Cadmus

Inclusive growth: Why is it important for developing Asia?

3. Is it possible to attain Full Employment today?
“If Globalization is a Bowl of Cherries, why are there so many Glum Faces around the Table?”21

To answer this question, we must understand the basic features of today’s world and the likely constraints to the achievement of full employment. In essence, we must answer if full employment is compatible with:
(i) globalization, understood as a process whereby countries throughout the world are becoming increasingly integrated. The effects of globalization on the distribution of wealth and jobs were benign until about a decade ago;
(ii) rapid technological progress that materializes in fast declines in transportation and communication costs; and
(iii) the opening of formerly Communist countries, China and India, to the global capitalist market. The perception of the impact of these forces on employment differs across sectors and individuals.

In my view, the answer to the title of this section is a clear no: today’s free market economies, if left to their own devices, will not generate full employment, insofar as the free market institutional system does not guarantee full employment, much less in a developing country.22 Traditional neoclassical theory puts forward a theory of how, under certain conditions, a market economy will tend toward full employment. This occurs through the workings of the price mechanism. However, the assumptions used to derive this result do not apply and the reality, i.e., the existence of persistent unemployment and underemployment, is that this theory is not too useful. As Keynes showed, even with flexible wages an economy has a tendency toward unemployment. To do this, he demolished the classical notion of “supply curve of labor” and showed that there was no reason to expect that an excess of unemployment would drive down real wages. Keynes showed that even with high unemployment, the employed workers would resist reduction of their nominal wages; and even in case this opposition failed, the subsequent reduction in nominal wages would bring down prices, leaving real wages unchanged.23

Moreover, the analysis of the “labor market” as if it behaved like the market for oranges is fallacious. For this reason, Galbraith speaks of a “job structure”, that is, “a historically, socially, and politically specific set of status and pay relationships in the economy, within and between firms and across industries”.24 The elements of a job structure are much more complex than the simple supply and demand characterization of textbook analyses. This means that wages are not determined by the workings of supply and demand, but by a very complex process of comparisons within and across occupations and industries, as well as the qualifications of the worker. Once the notions of supply and demand of labor (as in the market for oranges) are questioned, the idea of the “Natural Rate of Unemployment” crumbles.
Also, globalization has increased international labor competition. This has contributed, among other things, to rupturing the link between wages and productivity growth. In the developed countries, this rupture has undermined the old wage based system of demand growth, forcing in turn to rely on debt and asset price inflation to drive growth. It has also increased income inequality. Restoring the wage-productivity growth link is therefore vital for both economic and political stability.
The only possible way to approach the state of full employment is to bring explicitly the objective of employment creation to the top of the policy agenda. As a consequence, it will be necessary to redirect the objectives of policy away from controlling inflation (rather than promoting employment), balancing the fiscal budget, eliminating current account deficits, lowering barriers to international trade, opening up new investment outlets for MNCs and financial speculators, and eroding public policies and institutions designed to protect working people and the poor.*
It is important to also understand why, despite the obvious benefits of a full employment economy, it is not openly pursued by policy makers. This question was discussed at length by Kalecki, whose analysis continues to be relevant today.25 He argued that the best way to achieve full employment was by Government spending on public investment. However, Kalecki argued, despite the obvious benefits that an economy running at full employment provides, the business class will, in general, oppose it. There are three important potential obstacles to increasing investment. First, in a market economy the private sector is the generator of wealth. However, in many developing countries, private investment may not collaborate due to, for example, low profitability, large uncertainty, high cost of investment, or because the full level of firms’ savings out of profits is not reinvested. One possibility is, of course, to identify and relax the binding constraint on private investment. But perhaps doing this is not easy and may not be enough to increase investment to the necessary levels. For this reason, a policy of stimulating exclusively private investment may not be satisfactory. It is clear that, in these circumstances, the Government will have to step in to reach the desired level of investment. The role of Government investment is not, it must be stressed, to replace or crowd out private investment (much less in a region characterized by excess of saving over investment), but to complement it due to the latter’s insufficiency. Indeed, the most effective and egalitarian way to achieve full employment is through a program of public investments targeted carefully at location-specific high employment activities. For this reason, it will be the Government’s responsibility to provide a large volume of public sector investment, e.g., in infrastructure. This, I must stress, is not to deprive the private sector from any active role in the economy, quite the opposite. The private sector has to invest in whatever activities it finds profitable. This is the way a market economy will prosper, although this does not guarantee full employment of the labor force.
Moreover, in many developing countries the private sector cannot be relied upon to undertake the required volume of investment and of the appropriate structure. The reason is that nobody can force this sector to invest the required volume and in the areas that a developing country may need. In some developing countries the business class does not play, on a large scale, the role of dynamic entrepreneur that it should (contrary to what occurred in today’s developed countries at the time they underwent deep structural changes), driven by ‘animal spirits’ (i.e., a spontaneous urge to action and willingness to take risks), using Keynesian terminology.26 In some cases it is due to a poor investment climate (e.g., difficulties in opening a new business), the result of Government-imposed constraints; in other cases, the oligopolistic characteristics of some sectors of the economy favor some privileged groups that enjoy rents. These groups lobby to perpetuate this situation. The problem is neither the high cost of investment nor low returns (in the growth diagnostics terminology of Hausmann et al.) but the desire to maintain a situation of privilege.27 Investment takes place in the areas that these groups control and at the pace that it suits them. At any point, and for strategic reasons, they might be unwilling to expand capital expenditures simply because it favors their objectives. In many developing countries, the capacity for entrepreneurship that the private sector has must be nurtured and developed, since the driving force in a capitalist economy is the decision to invest and the rate of capital accumulation (and the demand for labor depends on it). But the objective of the private sector is not the maximization of employment and hence it cannot be and should not be made responsible for the achievement of full employment. Although some may not like it, this requires some planning.
Stimulation of private investment through, for example, reductions in interest and/or tax rates or through subsidies to private investment, will not deliver full employment. If the economy is already in a boom, measures to stimulate investment further will be pointless.
And in a slump some of these measures may not work, e.g., reductions in interest rates may be ineffective due to the existence of excess capacity. Private investment depends, especially in developing countries, on expectations and political stability. Moreover, a “one-time” reduction in interest or tax rates does not eliminate a downturn (business cycle). Policy makers would have to lower them successively and continuously to keep the investment rate going. Moreover, Vickrey argued that firms’ savings out of profits represent income not spent.28, 29 These savings cause the income of others to fall (through the multiplier effect). This is because savings not immediately transformed into capital simply ‘vanish’ and lead to reduced income. Therefore, private sector investment is the mechanism through which the sector’s profits are recycled into the income stream (i.e., the mechanism through which non-spending is transformed into spending). If a country’s total surplus were reinvested, the economy would get closer to the achievement of full employment. But when the total full employment level of firms’ savings is not recycled into spending by private investment (in fact, Vickrey believed that the private sector would not recycle the full employment level of its savings), some of the full employment level of output will not be justified by actual sales, i.e., part of the product will not be sold and goods will accumulate in stock. This will lead to reductions in production and employment. Unemployment is, therefore, the evidence of this gap (i.e., savings that are “kept idle” and not put to productive investment). Income (the equilibrating variable, and not interest rates) will fall and consequently savings will also decline until they are brought back to match the below full employment level of private investment. For Vickrey there is only one solution to closing this gap and bringing the economy to full employment: government deficits.
However, achievement of the full employment of labor through a large volume of public investment faces serious political obstacles. Kalecki argued that “The assumption that a Government will maintain full employment in a capitalist economy if only it knows how to do it is fallacious”. He gave three “reasons for the opposition of the ‘industrial leaders’ to full employment achieved by Government spending”: (i) the opposition against Government spending based on a budget deficit and the dislike of Government interference in the problems of employment; (ii) the opposition against this spending being directed towards public investment (or towards subsidizing consumption, for example through subsidies to keep down the prices of necessities), except when it is confined to objectives which do not compete with private investment, that is, for construction of hospitals, schools, highways, etc.30 It is interesting, however, that even these areas are contested today as domains of the private sector, and some argue that public investment crowds-out private investment on the grounds that the former lowers the real rate of return of the latter; and (iii) the opposition against maintaining full employment as this may give workers a very strong and dangerous position in the bargaining.31, 32 No wonder Kalecki asked: “…why do not they [businessmen] accept gladly the ‘synthetic’ boom which the Government is able to offer them?”*, 33
The second obstacle to increasing investment is that the investment goods sector (e.g., the construction sector) may be already running at close to or full capacity and thus may not be able to increase its output.
And finally, the third obstacle is that the country may run into the problem of how to secure an adequate supply of necessities to cover the demand resulting from the increase in employment. This increased demand will induce inflationary pressures as the supply of necessities (especially food) is limited.* This situation has an additional implication. Suppose that the economy is capable of increasing investment. This will lead to more employment and to a higher total nominal wage bill. However, the overall wage bill in real terms will remain unchanged as a result of the increase in the price level. What is the implication? That although the level of employment has increased (certainly a positive outcome), the real wage rate (i.e., wage per worker) will have declined, and this is an unfair way of financing the acceleration in growth. The conclusion is that the increase in investment under conditions of an inelastic supply of food will cause both a fall in real wages and the acceleration in prices. For this reason, it is important to expand food production in parallel to industrial development. Investment in public transportation and public utilities should be accompanied by measures to expand agricultural production, such as land reform and easy credit to farmers.
This discussion means that in trying to achieve inclusive growth, policy makers cannot throw the costs of capital formation on the wage earners and, in particular, on the poor. In a command economy investment is financed out of the incomes of state institutions and not out of the savings of private individuals; but in countries that have followed the capitalist path of development (i.e., where savings and investment decisions are distinct), who bears the cost of capital accumulation is an important political economy question that needs to be answered. The same way that Governments must be accountable for their actions, policies, goals, and ultimately for their performance and capacity to deliver, the domestic upper and business class of developing countries, in many cases a relatively small group of individuals and families, must also be made ethically and politically responsible for the development of the country. Domestic investment often depends on the decisions of a reduced group of businessmen. As long as private investment cannot be “enforced”, the public sector will have to cover the gap up to full employment. Many developing countries, however, cannot enforce the tax collection system, tax evasion is rampant, and the implementation of progressive financial reforms is an uphill battle. Under these circumstances, the funds for investment are hard to extract. Both agriculture and manufacture fail to develop efficiently and growth of total output is swallowed up in growing consumption.
To these arguments, we need to add the economic/technical arguments that make the achievement of full employment a very difficult task. Often, standard analyses rely on the assumptions of perfect mobility and substitution of factors. Under these circumstances, the system “instantaneously” and easily adjusts to changes in technology. Structural change, however, is path-dependent, takes place in historical time, and leads to disproportional growth across sectors. Moreover, capital goods tend to be highly specific, which means that they cannot be shifted easily across lines of production and there is significant uncertainty regarding the future.
Pasinetti and Taylor worked out the conditions to achieve full employment in a system undergoing structural and technological change.34, 35 Suppose an economy is growing, with some sectors expanding faster than others. Also assume productivity is increasing across sectors with unit labor requirements (i.e., labor per unit of output, or the inverse of labor productivity) declining at different rates. Are these trends compatible with full employment? Pasinetti’s general answer is no. The reason is that the condition Pasinetti derived is stringent, one that actual economies most likely do not satisfy: that labor per unit of output and demand per unit of labor must be in balance if demand is to support a full-employment output level. This condition obviously runs into difficulties in a dynamic context. First, labor per unit of output tends to decrease in time (since the 1950s, labor productivity has increased at a rate between 0% and 5% per annum, depending on the country). Second, per capita demand for many commodities or services may rise (e.g., iPods today) for some time, but ultimately tends to slow and even decline (demand saturation). If on one hand both unit labor requirements and demand per unit of labor are decreasing in a sector, the sector will lose employment. On the other hand, a rising demand per unit of labor in one sector may compensate a declining unit labor requirement in another sector, thus leading to employment growth. But this is not guaranteed to happen and, in general, the system will not be in balance. This means that in order to support employment growth, a market economy must constantly introduce new commodities and services as it eliminates the old ones.* Therefore, some of the major obstacles to full employment lie in the technological conditions of production. In advanced market economies, the main mechanism to enable real per capita demand to increase has been growth in real wages at a rate close to that of labor productivity. In other words, an increase in real wage rates can offset reductions in unit labor requirements by supporting a growing aggregate demand per capita. But, once again, this process is not guaranteed to go on, that is, even if wages go up to offset the decreasing unit labor requirements, higher productivity may not lead to higher output and employment.
The different situations of disproportional demand and productivity trends that arise across sectors may require substantial labor force reallocation in order to maintain full employment. Most developing countries are not able to deal with the social consequences of labor reallocation (e.g., think of the People’s Republic of China).36
The conclusion of this discussion is that the dynamics of structural change imply that, if left to its own devices (i.e., the vagaries of the market), a developing economy will not achieve full employment. For this reason, the country’s institutions, the government particularly, but also the central bank and the business class, must understand the importance of placing full employment at the top of the economic and political agendas.


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