Wednesday, September 18, 2013

Why Do We Have High Unemployment?

This article describes the different interpretations given for unemployment by Keynes and by one his colleagues at Cambridge (Pigou).  Unfortunately, the economics profession is still having the same debate about the interpretation of unemployment.  Pigou argued that unemployment was due to imperfections in the labor market.  Labor is commodity that is sold on the market and it is subject to law of supply and demand.  If the market were allowed to work properly the price of labor would fall and employment would rise.  The imperfections in the market were interpreted as frictional and structural problems in the market.  They are the same imperfections that are used today by austerian's to explain high unemployment. 

Keynes offered a radically different view of unemployment.  He did not accept the view that there would not be long periods of unemployment as long as the frictional and structural problems in the labor market were eliminated.  He believed that the market was inherently unstable, and that high unemployment was better explained by the cyclical nature of business investment.  He argued that government spending during a downturn in the business cycle could compensate for the decline in business spending during a recession.  That would prime the pump and encourage business investment.  He also argued that the government should run budget surpluses during good times.  That would enable government to more easily increase spending during downturns.

One of the problems with Keynes's theory is that governments are tempted to run deficits even in good times.  For example, George Bush inherited a budget surplus that was produced by the dot com boom.  He decided to cut taxes and to increase spending in order to deal with the slowdown in the economy.  The surplus turned into a large deficit and that it made it more difficult to deal with the consequences of the financial crisis.  Consequently, there are two basic reasons for opposing government stimulation during a recession.  Conservatives can point to frictional and structural reasons for high unemployment,  or they can argue that governments cannot be trusted to be fiscally responsible.

This article provides some data that show the relationship between unemployment and fiscal policy in response to the Great Recession.  Conservatives have won the argument over the interpretation of unemployment and it shows in the data.  Unemployment continues to be a problem everywhere but it is worse in countries that have employed procyclical fiscal policy.

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