Tuesday, August 21, 2012

Full employment, why it is important

In my intermediate macroeconomic classes at the University of Utah I always start by asking students what do they think is a more socially relevant problem an increase in inflation of 1% or the same 1% rise in the unemployment rate. Although the answers vary somewhat according to the macroeconomic circumstances, it is almost always true that the vast majority of my students think that inflation is the real problem.

When pressed on why do they think inflation is worse than unemployment they rarely suggest that inflation may hurt the poor more than the affluent, which would show a concern with income distribution, or seem to understand that moderate inflation might be good. Further, they have no idea that deflation is considerably worse than inflation, and that the reason for that is that deflation causes severe unemployment. The point is that they seem to think that unemployment does not hurt them more than inflation; after all they are getting a college education (which is not much of a guarantee these days, but I leave that issue for another post).

I then tell a personal story about inflation and unemployment and why one should be concerned with unemployment. In the Fall of 1999, fresh out of graduate school, I was hired as the Assistant Director of a small think tank. As I learned afterwards, there were another 5 candidates for the position. The average unemployment rate in 1999, I might add, was approximately 4.2 (see here). As it turns out I had another interesting piece of information that one seldom has about a particular position, namely: the number of applicants for the same position the previous time it opened up in 1995.

I always ask my students then, if you know that the rate of unemployment was around 5.6% (here again), that is, 1.4% higher than in 1999, how many people do they think applied for that same position back in 1995. They never get anything close to the 300 or so that vied for the job. In other words, in this particular case, a 1.4% higher unemployment rate implied an overwhelming difference in terms of competition. Of course one cannot, and should not generalize from one observation, but the anecdotal information fits the more substantive evidence for a tight labor market in the late 1990s, in which we actually saw increases in real wages for average workers in the Unites States.

If for no other reason, students, and everybody else, should be concerned with unemployment, because 1% more in the rate can hurt considerably more than the equivalent change in prices [ and that is why Okun's Misery Index, which adds the unemployment and inflation rates makes little sense; it mixes apples and oranges]. But even further, it is important to remember that whereas inflation hits everybody more or less equivalently – even if people have different consumption baskets – unemployment is a divisive social problem, which makes some ‘losers’ and others ‘winners,’ causing deep divisions in society (e.g. immigrants rob our jobs).

It is for that reason that full employment is the most important economic and social policy, the foundation on which to build the other policies. Work defines our lives, to a great extent, and gives dignity to people. And I do not mean just the poor. As I tell my students, I am a big believer in the ethics of hard work, and that is why I think rents and wealth should be heavily taxed, so that everybody needs to work to earn a living. That is full employment for all!

14 comments:

  1. [I]t is almost always true that the vast majority of my students think that inflation is the real problem.

    This is a marvelous thing to know. Having been an advocate of the Austrian School since 1973, this post supports by longstanding theory that not only is Keynesianism false but it is counter-intuitive. People have to be intimidated into believing it, like in “The Emperor’s New Clothes”.

    Of course “inflation” is THE problem. It is the cause of the distortions in the price, investment and capital structures that result in the boom/bust cycle and depressions. If people can be inoculated with sound Austrian analysis in advance, they would never fall for the Keynesian Hoax.



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    1. Not sure what you mean Bob. What hoax? So you think there is a tendency to full employment, which you should as a believer in marginalism. On the basis of what evidence? And by the way, yeah a college professor frightening his poor students, that's what you think is the problem in the US? Inflation is no problem and has never been in the US. By the way, I actually do know a thing or two about inflation rates that are problematic having lived in countries with the real thing.

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    2. Do you really still hold Okun's law as true? If stagflation didn't cure you of the notion, then what sort of economic event would it take you to disbelieve this logically fallacious "law"?

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    3. Hi Doug, yes and I also belive in the Law of Gravity. I'm old fashioned that way. The relation is still very much there, even if arguably weaker (not convinced myself since I think it was 2 to 1 almost all the time, for reasons associated with another Law, Verdoorn's). Will post something on that. But thanks for the comment.

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  2. Cool, saw your lecture last friday in BNDES and became a fan.
    It's funny how americans are so against less unemployment with more inflation(not that i think there is a inevitable trade-off between them)when they achieved full employment once in the 50's and 60's and never actually had a huge inflation like us in Brasil. I believe the problem is in the teaching of economics in the USA. My cousin majored in economics and after a while I realized she became too narrow minded on the "benefits" of free market. I think she'd be better off here at UFRJ, which she disagree because we "lose" time reading the classics

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  3. Hi NK,

    "unemployment is a divisive social problem, which makes some ‘losers’ and others ‘winners,’ causing deep divisions in society (e.g. immigrants rob our jobs)."

    This is a subject that I find very interesting. In Australia, for reasons that are long to explain, this is a subject that defies a rational discussion. The moment one mentions this, is one labelled a racist/xenophobe, by both, propertarians and socialists of the high middleclass variety.

    Is there good and freely accessible research material on this topic that you could recommend?

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    1. Not much I'm afraid. The social consequences of unemployment were never big in the economics profession agenda. You'll have more luck with historians.

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    2. Mainly rather tangential to your query, but here is a great old book I was happy to come across some weeks ago, Nels Anderson's 1938 The Right to Work . Great read if you haven't already.

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    3. Thanks, didn't know that reference.

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  4. Bill's blog post today might make interesting reading for your class:

    http://bilbo.economicoutlook.net/blog/?p=20700

    "Disinflations are not costless. Sacrifice ratios have risen for the seven countries from on average 0.7 in the 1970s to 3.5 in the 1990s. This implies that any attempt to bring down inflation nowadays with 1 per cent-point will result in a cumulative loss in GDP of 3.5 per cent on average.

    In terms of unemployment the latter can be interpreted roughly speaking as a cumulative increase by 7 per cent."

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    1. Sure, I didn't even deal with the fact, that while inflationary process (below very high levels like 40% according to the World Bank) are beningn for growth and employment, deflationary processes are a nasty thing. Thanks for the link!

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  5. By the way, Bob a reply to your post (http://bobroddis.blogspot.com.ar/2012/08/as-ive-said-for-forty-years-people-do.html#comment-form) here. By the way, I don't set anybody straight with any powers of intimidation. There is open dialogue and students and can and do say whatever they want. People do their exams, and provided they respond correctly using the model under consideration (which in the class I referred to in the post is an ISLM with Phillips Curve) they get an objective grade. I explicitly say that provided they move the curves correctly I don't care what kind of policy they follow. Contrary to the way you write about this "Vernengo", without even spelling it right half the time, I treat my students with respect. Funny thing is that you do not discuss any of the substantive issues of the post. Note that unemployment is a divisive social problem while inflation is not. Inflation hits everybody more or less equally, not so in the case of unemployment.

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