Unemployment, a Hydra that keeps growing

Dorothea Lange's "Migrant Mother," a...Image via Wikipedia

Unemployment is the one feature that distinguishes the current crisis from past ones. It just won't go away.Why?

A hard question to answer. It's been haunting economists since the Great Depression - the last time unemployment would NOT go away. To cure unemployment, Keynes came up with a solution that was deceptively simple: replace the shortfall in private investment with government spending. Pump money in through paying out salaries even for useless activities like digging holes. That will strengthen consumption and jump-start the economy. Industries will be encouraged to expand employment as they see a renewed demand for their products.

That was back in the 1930s. And we all know how it played out in the end. President Roosevelt didn't dare keep up with the Keynesian recipe because of the political upcry over the ballooning deficits. So, in 1937 he went back to old-fashioned deficit cutting and budget balancing. With the result that the economy immediately dipped back into a Depression mode, and it took World War II expenditures to come out of it.

Now it looks like we're doing the same. The political class in Europe and America, supported by old-fashioned central bankers like Trichet, the head of the European Central Bank, is meddling with austerity programmes and cut-backs, just like in 1937. Moreover, the growth engine that's kept us afloat in the last few months - demand from emerging countries, especially India and China - is showing signs of slowing down. And that's scary: it means the Great Recession could turn into another Great Depression.

We've had World War II, are we going to get Great Depression II?

According to Bob Herbert in his recent and very interesting article (see New York Times August 9,2010), if you add to the official statistics the number of people who have stopped looking for a job but say they want to work and those working part time, "you end up with nearly 30 million Americans who cannot find the work they want and desperately need."

If you think 30 million is a staggering number, you haven't heard the half of it. From the UN, a new report on youth unemployment - always a sticky issue - has just come out (the ILO report on Global Employment Trends for Youth 2010) and it points to a 2 percent increase since 2007, to a level of 81 million people. Actually, the figures are put together in a rather unconvincing way and unemployment is likely to be much, much higher. The ILO includes in their analysis only those between the age of 15 and 24 and that doesn't make much sense. In developing countries, the young go to work much younger (at best after finishing elementary school when they're 11 or 12) and in developed countries, the young often stay home much longer, attending the university rather than working.

Historically, unemployment among the young has always been the worst: they're the first laid off and the last hired back. And in any case, even when there's no crisis, they have a hard time finding a job. Why? Many reasons are adduced:  vested interests as trade unions defend their members from young job-seekers; advances in technology that displace labour; mismatch between training/education and job availability. The last is probably the most serious. It stems partly from the conviction that a university education automatically leads to employment - a conviction prevalent in the lower and middle classes. Let's not forget that every blue-collar worker's dream is to see his children wear white collars. And since universities are enterprises like any other business, they respond by producing as many graduates as they can, regardless of whether there are any jobs out there.

The disconnect between education and the labour market is total. Governments have tried to remedy with fiscal stimulus of all kinds from tax holidays to business incentives and have set up training programmes to recycle the old and prepare the young for specific jobs.All to no avail, or at least with only moderate, temporary results.

The unemployment hydra always grows back other limbs. It's like running on a treadmill, with the mill being pushed along by demographic growth. To keep employment even, in the US alone, some 200,000 jobs have to be created every month. From that standpoint, "Old Europe" with its diminishing birth rate (except for France) has it easier. But it is harder from another point of view:  European labour markets tend to be rigid and inflexible(except for Germany that has made it easier to hire and fire).

And keep the young out.

Actually, there are many problems adversely affecting the labour market. Keynes was the first to come up with a serious "disconnect" in his savings-investment function: the self-fulfilling effect of negative expectations. Businessmen who feel glum and don't see a growing demand  for their products, will stop investing. Consumers who wish to save because they're afraid of bad times, will stop consuming. More recently, economists have pointed to lack of information and uncertainty.No doubt these are all very serious problems that at one time or another prevent the market from clearing.

But to find a solution, we need to understand exactly what causes unemployment and why it persists through economic cycles.  We all know since ECO 101 that an economy's savings go into investment and that leads to employment. Investment is however dependent on expected returns - which can turn to the better when there's a wave of innovations, like the dot.com boom in the late 1990s. Actually, innovations are the key, or to use Schumpeter's famous term: creative destruction : jobs in old industries are destroyed, new jobs are created in the technologically advanced.  The trouble is that the  numbers created don't necessarily match the lost ones (that's what's meant by the term "structural unemployment"). Old industries die before the new ones are born or come out of diapers. And it takes time and effort (more training) to move from the old to the new. But it can be done.

Another source of job creation is trade. That's what Germany's 2.2 percent growth in the last quarter is all about: the Germans have been bragging about their "model", but there's nothing new or special about it. They've just been selling cars (and other luxury, niche items) to the Chinese and other developing countries. And, incidentally, unemployment in Germany is still at excessive levels in all other areas of the economy not tied to exports.  Developing countries are juicy markets - as long as they keep growing, which means selling their wares and services to developed countries. But we all know how people in the West feel about outsourcing to India and being flooded with cheap Chinese goods...So you kill trade and cut off your own nose.

But are innovations and trade the ultimate solutions? I'd love to believe that but unfortunately, even at the best of times and at the height of economic booms, we still have unemployment, especially among the young. So there has to be another explanation for persisting unemployment.  And I'd like to submit an unlikely candidate: income inequality. Don't scream! I know it's not politically correct to talk about it. Those who do are immediately tagged as throwback communists (btw, I'm not! I lived in Russia in the 1950s and 1970s and I got to know the system very well and I thoroughly dislike it).  Still, one has to recognize that  Soviet-style communism is probably the only type of government that has managed to neatly do away with the problem of unemployment: it simply decreed that unemployment couldn't exist. Every soviet citizen was ensured a paying job, whether he/she produced anything or not...and productivity be damned!

That is obviously not a solution.

Stay with the idea of income inequality for a minute. Imagine it keeps growing, and you don't need to imagine it because we know that in the real world it does. There are over 10 million millionaires around the world and their number is still rising, as does the amount of wealth they command, and all this in spite of the current Great Recession. So how are the ultra rich going to spend their money? Even the most outrageous, lavish lifestyle won't make much of a dent in their income, percentagewise. There's a limit to how many luxury yachts and conspicuous castles you can enjoy. The ultra rich obviously place their savings in banks and hedge funds. This is where the well-known hubris in financial markets comes in. New instruments were invented to attract "investors". We've seen with what results since December 2007. Wall Street has been turned into a gambling casino, quite literally, and it means that money was kept churning inside rather than allowed to go outside, into productive investments on Main Street. In a way savings have been sterilized, or, if you prefer a less extreme view, the flux into productive investment has been slowed down. Causing unemployment.

Does this mean we should tax the ultra rich? I don't think so. In any case, it's politically unfeasible, they'd always run to another country that would offer them a tax refuge.What it does mean however is that we should regulate Wall Street in such a way that it is encouraged to develop instruments tied to innovations. Venture capitalists are too few and far between. They should receive strong incentives and tax breaks, particularly for innovations that demonstrably work. And tied to support training for the jobs created by the said innovations. And also, why not while we're at it, support international trade?

In short, everything should be done to move money out of Wall Street into constructive ventures on Main Steet.

Do you agree?

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