In the 1970s, mainstream thinking on unemployment converted to a new conservative orthodoxy. Now, liberals are making those ideas their own

IN 1968 Milton Friedman and Edmund Phelps, in papers written independently, assaulted the prevailing consensus on unemployment. They said it was wrong to suppose, as most economists had up to then, that governments could lower the rate of unemployment if only they would accept a little more inflation. This imagined trade-off, they argued, was a trap: governments that tolerated higher inflation in the hope of lowering unemployment would find that joblessness dipped only briefly before returning to its previous level, while inflation would rise and stay put.

Unemployment, they argued, has an equilibrium or “natural” rate, determined not by the amount of demand in the economy but by the structure of the labour market. Only one level of unemployment, the “natural” rate, is consistent with stable inflation. The notion that there is a “non-accelerating-inflation rate of unemployment”, or NAIRU, became a touchstone of free-market economic policies around the world. But now, economists who believe that governments should be more active in fighting unemployment are making the NAIRU their own.

Why did the NAIRU become identified with conservative thinking? The answer is timing. Just a few years after Messrs Friedman and Phelps unveiled their theories, many countries, including America, suffered rising inflation and rising unemployment at the same time. “Stagflation” appeared to confirm their view that macroeconomic policy could not conquer unemployment. That became conservative orthodoxy--in good part because the political mood was anyway turning against big government. As James Galbraith, a professor at the University of Texas, writes in a symposium in the current issue of the Journal of Economic Perspectives*, “Since Friedman's [paper], orthodox macroeconomics has virtually always leaned against policies to support full employment. In spite of stagnant real wages, it has virtually never leaned the other way.”

Yet it might have been otherwise. A crucial question had been neglected: whether, and under what circumstances, the natural rate might change. Increasingly, economists have concentrated on this question. As a result, by degrees, natural-rate theory has been recaptured by the centre-left.

Mr Friedman, staunch foe of the state, has consistently opposed government intervention in this area as in almost every other. But anticipating more recent work, Mr Phelps, the theory's other pioneer, has long emphasised the need for measures to lower the natural rate--essentially, by making more people employable at the prevailing level of wages. In a book to be published next month† Mr Phelps advocates an enormous programme of employment subsidies aimed both at lowering the NAIRU and at raising the incomes of the working poor.

The initial association of the natural-rate theory and conservative ideas on policy was exaggerated in another way. Suppose, to take the extreme case, that the NAIRU were fixed after all. Even then, allowing inflation to rise in order to curb unemployment may not always be undesirable. It might be worth sacrificing a permanent increase in inflation for a temporary cut in unemployment--if the increase in inflation were tiny, and if the drop in unemployment were big and prolonged (albeit not permanent). In short, the success of the natural-rate paradigm need not have been the triumph for conservatism that it was initially.

These days, liberals have all but reclaimed the ground they surrendered in the 1970s. The main thing is that nobody any longer thinks that the NAIRU is fixed, which puts the spotlight back on policies that might reduce it. In another Perspectives article, Joseph Stiglitz, until recently the chairman of President Clinton's council of economic advisers, argues that the changing demographics of the labour force, as well as more vigorous competition in the markets for goods and jobs, have contributed to a fall of some 1 1/2 percentage points in America's NAIRU since the early 1980s. He estimates it to be 5 1/2% or a little less, which also happens to be the current rate of unemployment.

Robert Gordon of Northwestern University broadly agrees. And a third set of calculations, by Douglas Staiger and James Stock of Harvard and Mark Watson of Princeton, tells roughly the same story (see chart for their estimates).

Swimming lessons
There is less agreement over whether, given that the NAIRU is so changeable, the concept has any meaning at all. Certainly, without Mr Friedman's implicit claim that the natural rate was a constant, the theory would have made far less of a stir in the first place. Nonetheless, Mr Stiglitz says the idea makes sense theoretically. And in practice, he argues, the gap between the estimated NAIRU and actual unemployment turns out to be a good predictor of changes in inflation. Even if the NAIRU moves around and cannot be measured precisely, it still provides a helpful guide to thinking about economic policy.

But praise for the brainchild of Messrs Friedman and Phelps goes only so far. Mr Stiglitz, for one, gives the natural-rate framework a markedly anti-conservative spin. In particular, he argues for a more relaxed approach to fighting inflation. The new research, he says, does indeed suggest that the costs in higher inflation of driving unemployment below the NAIRU are small. So, “in testing the waters, we do not risk drowning. If need be, we can always reverse course. But by experimenting, and showing some hesitation about restraining the economy through higher interest rates as the NAIRU draws nigh, we might learn a little more about the depth of the waters and possibly become better swimmers.”

Mr Friedman would doubtless regard this plea for flexibility in monetary policy with disdain. Giving policymakers that kind of discretion, he would say, is exactly what gets economies drowned. As the American economy continues to expand vigorously, the Federal Reserve will soon have to decide how cautiously to swim

posted by iambrianfu [ 10:37 PM ] <$BlogItemComments$>

A manifesto to raise employment

AS DEVELOPED economies emerged from their last deep recession in the early 1990s, there was high anxiety about high unemployment. Thus in 1994 the OECD set out a programme of labour-market reforms through which its member governments might cut the jobless count. A decade on, rich economies are recovering from another slowdown and unemployment is on the rise once again. On September 17th, in its annual Employment Outlook, the OECD issued a new manifesto that reflects the anxieties of western governments about jobs. But the aim this time is not just to reduce unemployment but to raise employment.

Eh? What's the difference? Plenty, in fact. To be counted as unemployed, people usually have to be part of the labour force: they must be available to work and actively looking for a job. But there are many other people of working age—housewives, students, lone parents, disabled people and early retirees—who neither have work nor seek it. These are termed the “economically inactive”. Policies to cut unemployment aim to lower it as a share of the labour force. Policies to raise employment aim to raise the proportion of the whole working-age population with jobs, not just by getting the unemployed into work but also by mobilising the economically inactive.


One reason for setting the new goal is that OECD governments have had some success in bringing down unemployment during the past decade. Generally, jobless rates have fallen; in some countries, notably Ireland, spectacularly. Some of the gains have been lost during the recent global slowdown, but the setback has been less severe than in previous downturns. Much of the long-term improvement will therefore prove sustainable, argues the OECD.

However, the emphasis on raising the employment rate also reflects new concerns, especially in Europe. A particular worry in the early 1990s was that too many young people were unemployed—ie, looking for work but unable to find it. Now, governments are concerned that there are too few young people in the labour market overall. In the European Union, there are now four people of working age for every person aged 65 or over. By 2035, this ratio will have fallen almost to two-to-one. As it falls, the burden on workers of tax-financed pension schemes will rise and public budgets will come under ever greater stress. One remedy is to raise the employment rate and so increase the number of people contributing to public pension schemes.

The rationale for cutting unemployment is straightforward. If people who want to work cannot find jobs, then potential labour resources are being wasted and taxpayers are having to support the involuntarily idle. The rationale for raising employment is less obvious. There are good reasons why students, for example, are not employed. If people choose not to work and can support themselves, what business is it of the state—however cash-strapped—to try to push them into work?

One answer is that inactivity costs taxpayers money, over and above what they must pay to support the unemployed. Besides unemployment payments, there is a wide range of other benefits, including support for early retirement, disability and lone parenthood. In the EU, there is now one person of working age receiving a benefit for every three people in employment. In America and Japan the figure is one in five. In many countries a majority of people who are neither employed nor in education get some form of income support.



Springing the trap
This benefit culture is not just a burden on the working taxpayer. It also generates incentives for people not to work. In the early 1990s, the talk was of unemployment traps, where high, long-lasting benefits dull the spur to find work. Now the OECD highlights inactivity traps where people outside the labour force face little financial incentive to seek work.








The substantial variation in employment rates between broadly similar economies suggests that in some countries there is plenty of scope for getting more inactive people into work. In Iceland, for instance, 80% of working-age women are employed; in Italy, the figure is a mere 42% (see chart). The report estimates that a convergence in working patterns would raise the average employment rate (for women and men) in OECD countries from 65% to 77%. Based on what the economically inactive say about their willingness to work, the increase would be less, to 72%.

It is easier to identify the potential gain than to realise it. The OECD sets out three main policies. The first is to make work pay for the low-skilled. To encourage more of them into the labour market, more use could be made of top-up benefits for those on low wages. Reduced payroll taxes on low-paid jobs would enhance employers' demand for such labour. The second is to remove other barriers to joining the workforce such as the difficulties women find in juggling families and jobs; for example, through subsidising child-care services. The third is to restrict the flow of people on to out-of-work benefits and to encourage those already getting them to look for jobs.

The main question is whether governments will have the courage to implement the more unpopular reforms. By extending in-work benefits, they will offer people a carrot to join the labour force; but as long as people can draw welfare payments when out of work, there will be no accompanying stick. The OECD calls for the removal of incentives to early retirement, but this requires unpopular reforms, not just to pensions but also to other benefits that allow older people to quit the workplace.

Some increase in employment rates will occur anyway as a younger generation of working women replaces an older generation that largely stayed out of the labour force. But most countries will struggle to raise the employment rate without harsh reforms. The OECD's manifesto sets a daunting challenge

posted by iambrianfu [ 10:17 PM ] <$BlogItemComments$>