited 19 August 2006]. Chapter 3: The Foundation of Keynes' Economics. Available: http://www.marxists.org/archive/pilling/works/keynes/ch03.htm>. Rodda, C. Keynesian Economics [Online]. [accessed 19 August 2006] Available: . Sleele, G.R. What is Unemployment [Online]. [accesses 19 August 2006]. Available: . Taylor, K. Chapter 15: The Keynesian Revolution [Online]. [accessed 10 August 2006] Available: http://distance-ed.bcc.ctc.edu/econ100/ksstext/keynes/keynes.htm>. University of Strathclyde Department of Economics (2000) Progressing Backwards [Online}. [accessed 19 August 2006]. Available: . Read More