Unemployment is a Government Policy Choice

A common misconception is that if everybody was prepared to take awful enough jobs, unemployment would be eradicated automatically, at least eventually, irrespective of the government’s fiscal stance. Embedded in this argument is a misconception that unemployment, overall, can be eliminated through lower wages or deteriorating working conditions. In a capitalist monetary economy, this is not true. To think otherwise is to succumb to a fallacy of composition.

Neoclassical economists made this claim prior to the contributions of Keynes and Kalecki, but it was shown to be unfounded in the capital debates as well as in later work by neoclassical general equilibrium theorists themselves.

Even intuitively there is little reason to expect that an inverse relationship between wages and aggregate employment would hold. A reduction in the price of anything always means two things simultaneously. It means: (i) somebody has to pay less for something they want; and (ii) somebody else is receiving less for providing that thing. At the aggregate level, it means: (i) all of us, taken as a whole, are paying less for the stuff we want; and (ii) all of us, taken as a whole, are receiving less for providing the same stuff. Why would this have any systematic effect on how much stuff will be produced in the economy? It doesn’t, as has been demonstrated formally in the capital debates and later work.

Unemployment is a government policy choice. It occurs when the government fails to maintain demand at a level sufficient to sustain full employment.

Merely redistributing existing income from workers to capitalists by lowering wages has no systematic effect on aggregate demand and employment. The lower wages mean workers are cheaper for firms to hire, but demand for consumption goods may be reduced. So is there more or less impetus for firms to undertake production of consumption goods? Is there more or less impetus for firms to undertake production of investment goods that will increase the capacity to produce consumption goods in the future? The answers to these questions are indeterminate. A mere redistribution of income (from wages to profits or vice versa) has no systematic effect on output and employment.

The bottom line is there are not enough jobs. One person may be able to get an existing job ahead of somebody else by offering to work for less pay, but this does not alter the aggregate level of employment and unemployment in a predictable way. It may cause employment to increase. Then again, it might cause it to decrease. For instance, redistributing income to capitalists might simply encourage saving and reduce the level of private spending. If so, there will be a multiplied contraction in output and employment.

Unemployment occurs when all of us in aggregate (the non-government) try to save more and spend less than is consistent with full employment given the government’s fiscal settings. The government is uniquely positioned to solve the problem because its spending injects extra demand and financial assets into the economy. Its spending adds financial assets in the form of additional reserve balances. These have no offset within the non-government sector. They are the government’s liability, which a currency-issuing government can cover without difficulty. The enhanced financial wealth gives the rest of us greater capacity to spend and save; more spending power. Net saving desires can then be realized alongside higher output and employment. When government chooses not to do this, there is unemployment. That is why it can be said to be a government policy choice.

We as the non-government sector, in contrast, cannot orchestrate an increase in overall spending power on our own. Private loans are always offset by private debt. Every private transaction creates an asset and offsetting liability. A spontaneous redistribution of existing spending power (for example, a move to higher or lower wages) might – by sheer fluke – reduce the net saving desire and boost demand and employment. But there is no inherent tendency for this to occur.

By injecting additional financial assets into the system, the government can render our spending and saving behavior consistent with higher output. That would eliminate the greater part of mass unemployment, and can happen the moment we put our collective foot down and insist on it.

Two qualifications, however, should be noted. First, although it is always possible for a currency-issuing government to enable our spending and saving behavior alongside demand sufficient to sustain full employment, this does not mean that this action will always be appropriate. An excessive saving desire might reflect extreme inequalities of income and wealth. The wealthy typically spend a lower proportion of their income than middle and low-income households. By moderating distribution, government can encourage stronger private spending and lower saving for a given fiscal stance. It will then take a smaller government deficit to sustain demand consistent with full employment.

Second, as the economy gets close to full employment, inflationary pressures are likely to emerge. To eliminate involuntary unemployment completely while maintaining low and stable inflation, a job-guarantee program would need to be integrated into the institutional structure of the economy to act as an automatic stabilizer and nominal price anchor. In the absence of a job guarantee, price stability can only be achieved through the deliberate maintenance of some unemployment. Governments of the neoliberal period have tended to take that latter choice.