Unemployment, Welfare and Minimum Wage

The most visible indicators of macroeconomic health are related to employment and welfare. A healthy economy is recognisable as one in which anyone willing to work can find a suitable job with a fair wage and no one has to die for lack of access to food, water or shelter. In previous posts I have explained the mechanics of certain abstract macroeconomic phenomena in order to discredit conventional economic theory; in this post I will explain the macroeconomic significance of the familiar mechanics of employment in order to advocate a new policy. I will build on the macroeconomic model from previous posts by introducing the unemployment rate, minimum wage and welfare payments.

To the extent that the central bank is able to influence investment decisions it is also able to influence the unemployment rate: if loose monetary policy encourages building a new factory then labour will be required to build and staff it. The monetarist school of thought that is mainstream throughout most of the developed world asserts that investment (as a function of inflation) is always controllable by monetary policy. Many governments therefore delegate responsibility for maintaining full employment to the central bank. Often unemployment is presented in textbook models as a tool for controlling inflation: when prices begin to rise faster than the desired rate of inflation (because aggregate demand has outpaced the nation’s productive capacity) then tight (also called contractionary) monetary policy is used to create a buffer stock of unemployed people – which softens wage demands and eases upwards pressure on other prices – who can be called upon to work when in the reverse situation the central bank decides to embark upon expansionary monetary policy.

The Paradox of Thrift

If everyone attempts to save more of their income at the same time, there will be correspondingly less income to go around, the attempt will fail and ultimately be harmful to the wider economy as the shortfall in demand costs jobs and discourages investment. Keynes coined the term ‘paradox of thrift’ to describe this situation, though it has been recognised less formally for centuries – Adam Smith coyly questioned the old wisdom that “what is prudence in the conduct of every private family can scarce be folly in that of a great Kingdom.” We have seen some hints that the virtues of saving evaporate if everyone is doing it when we looked at how a negative real interest rate punishes savers when there is a shortage of investment.  This “paradox” represents a formidable challenge for heavily indebted countries: how can there be a concerted effort to lower the debt level when any collective attempt to save must fail?

The production function Y = C + I + (G – T), rearranged so that gross household savings equals income minus consumption expenditure (S = Y – C), tells us that household savings minus investment expenditure (i.e.: net private savings) equals the government budget deficit: S – I = G – T. That means that for a positive change in net private savings in a given time period, there must be a corresponding increase in net public debt. In previous posts we established that it is meaningless for a government to save in its own currency; it follows that running a budget deficit is not incompatible with the notion of everyone trying to save. Mathematically, at least, the paradox of thrift requires only a liberal application of fiscal policy to resolve.

To determine when government spending should be applied to control a paradox of thrift situation, and to what degree, we can look at it as a question of supply and demand. Traditionally the government – which has a monopoly over the supply of net savings – chooses how much and to whom savings are distributed to, and from whom they are taken, in order to meet a budget target. Instead of a budget target, the government could target a desired distribution of wealth in order to match the private demand for savings. The tricky part is working out how to do this.

Consider a private sector that wishes to save. The following happens:

  1. Individuals spend less on consumption and luxury goods, causing reduced income for businesses.
  2. Businesses respond to the fall in income by hiring fewer workers or laying-off existing ones, and new investments are put on hold.
  3. The unemployment rate rises, creating a new incentive to save.

Some proportion of every dollar earned must either be saved or spent. Spent dollars represent dollars earned by the next person. If the private sector wishes to save an additional $15, this comes at the expense of $15 earned by someone – which might represent an hour’s wage by some factory worker. If the private sector wishes to save an additional $30,000 it might represent a worker’s annual salary. We call this relationship the private demand for savings. It is, by definition (and hopefully, soon, by intuition!), impossible to satisfy within the private sector itself; new private savings, net of existing debt, must come from government spending.

Unfortunately it is not a figure that lends itself well to reliable determination from historical data, let alone predicted for current policy. Nor is it clear who should be the recipient of the new savings, or that the political process would be able to respond quickly enough to be effective in preventing a recession. A successful policy approach to meeting the private demand for savings must be long-term, be able to respond quickly to changes in demand, yet must not overshoot the mark and create excess inflation or devalue the currency.

Minimum Wage and Unemployment

The debate around minimum wage suffers the same framing problems as most popular economics, with two roughly defined groups – the political left and right – arguing different sides of same rusted old coin.

On one side are free market advocates and business owners (often grouped under the heading of ‘conservatives’), who argue for reducing or eliminating minimum wage laws. The essence of their argument is that enforcing an artificial minimum wage distorts market outcomes and costs jobs. From this perspective, the jobs that are lost because businesses can’t afford to hire – including many cases where a worker may become worth a higher wage once they’ve built up some experience working more cheaply – will ensure that there is work for everyone and that in turn the overall standard of living will improve too. Market forces will ensure that everyone is paid a fair wage, and in the extreme form of this advocacy, they argue that in a free market those who are unable to command a high enough wage are not making a high enough contribution to society.

From the other side – the political left – comes the argument that minimum wage is necessary and often that it should be raised. The argument is that people on low wages are already being unfairly exploited, that the ‘free market’ does not ensure fair wages because the lowest income earners are often in no position to negotiate pay. Usually they advocate extensive government welfare programs, and intervention to ensure fair hiring policies in corporations. Though few would disagree that a minimum wage may cause some loss of jobs, they believe that this is a lesser evil compared to allowing disadvantaged people to be trapped in exploitative working conditions.

Not everything about the two camps is opposed – mostly importantly both are interested in creating a healthier economy and differ chiefly in their means for doing so. If the debate could be exorcised of its ideological demons we could even see similarities in the differences, in particular that:

  1. The argument between the relative merits of ensuring reasonable wages versus ensuring that businesses can afford to hire implies a shared belief that there exists a trade-off between unemployment and fair pay, and
  2. Changes in the number of jobs available will affect the unemployment rate, and therefore that the unemployed will be ready and willing to work if work was available.

This ideal of the ready and willing to work unemployed person is more or less consistent with the formal definition of ‘unemployment’ used in government statistical releases. Only those actively looking for work are considered unemployed. Those who are not interested in working are not part of the labour force and not counted. Those who might take a job if offered but are not actively searching are considered ‘discouraged workers’, and also not counted. Those who are gaming the system to receive welfare payments but are not truly looking for work appear as statistical anomalies – they are counted in the unemployment rate, and they are without employment, but they are not part of the narrow “buffer stock of unemployed workers” that comprises the official definition, or the people whose jobs are assumed to be created or destroyed by minimum wage regulation.

The “buffer stock of unemployed workers” is the neat and tidy little explanation of what happens when policy decisions create unemployment through diminished investment. The idea is that those left unemployed by contractionary policy will create a pool of workers ready to draw upon when signs of slowing growth call for expansionary policy. Like all neat and tidy models of human behaviour, it fails to capture the messy detail of reality. As anyone who has spent longer than they would like out of work can tell you: being unemployed sucks. The longer the period spent unemployed, the harder it becomes to find work. Employers prefer to hire people who are already working. Long gaps in the resume look suspicious. There is an emotional cost to being unemployed which eventually discourages many from looking for work at all (which makes them somewhat difficult to place in the traditional labour force classification). These social costs of unemployment can be severely problematic to the “buffer stock” that contractionary policy presumes to create.

The Job Guarantee

This is all we need to know to understand how we can begin to build a real solution. We know that the government is the monopoly supplier of net savings and can supply savings in unlimited quantities constrained only by inflation. We know that the private demand for savings manifests as lost private income, and lost jobs, but we can’t precisely measure it. We know that the government tries to create a buffer stock of unemployed people to support expansion when the time is right. We know that the social costs of unemployment make the transitions much less fluid in reality. With these understandings we are finally able to reframe the problem it the full undiluted context of the wider economy: what can the government do to simultaneously eliminate the social problems associated with unemployment, fulfil the private demand for savings, allow mutually beneficial employment arrangements at low wages, prevent anyone being forced to work for an unfair wage, and do it all quickly and responsively enough to avoid these problems getting out of control?

It’s easy: hire them. Instead of creating a buffer stock of unemployed workers, create a buffer stock of employed workers by giving the government the role of employer of last resort. Guarantee a job for all citizens, paying a basic liveable wage indexed to inflation, up to 40 hours per week.  The guaranteed wage could effectively replace the minimum wage, because no one could be forced to work below it, though anyone could choose to work for a private firm at less than this rate if they felt it was worthwhile experience. There would be a similar flooring effect on working conditions for those on low wages. In slow economic periods the government payroll would automatically expand as people who could not find work in the private sector transfer to the public sector, expanding the deficit and creating new net savings. Once the private demand for savings has been satisfied, consumption and investment resume, and the private sector starts competing for labour. This will drive up wages, creating incentives to leave the minimally paying government job, shrinking the government payroll and deficit in the process. These twin behaviours make it a kind of automatic stabiliser – a policy which activates automatically to set in motion stabilising effects on the economy.

It doesn’t have to be useful work – it might be better if it’s not, if you’re afraid of crowding out private business. Those who need a lot of time off to find a new job in their field could work for only part of the week and still earn more than they would have received on welfare payments. Welfare payments would still be available for those with genuine disabilities or other barriers to work, and the scope for gaming the system would be drastically reduced. The programme would have no relative wage effects in the private sector – that is, it would not create upwards price pressure on other wages – because the expenditure on the programme reflects only the private demand for savings, not consumption. On the other hand, it would allow workers who are already at low wages to bargain for higher pay with their employer without fear of losing their job and being unable to pay the bills, since an alternative income stream is always available.

The Job Guarantee was proposed independently by MMT pioneers Warren Mosler in 1997, and Bill Mitchell in 1998. In Australia, the Centre of Full Employment and Equity at the University of Newcastle acts as one of the chief advocates and developers of a complete set of Job Guarantee policies. Several countries have implemented similar schemes with some success, including post-crisis Argentina, India and South Africa. In Australia and soon in the UK, work-for-the-dole programmes are analogous to a weaker version of the job guarantee – the pay is still woefully inadequate, but it works the on the same principle. There are many questions still to be answered. How to deal with underperforming workers (can you be fired from the programme?), what kind of unemployment welfare payments should still exist, what the nature of the work should be – these are all still issues of some contention. These operational questions form most of the work in turning the idea into a workable policy.

Then all we need to do is sell it to the politicians.

2 comments to Unemployment, Welfare and Minimum Wage

  • Nice Blog LAW, I believe you have erred here:

    It doesn’t have to be useful work – it might be better if it’s not, if you’re afraid of crowding out private business.

    It does have to be useful work but it does not necessarily have to be monetary profitable work, as long as it is socially beneficial.

    PS. Got your email, keep an eye out late tonight/first thing tomorrow on my place.

  • [law]

    Agreed, but there is an inherent social benefit to any JG work since the alternative to being employed in a job guarantee programme is being unemployed. Think of it as avoiding a social opportunity cost.

    You could have people sitting at a locked-down computer typing in word-for-word copies of books related to their desired field of work. It would scale well and automated performance monitoring would be easy. It wouldn’t be the most useful application of labour, but from a monetary perspective it would be quite sufficient to meet the demand for savings, and hence prop up aggregate demand during a downturn.

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