• • • • •

Economic Development and Unemployment: Do They Connect?

The most striking developmental phenomenon is the lasting unemployment In mainstream literature, unemployment is principally attributed to labor market rigidities In Keynesian tradition, unemployment is due to lack of effective demand The theoretical and empirical studies with respect to employment have reached over the years contradictory and inconclusive results. The present paper argues that unemployment is a systemic element of the normal operation of the labour market.

The ‘specter’ of unemployment in developed economies.

• • • • • • Unemployment categories: seasonal, frictional, structural and cyclical. The first three categories are considered normal and acceptable inasmuch they are viewed as the by-products of the normal operation of the labor market.

Only cyclical unemployment is viewed as a deviation from the normal and so Keynesian economics suggest countercyclical economic policies to minimize, if not eliminate, this kind of unemployment. In the late 1960s economies entered a prolonged period of recession with the simultaneous occurrence of inflation and unemployment (stagflation) which could not be explained and, of course, cured within Keynesian economics. Thus alternative approaches (monetarism, supply side economics, new-classical economics,

etc.

) rooted in mainstream economics arose in an attempt to interpret stagflation. Meanwhile, unemployment continued to be high in the developed economies even in the 1990s, in spite of the fact that this period was characterized by high growth rates.

• • • • • • • •

Theoretical approaches to unemployment: neoclassical view

unemployment can only be temporary. With no obstacles in the labour market, variations in the real wage soon restore full employment of labour. Real wage designates the market clearing price which is governed solely by technology and household preferences Thus, unemployment can only be voluntary and as such does not present any significant problem requiring government policy. The equilibrium in labour market and the determination of real wage are independent of social forces (unions, government,

etc.

). if, however, such forces exist they may give rise to disequilibrium phenomena.

Unemployment is the result of ‘stickiness’ and inefficiencies in the labour market caused by powerful labour unions, government interventions and the like. From this perspective, persistent unemployment is attributed to labour market rigidities which together with poor education, lack of motivation and insufficient information about available vacancies make unemployment to persist (Pissarides, 1985; Mortensen, 1986; Blanchard and Summers, 1987; Layard,

et al.

, 1994). The current practice of economic policy particularly in the USA and EU countries is based on this theoretical framework with a heavy reliance upon monetary policies whose objective is the control of inflation allowing no room for an explicit employment policy (Grahl, 1997; Grieve-Smith, 1994).

• • • • • • • • •

Theoretical approaches to unemployment: ‘natural rate of unemployment’ and NAIRU

The idea of the ‘natural rate of unemployment’ supplements the above analysis for it is viewed as the minimum unemployment level consistent with market clearing conditions in the labour market. As a result, the economic policy has been heavily influenced by the perception that low levels of unemployment will cause inflation to accelerate. In this context, there is no room for an active employment policy, since such a policy interferes with the functioning of the markets Any effort to lower the existing ‘natural rate’ of joblessness would trigger inflationary wage and price pressures which is the well known non-accelerated inflation rate of unemployment (NAIRU) argument.

According to NAIRU approach, wage-push variables are crucial in explaining the rise in unemployment and within this context, most of the policies designed to combat this problem focus on the necessary labour market reforms. Siebert (1997: 53) notes that “the specter of unemployment that is haunting Europe will not be exorcised unless governments are prepared to undertake major reforms of the institutional set up of the labor market”.

Krugman (1994: 57) notes “that the generosity of Europe’s welfare states is in some sense responsible for the rise in their unemployment rates”. The pertinent economic (empirical) literature is not supportive at all to the view that labour market rigidities are the primary cause of unemployment and to the idea that the deregulation of national labour markets will increase the level of employment (Howell, 2005; Baker

et al.

, 2003). The concept of natural rate of unemployment remains popular among economists and policy makers despite of criticisms even from mainstream economists (Henry,

et al.,

2000).

• • • • • • • •

Theoretical approaches to unemployment: Keynesian view

The Keynesian approach to unemployment, at first sight, appears to be different from the neoclassical – – A closer inspection, however, reveals that both approaches share the view that unemployment is the result of the malfunction of the labour market. According to neoclassical economists, unemployment is the result of the malfunction in the price mechanism For the Keynesians, the malfunction relates with the inability of the market to generate enough effective demand The NAIRU hypothesis fall within the idea that a proper policy mix can achieve the desired result The full employment has been redefined not necessarily according to the number of unemployed but rather according to whether or not the existing level of unemployment accelerates or decelerates the inflation rate. The level of unemployment that corresponds to zero acceleration or deceleration of inflation rate is viewed as the normal or natural level of unemployment and not much can be done about it, because it is viewed as people’s choice to remain unemployed at the going wage rate. The economic policy strategy adopted by mainstream economist shares many similarities with the NAIRU hypothesis in which also wage-push variables are crucial in explaining the rise in unemployment and most of the policies designed to confront unemployment focus on labor market reforms. Clearly, the NAIRU argument is a Keynesian devise and ‘full employment’ is viewed as an attainable and at the same time desired objective.

Mainstream and Keynesian approaches share that social forces play no role in determining the level of employment in the system.

• • • • • •

Theoretical approaches to unemployment: Classical approach

The mechanism that regulates the dynamics of capitalism is competition which is envisioned as a turbulent and a war-like process. – – Capital fights mainly in two fronts: in the labour market to reduce unit cost in the product market to gain market share The most effective way for capital to keep wages low and increase productivity is through the mechanization of the labour process which is achieved with the introduction of fixed capital. The survival of individual capital in this turbulent and inherently violent process requires not only a rising mechanization of the production process but also the full utilization of capital. Because, idle machines signify lost opportunities for producing more profits. The displacement of labour by machines increases productivity, lowers unit cost and enhances profits. Hence, the replacement of labour by capital is not only a stylized fact of the process of economic development but it is also, to a certain extent, a desired outcome of this process

i.e.,

the reserve army of the unemployed

An Alternative View on Unemployment: the Marxian

• • • • • • • • • The dynamics of capital accumulation and economic development regulate the supply and demand for labour in such a way as to ensure that an excess supply of labourers (or ‘reserve army’) is constantly reproduced. In other words, the labour market is ruled by laws other than those of supply and demand that regulate the product markets. – – – The continual generation of the reserve army of labour relies on the dynamic interaction of the following three factors which characterize the developmental features of advanced economies: changes in the rate of accumulation changes in the capital-labour ratio changes in the potential working population. The rise in the rate of capital accumulation increases the demand for labour. Neither the variation in the supply of labour nor the change in the wage rate determine the outcome in the labour market Marx’s analysis of the aggregate labour market relies on the long-run tendency of the capital-labour ratio to rise through the incessant need for mechanization of the production process. Capitalist development also forces larger parts of the population into the wage-labour market. The depressed wage rate coupled with the commodification of the domestic economy and the lightening of factory labour due to mechanization also brings into the market masses of unskilled labour further facilitating the increase in the reserve army. Marx, in his analysis, suggests that the rising “reserve army of labour” is not a product of disequilibrium; nor is it a dysfunctional outcome of the system that can be eliminated by an appropriate economic policy. On the contrary, the reserve army of labourers is an essential component of accumulation because it supplies capital with a necessary degree of flexibility and a critical mechanism to regulate the wage rate. It is interesting to note at this point that some neoclassical economists ( percentage of unemployment may work as a necessary “worker discipline device” in the labour market (Shapiro and Stiglitz, 1984).

i.e.,

efficiency wage theorists) argue that a certain “The industrial reserve army, during the periods of stagnation and average prosperity, weighs down the active labour-army; during the periods of overproduction and paroxysm, it holds its pretensions in check. Relative surplus-population is therefore the pivot upon which the law of demand and supply of labour works” (Marx, 1867: 639).

Core Models of Unemployment.

Neoclassical/NAIRU model:

Ui = ƒ

[

Xi+, Pi-, Zi

]

Keynesian Model:

Ui = ƒ

[

Di-, Zi

]

Clasical/Marxian model:

Ui = ƒ

[

Ki-, ki+, Li+, Zi

]

Empirical Evidence for Core Models of Unemployment.

Germany

Model 1 Model 2 Model 3 Model 1

USA

Model 2 Model 3

Sweden

Model 1 Model 2 Model 3

BRR CU Y K k L P LABC

c t 2.62

(0.02) -8.26

(0.11) 21.47

(0.59) -1.24

(0.85) -10.73

(0.02) -7.77

(0.01) 4.12

(0.07) -2.52

(0.36) -5.26

(0.17) 1.22

(0.69) -4.27

(0.01) 5.38

(0.00) 9.22

(0.18) 2.53

(0.00) 6.94

(0.21) 39.70

(0.02) -0.39

(0.59) -5.71

(0.01) -0.14

(0.62) -2.39

(0.41) 81.24

(0.00) 1.52

(0.00) 7.09

(0.14) 7.58

(0.12) -13.41

(0.02) -20.16

(0.05) -1.05

(0.01) 1.84

(0.01) 8.59

(0.00) -6.07

(0.00) 8.71

(0.01) 60.60

(0.00) 0.01

(0.99) -5.35

(0.28) 4.61

(0.88) -0.13

(0.64) -4.53

(0.14) -23.31

(0.03) -9.72

(0.080) -61.41

(0.03) 10.38

(0.10) 202.18

(0.10) 75.16

(0.01) 0.49

(0.12) -21.49

(0.01) 6.44

(0.02) 1.82

(0.62) -5.86

(0.04) 27.67

(0.16) 403.81

(0.01) 0.69

(0.04)

conclusions

1.

2.

3.

4.

5.

6.

The econometric analysis used the ARDL cointegration method in order to explore the presence of a long-run relation between the variables. The Benefit Replacement Ratio, a variable which is supposed to capture the different levels of labour market rigidities and regulations of each country, did not prove statistically significant in explaining the unemployment rate. This outcome is confirmed in all three countries (USA, Germany and Sweden) despite the fact that they represent diverse, with respect to labour market, economies. Turning to the Keynesian core model, our results confirm that the growth of effective demand and the degree of capacity utilization are statistically significant in all three countries. These results give credence to the Keynesian argument according to which demand boosting policies may be effective in copying with the unemployment problem in most economies independently of the structure of labour markets. Furthermore, this is verified by the fact that in all three economies with such diverse labour market structures, the demand variables are significant in determining the unemployment rate. As for the classical/Marxian core model, we found that its core variables (capital stock and capital labour ratio) are statistically significant in all three countries; hence, the results give credence to the hypothesis that unemployment depends on the dynamics of capital accumulation and not on the specifics of the labour market structure of an economy.

In conclusion, the results of the present empirical analysis are in sharp contrast to the view that the presence of labour market rigidities bears responsibility for the high unemployment rate and to the policy conclusion according to which countries with considerable unemployment figures should undertake structural reforms in order to free labour market from alleged rigidities which do not allow its proper function (IMF, 2003, p. 129). In fact, our findings suggest that the growth dynamics of an economy may constitute the main causes of unemployment and not necessarily the structure of labour market. Hence, these findings may give rise to an altogether different perspective to the problem of unemployment and may suggest different policy proposals whose emphasis will be on the dynamics of capital accumulation in combination with demand forces and will not focus solely on establishing an unrestricted labour market.