The Different Sources of Unemployment, and the Economic Remedy for Each of These
Fri 8th Nov 2013
Unemployment is a complex phenomenon. The ultimate roots of all large-scale unemployment is the lack of an adequate economic understanding by a country’s professional economic advisors and its politicians, coupled with poorly advised political action based upon wrong-headed advice. Apart from war itself, unemployment is perhaps the greatest example of how wrong thinking in high places can (and does) have appalling results. Wrong thinking nearly always leads to wrong action in the form of mistaken policies, leading in turn to the great suffering caused by the needless continuation of the social evil of unemployment, underemployment and, in countries with incompetent right-wing governments, such as the Coalition government of the United Kingdom, the victimisation of the poor in the alleged cause of a completely unnecessary fiscal rectitude.
The primary purpose of this short article is to set out the three major kinds of unemployment arising from deficient demand in the three major components of national income. A secondary purpose is to set out some other more complex causes of unemployment, often due to a lack of economic understanding in nations (whether underdeveloped or developed) and the frictional temporary unemployment which can be caused by automation and innovation.
The Three Basic Kinds of Unemployment
The Keynesian national income formula that annual national income (or NY) is equal to the sum of consumer expenditure (C) plus investment expenditure (I) plus government expenditure (G) or
shows the potential origin of each of the three main different types of unemployment, although there are several subtypes lurking within that formula and not immediately obvious to the casual observer.
Keynesian “Deficiency of Demand” Unemployment
This is the classic “lack of consumer demand” unemployment of the 1930s, caused by a temporary reduction in consumer demand, produced by a fall in employment created by the “bust” part of the “boom and bust” economic cycle which can occur, in the absence of an adequate economic understanding, due to a large stock market decline or other pricking of an asset bubble. Mankind’s economic history is full of such events. The only cure for these recurrent events, as John Kenneth Galbraith has remarked in the conclusion of his book, A Short History of Financial Euphoria (Penguin Books London,1990) is for people to become better informed, less willing to invest in asset speculation, and more capable of spotting the shysters who wish to promote such asset bubbles for their specific and early enrichment at the cost of the majority of later investors, and at the potential cost of a major depression affecting all the workers in the economy. The major difficulty with asset speculation is that during the first phase of its development, everybody who gets in early and leaves early makes a profit and wins, thus inflating the bubble and attracting the majority of losers who suffer devastating losses in the later inescapable downturn. If people were only gambling with money they could afford to lose - if the merchant banks were quite distinct from the retail banks - if merchant banks did not all stampede into the latest fashionable speculation but retained an educated common sense - and if, among the secondary players, a badly-informed greed did not predominate over common sense - then asset bubbles would be a thing of the past. Unfortunately they are not, and given the short-term gains made by market makers in the financial system, perhaps they never can be.
Fortunately the work of John Maynard Keynes convinced virtually everyone, for about three glorious decades from the middle of the 20th century, that a deficiency of demand could be tackled by government programmes to restore the previous (prior to asset bubble) level of demand and prosperity by employing the unemployed resources in the economy.
3.2 Marxian “Deficiency of Capital Investment” Unemployment
The Marxian analysis contained two bleak predictions - that the wages of the workers would first fall to subsistence level and then below that level, because capitalists would not provide the capital to enable full employment. This is pretty well what has happened in both the UK and the USA, where legislation to limit the powers of the unions during the Reagan-Thatcher era led to nearly all of the benefits of growth going to the top twenty percent of households with vast gains to the already rich shareholders through dividends and capital gains, and (possibly worst of all) the income of the poorest 20% has actually fallen by about 20% in real terms since 1975. Furthermore, the credit which was created in both the UK and the USA was used by the banks for the ultimately disastrous speculation which led to the credit crunch.
It seems a great pity that American economists have forgotten how they created the first economic bomb during the 1938-44 FDR years when the USA grew at an average rate of 12.2% pa. Roosveltian-Shimomuran economics, by creating credit at the central bank, provides the capital required to ensure higher investment in nearly all industries and higher wages for the continually upskilled workforce. There is no deficiency of capital investment in a Shimomuran economy and the dismal Marxian predictions of low wages and a capital strike can be completely invalidated by wiser political action based upon a better economic understanding of the process of wealth creation.
3.3 Friedmanite “Deficiency of Government Expenditure” Unemployment
The response of some western governments towards relative industrial decline has been Sado-Monetarism - blaming the poor for their poverty, and reducing government expenditure and welfare bills as growth in national income is increasingly diverted to the already rich. When de-industrialisation occurs in modern, otherwise advanced, economies it happens because governments and their economic advisors do not understand modern economics. Industrial decline is not the fault of the poorer sections of society but due to a lack of economic understanding in high places.
For example, Michael Gove, the Secretary of State for Education, has said that the reason for the poor being forced to use food banks is because “They've only got themselves to blame for making bad decisions.“ He is reported as having argued as follows:
“The Education Secretary argued that people who find themselves unable to buy essentials, including food and school uniforms have themselves to blame for being unable ‘to manage their finances’.”
Gove appears to have adopted the “chic-callousness” of the Cameron Coalition government in the hope of further political advancement. Gove implies that the starving poor are not equipped with the magnificent quality of thinking apparatus with which he quite wrongly thinks he is blessed. About five million workers in the UK do not have a living wage - meaning that they do not earn enough to live on. These workers cannot stretch their pay packets to meet the essential costs of the bare and fundamental necessities of family life. Poor families in the United Kingdom face an appalling daily choice in their lives, having to choose between their families eating regularly, but falling behind on housing costs (such as the rent or mortgage payments) and the monthly gas, electricity and water bills, or vice versa. Immediate demands for the payment for food are often more urgent than the later monthly bills. If there is insufficient family income, buying food is naturally often a first priority. But among those poor families who do plan their monthly expenditure, money is usually set aside for the future payment of the rent, gas, electricity and water bills, leaving insufficient money for more immediate food needs. As is often the case, Michael Gove has got it entirely wrong - families with inadequate incomes using budgetary planning are among the half a million UK families who either go to food banks or they are among the first to starve. The explosive increase in the numbers of families who are behind in paying the rent and who cannot pay their utility bills and the new “hit the poor” bedroom tax are making things worse.
Other more complex kinds of unemployment:
a) Developmental “Under-Equipment” Unemployment
This kind of unemployment is common in developing countries. Where less than 40% of the population is educated, economic take-off is generally reckoned (by perhaps a majority of economists who have examined this issue) to not be possible. The absence of an intermediating banking system that can collect short-term local saving and perform “maturity transformation”, using these savings as a basis for lending longer term loans to local industry, disables some economies from higher rates of development. The absence of a properly educated political ruling class, who have often been wrongly educated about economics in leading western universities, is also a major factor behind the persistence of such underdeveloped economies. It is easy to recognise such economies - the levels of machinery per head in their few factories is much less than in more developed economies. These three deficiencies are all remediable. Education - literacy, numeracy, computeracy - is the essential foundation of all economic progress. A good banking system can be established and developed through appropriate political action. The leaders of the less developed countries could follow the lead given by China and Japan and aim to develop their economy at breakneck speed without foreign investment using Shimomuran no-debt investment credit and by using the major investments (which investment credit economics enables) as an accelerator of social and economic progress.
b) Transitory “Labour-Replacing” Automation Unemployment
The complete automation of the work processes previously performed by labour can cause some unemployment. Some unemployment is also caused by investments which require less labour in the production process - in fact this kind of partial productivity-improving automation is the preponderant process in nearly all manufacturing industry, because complete automation of industrial production processes is very unusual while the continual upgrading of industrial plant and machinery to improve worker productivity is the norm. In a competently run economy, where investment credit produces booming investment, the displacement of some labour by machinery does not matter much because the labour required by the manning of new investments can equal the labour thrown free by automation. This is the official policy of the Abe-led Japanese Government, that the reduced employment arising from greater automation of the production processes should be matched by higher labour demand for machine manning due to very high investment. That policy could be adopted with advantage everywhere.
c) Obsolete Financial-Industrial System Unemployment or “Wrong Frame of Economic Understanding” Unemployment
Where governments do not understand Shimomoran economics and thus do not know how properly to analyse the causes and remedies of the different kinds of unemployment, they consequently do not know how best to deal with these issues and cannot produce a full-employment economy in the interests of all their people. The financial so-called “free market” in these economies acts in the interests of the merchant bankers and asset speculators and does not fulfill its primary function of providing long-term loans for investment. This position describes the situation in the UK, the EU and the USA.
d) Foreign-originated “Innovation-driven” Unemployment
Industries can be (and in Britain and the USA, have been) first diminished, then threatened and then ultimately partly or totally destroyed by foreign competition, by much higher industrial investment (indirectly funded by Central Bank credit creation) in Japan and China providing the consumer goods which the local economy has failed to produce.
Many British industries - the motor vehicle, shipping, and motorcycle industries for example - were destroyed by the investment-credit funded growth of these industries in Japan. If successive British governments since 1945 had understood ICC, the relative economic decline of the UK would not have happened. China has a similar potential to destroy the domestic industries of the EU and the USA if no action is taken.
One outcome of the recent 26th June Obama-Merkel meeting is the establishment of some common ground and their agreement that neither Germany nor the USA are prepared to allow the destruction of their motor vehicle industries by foreign competition. I wish that the UK were as wise but have abandoned all hope that the Coalition government ever could be.
The Economic Effect Of Different Remedies to Unemployment
The application of money and credit to the three different sectors of the economy have major effects, depending upon where these funds are focused.
A Keynesian-style increase in employment by employing the unemployed can add a great deal to consumer demand and that can be very helpful if there are under-employed manufacturing resources in the economy, because an increase in consumer demand is the right remedy to the economic depression caused by suddenly depressed demand. Keynesian economics would have been the right response to the deficiencies of demand which existed in the 1930s, and these policies were helpful in maintaining prosperity during the transition from a war-based to a peacetime economy, as the post-war period illustrated in both the UK, the USA and elsewhere. Where there is the need to stimulate investment, employment and higher productivity in manufacturing industry, investment credit creation is by far the best method of achieving that. And where the government has that Shimomuran economic understanding, governments can focus the nation’s capabilities to create new industries and production possibilities as Obama’s new energy innovation groups are currently doing.
Some illustrative numbers
Each type of economic stimulus has a primary and a secondary effect. It is instructive to set these effects with rough calculations, because that process clarifies the issues and illustrates the differences produced by injecting funds into various parts of the cycle of money circulation. In order to make a comparison of UK economic effects, the effect of an injected sum of £100bn of new credit is assumed in each of these cases below, and a British GDP of about £1.5 trillion pounds is taken as the current position, and the initial stimulus in every case would be about 6.6% of UK GDP.
a) Consumer Credit Creation or "Helicopter Money"
If consumers had access to a one-year one-off injection of £100bn, and assuming the Office of National Statistics figure of about 26.4 million households in the UK, this would represent an initial stimulus averaging about £3,787 per household. There would be an increase in consumer demand of about £95bn assuming a five percent household savings rate. Shops, supermarkets and other consumer products outlet businesses would receive that £95 bn increase, and assuming a six percent after-tax profit level, theoretically could invest these £5.7bn profits the following year. Assuming a capital-output ratio of about 5 for the whole economy, that investment might produce an addition to GDP of about £1.14 bn or about 0.075% of GDP. Assuming about half of this permanent increase in GDP (or £570 million) was allocated to wages at an average wage of about £25,000 pa, there could be an increase in employment of about 22,800 - a reduction of under 1% in the 2.5 million of registered unemployed.
The effect of consumer credit creation on the inflation rate cannot be accurately estimated because the extent of spare capacity in the UK is impossible to assess in the circumstances of the ongoing Cameron-Osborne depression. Much of the money would be used by poorer families for buying food and the major retail chains - Asda/Walmart, Tesco, Morrisons etc - would probably see a significant increase in sales, and perhaps a temporary increase in retail staff. Shopping malls would temporarily flourish.
b) Investment Credit Creation
An increase of £100bn in investment credit directed through a co-operative banking system towards long-term investment credits in commerce and industry would result in an investment boom in the UK, where manufacturing industry has been starved of such funds for decades, compared to their availability in Germany, Japan and China. £100bn of additional credit available for investment would probably be allocated 25% to working capital and 75% to new investment. The extra £75bn of new investment would create, assuming a capital-output ratio of 3 (because these funds be used by firms needing investment rather than spread over the whole economy) and this would permanently add about £25bn to economic output. Assuming a tax take of 40% on investment and output, Government would receive about £40bn from the capital investment and sales of working capital, and an annual increase of about £10bn a year from the additional GDP.
Quasi-permanent employment (again assuming half of the increase in GDP [or £12.5bn] was allocated to wages averaging about £25,000) would increase by about half a million people, reducing by 20% the number of people registered as unemployed (currently about 2.5 million people). There would be a temporary boom in the construction industry due to that £75bn capital investment, amounting to perhaps about 1.2 to 1.5 million people and massively reducing UK unemployment and increasing Government net revenues due to lower benefit payments and higher income taxes on the newly employed.
c) Government Credit Creation
Credit creation by the UK Government could be used as helicopter money, giving funds to households, or it could be used to maintain employment in essential services, such as the NHS, or it could be given as a grant to the privatised railways and to energy supply companies to help them invest or to pay their shareholders.
The effect of such credit could be to maintain UK GDP at its current level, to maintain NHS services or to maintain essential services in quasi-monopoly companies. These are all worthwhile aims, but as the above calculations make clear, the most effective use of credit is the no-cost credits created at the Bank of England if only they could be loaned onward through a cooperative banking system (which the UK does not at the moment possess) to stimulate private investment.
All of the calculations in above three sections ignore the economic multiplier which probably lies somewhere between 1.5 and 2.0 in the UK, so the final effect of a £100bn consumer credit stimulus might be about 50% greater or up to twice as much as these provisional estimates.
The Time Lag in Western Economic Understanding
The greatest obstacle to more rapid development in the Western economies is the absence of understanding of Shimomuran economics and the associated government industrial policies and administrative procedures that enable faster development. Businessmen in the Asian economies of Japan, South Korea, Taiwan and China have enjoyed the great advantage of plentiful cheap loans for investment capital while their Western counterparts have not. Once that situation changes, the historical record shows that economic recovery can be very swift.
Keynesian economics legitimised the management of demand by governments; investment credit (Shimomuran) economics enables the stimulation of economic supply by governments, once they understand the process; and governments can more competently manage the economy in the interests of all their people through an appropriate combination of Keynesian demand management and Shimomuran supply management using investment credit creation.
Inventions are occurring at a relatively high rate in the world’s major Western economies, but the lack of long-term loans for private company investment capital means that innovation - the transfer of invention into new products on the factory floor - in not happening to the benefit of the people in these countries. Production is being transferred abroad with the inevitable loss of wealth, control and skills development because of that transfer.
Economics is not immune to the generalised Godel observation, that “no logical [intellectual] system can be both consistent and complete.” Economics still has no adequate answer to the persistent wealth-destroying asset bubbles which plague the economic progress of mankind. The fact that most people - whole economies and nations - can lose astronomical amounts of money in the wealth destruction following the pricking of an asset bubble does not inhibit the manipulating shysters who can make a lot of money in the short term, which is all they are interested in. The few winners win a lot at the expense of the wider society, and there is no point appealing to a better nature which they do not possess. The South Korean solution, of treating currency speculation as a capital offense, is one effective way of dealing with the problem within a country, and certainly seems to have inhibited that aspect of speculation by rich individuals in that nation.
The various types of unemployment in the economy, and their possible remedies, seem to fit together like the pieces of the proverbial Swiss watch. An adequate understanding of economics - including a proper integration of Shimomuran economics into the mainstream of economic theory and practice - enables that integrated overview of the causes and remedies of unemployment, and provides economic remedies to most situations.
Once Shimomuran economics is integrated into the mainstream of economic considerations, Governments have an effective panoply of options in dealing with the various economic difficulties with which they are faced. It seems a great pity that many Western governments neither understand these issues nor the Shimomuran economics that would would assist the more full achievement of the economic possibilities of their people and their nation.
© George Tait Edwards 2013