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Imagine that you are an economic advisor based in the Treasury. It is post election time. The incoming Chancellor of the Exchequer has requested an evaluation of the enclosed research policy paper. 2A4 sides.

The paper is one of the classical "Can Lloyd-George do it?" type suggesting more state involvement to create artificial jobs and combat UE. But the situation today is far from being as drastic as in 1930s and thus my view is more of a Treasury type.

Unemployment(UE) is one of the main political issues concerning the government today. Although the latest Economist opinion poll shows that people worry nowadays more about education and health, UE is still thought as a major issue by 37% of voters. Besides increasing the social security bill in the Budget and causing misery to people involved, UE is highly correlated with crime and other social evils, so its very expensive to the society. Although UK is doing well at present with UE falling experience of 1991 shows how things can go worsen quickly. Before surveying the paper I will summarise the theory on UE and its applications based on current data. Critics for the paper and alternative solutions are discussed at the end.

UE is people actively searching for jobs and thus qualifying for UE benefit. There are different types of UE arising from changes in economy (structural) and deficiency in demand for products (general). There will always be some UE arising from people changing jobs. However, the actual UE figure should be higher than that in order to fight inflation. The inverse relationship between inflation(I) and UE was first observed by Philips. This simple relationship does not hold for any longer periods at present, instead we have I spirals. They are caused by I expectations - people will get used to I and will demand higher wage leading to high UE as well. This led Friedman to suggest an existence of Non Accelerating I Rate of UE (NAIRU). At this level of UE I does not change. However, empirically NAIRU has not been stable and has followed actual UE leading to hysteresis theory. Rational long term unemployed will not participate in wage bargaining as his skills have vanished and trade unions (TU) do not take him into account (insider-outsider model). So persistently high UE will increase NAIRU, leaving NAIRU with a limited use for policy measures. From a different angle, the UE will lead to inequality(IE) among nation, a theory pioneered by Lorenz. IE is not popular among voters, however, moderate IE increases possible rewards to hard working and can make a capitalist system more effective. UE serves as punishment then.

At present UE stands at 6.5% and NAIRU is between 5 and 7%. There is no apparent increase in I. These figures are amongst the lowest in Europe. This low outcome has been due to the success of British government in reducing the job security. Government calls it the supply-side policies. The number of TU-s and their power has been reduced. Labour markets have been made more flexible by increased training and repeal of European Social Chapter. As it is easier to fire people, firms are more willing to employ. There is also a problem with social dumping - UK is at present definitely gaining in employment at the expense of other EC states. Foreign firms invest in Britain as they can have access to EC market with the least labour cost. This cannot go on forever.

There is also evidence of increased poverty and inequality. Although new job-creation figures in UK are among the highest in Europe, most new jobs go to families who already earn income in UK. People are also cheating the UE benefit system. Tories have been cheating, too, by changing definition of UE. Furthermore, most new jobs created have been part time. This all renders the validity of UE statistics highly uncertain.

To combat UE and IE a possible state intervention has been suggested by the paper. It would involve investment to tradable goods' sector, (i.e. manufacturing) raising national income. Investment to public services should occur as well. This would be necessary to increase international competition, so that extra manufacturing output can be sold. The policy would boost domestic demand and improve the public service while taking social costs like environment into account. The proposed program would create 750000 jobs directly and further 250000 jobs due to various links in the economy and multiplier effect. IE would be reduced and economic growth increased. The programme finance (17b) would consist of savings in welfare payments (10b) and increased tax (2.5% increase in overall tax, done by increasing top rate).

The propositions look nice on paper. However the numbers calculated are only rough estimates. The change in economic growth brought about by these changes is not counted. Increasing tax will have detrimental effects on incentives. The evidence in Soviet Union shows the ineffectiveness of a too large state sector. Diseconomies of scale would arise due to increasing administration costs. The whole program reduces UE to roughly 4%. Same results can be obtained by pursuing cheap monetary policy and running fiscal deficit, or imposing trade barriers. But the effect of this, the increased I, would overweigh the benefits. The I arising from the project is not taken into account. It can be substantial. People will not be afraid of becoming UE anymore, as they get jobs by the state. They will thus increase the wage claims.

Furthermore, the apparent extra increase in jobs (250 000) due to multiplier effect is highly speculative. First, increased taxes will increase leakages leading to contraction of GDP. Secondly, very large proportion of the extra income will be spent on imports, while the jobs created will not increase exports. Besides reducing multiplier effect, this will lead to balance of payments problems as international experience has proven.

There is also no apparent shortage in public sector workers. Employing more from the UE mass (mostly unskilled) might not improve the public service too much.

There are completely different policies of decreased state intervention and introducing extra competitiveness available. The are employed by the state successfully nowadays. A compromise between social and capitalist system, the stake holder society, will also lead to increased employment, without the extra cost arising from artificial jobs.

As a conclusion, UE is still a problem and there will always be the two conflicting views of less or more state intervention. The apparent success of rational expectations based theories of NAIRU and hysteresis have helped to understand the UE better and have provided the apparently successful deregulating policies. We should revert to increased state intervention only if other policies fail. However, the social dumping used by the UK at present could trigger an international response, so the failure could come soon. But with the introduction of EC, the UK government will have less flexibility to pursue any of the proposed policies anyway and the UE decreasing would be done from Brussels!


1. Introduction

a. Overview - although UK is doing well, recent experience shows how quickly unemployment can go mad.

b. Importance - the misery it causes. Specially Longterm. UE also causes crime and other social evils.

c. Methodology

2. Theory

a. What is unemployment

b. How it is measured

c. NAIRU - Elmeskov pionered measuring. Supply side measure, this article is demand side.

d. Links of unemployment with

i. Inflation (Philips)

ii. Economic growth

iii. Social Chapter

e. Hysteresis (rational expectations)

f. Long term

g. Insider outsider and jobseeking

h. trade unions

i. poor perfor better when they are paid less and rich when they are paid more, capitalism needs a reserve army of unemployed

3. Evidence

a. Latest data on UE and Nairu(7-5%, error), job creation

b. On Inflation

c. Philips curve evidence is bad lately. Short term curve

d. Hysteresis evidence

e. Evidence on public oppinion

f. trade unions. Now secret balloting. If goes through negotiations occur instead of strike. Less working days lost. job insecurity - modest wage claims

g. long term (connect with 1930s)

h. Inequality and poverty.

i. reserve army thing does not work well (hysteresis)

j. Problems with evidence

i. household measures poverty, individual unemployment. Jobcreation goes to households with an employed person already.

ii. People cheating

iii. Change of measuring unemployment

iv. New jobs part time

4. Applying

a. Philips curve does not hold

b. NAIRU is changing. But the change is predictable. Output gap that we lose in raising unemployment to get down inflation is not temporary, but permanent!

c. Very sensitive politics must be used to get down both, ot some other solution, discussed in solutions.

d. Right thing done by conservatives in reducing unions. However do not go to far.

e. Weak evidence in long-term and insider outsider. Hard to measure

5. Possible solutions for reducin unemployment

a. State intervention - theme of the article

i. investment in tradeabel goods sector(manufacturing)

ii. Needs also productivity gain to compete internationally - investment in public services

But

International response. You could as well say put a tariff

How it works through:

i. demand boost

ii. better public service

iii. investment increases (skill and capital)

iv. social costs (environment) counted

Results using a computer program

i. 750k jobs direct

ii. further 250k due to links in economy (multiplier)

iii. income inequality reduced

iv. higher economic growth in the future would lower costs

Total cost 16.9 billion. Average cost after revenues 10k a job for unemployed. Still half of the cost must be financed by taxes.

Will be financed from

i. reduced welfare payments (3b)

ii. increasing tax (5.5b-direct, 1.4b indirect)

iii. total about 10b depending on the families that take the job

iv. increased top taxrate

Critics

i. too round numbers

ii. Other strategies below

iii. No extra administering costs involved (diseconomies of scale)

iv. Where dp you put extra public service people

v. incentives go down, tried before!

vi. Not just a single cost - cost every year!

b. Supply side

c. Deregulating

d. Rejecting EC social chapter (competitive environment, flexible labour markets)

e. Moral suasion

f. Stake holders society

6. Conclusion

a. Still a problem

b. However situation is improving

c. The new theories of hysteresis, NAIRU being path dependent and rational expectations are successful

d. Current policy of Britain being the first is successful for Britain, but social dumping for other countries. Not fair and with EC could be elliminated.

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