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Job Destruction and Job Creation
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schools brief
Job Destruction
and Job Creation
A Beginners Guide
Wolfgang Kasper
Contrary to much political rhetoric, it is private enterprise that creates jobs,
not governments, whose interventions often kill jobs.
A
low rate of unemployment—measured as the as additional workers add to their profitability. If we
percentage of those in the working-age consider production level [Y/P]* and assume that the
population seeking work at the prevailing average real wage level (wages adjusted for inflation)
wage—is widely considered an important goal of stands at [w/P]*, the business sector will over the
economic policy in Australia. Unemployment is thus medium term seek to offer jobs to L* number of workers,
an excess of the demand for jobs (or employment) over no more and no less. Were business to offer fewer jobs
the supply of jobs by enterprises at a point in time. (say, L**), profitability could be increased by adding
workers. The marginal workers would contribute more
A simple model of the labour market to output (have a higher productivity) than they cost
Standard economic analysis can help to clarify the (namely the prevailing wage [w/P]*, see central panel
demand-and-supply situation in the jobs market. in Graph 1). If, on the other hand, more people were
First, we have to ask: What determines the supply of employed than L* (say L***), businesses would make a
jobs? Time-tested theory relates employment to loss, as the marginal workers would cost more than they
production, through what economists call an ‘aggregate add to output ([w/P]* > MPL***). In other words, there
production function’. It seems plausible that expectations is a tendency for job offers to adjust to the real wage
of additional units of output (for example, measured as level.
billions of dollars of national product in real terms) lead If the real wage level rises, then fewer jobs will be
to expectations of additional demand for labour input (refer profitable and fewer jobs will be offered. The marginal
to Graph 1 opposite, upper panel). The relationship productivity of labour (MPL) is thus equal to the
between inputs of labour and outputs of national product demand for labour (or the supply of jobs). The amount
tend to be such that the marginal output-input ratio or of labour that people seek to supply also depends on the
‘marginal productivity of labour’ (MPL, depicted by the real wage. The higher it is, the more people will plan
gradient of the national production function) becomes to work (lower panel in Graph 1), which reflects the
gradually flatter as production increases. What this means labour market. This allows us to depict unemployment
in plain English is that—for a given capital stock, given for alternative real-wage levels as the difference of supply
skills and technology, given natural resources, and given
economic structures—additional workers add less and
Wolfgang Kasper is Emeritus Professor of Economics,
less to overall output until the marginal product of University of New South Wales, and Senior Fellow, The Centre
additional workers (MPL) becomes zero (middle panel of for Independent Studies (CIS). Among his many CIS
Graph 1). publications, ÂSchools BriefsÊ readers may find his monograph
When businesses are exposed to a reasonable degree on Property Rights and Competition: An Essay on the
of competition, they will seek to hire workers as long Constitution of Capitalism (1998) of particular interest.
58 Policy vol. 18, no. 2
J OB D ESTRUCTION AND J OB C REATION
of and demand for labour (expressed differently: the of job seekers will fall until there is an ‘equilibrium’
excess of jobs sought over jobs offered). in the jobs market, the demand for and the supply
of jobs being compatible with each other.
How to eliminate unemployment? A high flexibility of nominal wages is how job
Graph 1 can help us to discuss various ways in which markets used to function in 19th century Australia,
unemployment can be eliminated. how they work in many parts of the flexible US
economy and how they still function in many third
(a) Cut nominal wages: One obvious way is to reduce world countries. The normative argument against
the real wage by cutting nominal wage rates [w]. The this state of affairs is that wage cuts impose hardship
number of jobs offered will increase and the number on workers. But what is harder to take for someone
willing to work: to be out of work or to
Graph 1. take home a smaller pay packet? When
Ansett Airlines went broke in 2001-02,
many pilots and cabin staff welcomed
Aggregate Production Function
new jobs with Virgin Blue even if that
meant a pay cut. For many people, the
social life and the stimulation on the job
are preferable to sitting idly at home—
but this is a subjective, normative issue.
In addition, one can argue that it is often
not desirable to shrink wage incomes, as
this might reduce demand for product
and hence the employment of others.
(b) Erode the real wage by inflation:
Another way to eliminate un-
employment is to encourage inflation
(rising price level P) and keep nominal
Marginal Product of Labour wages constant, so that the real wage
[w notional /P] is reduced. When trade
unions and government regulations made
nominal wages downwardly rigid in the
late 19th and early 20th centuries,
industrial economies began to experience
high and durable unemployment levels.
In the 1930s, these levels became socially
intolerable.
British economist, John Maynard
Keynes, suggested that unemployment
Labour Market could be lowered by the surreptitious
means of keeping nominal wages low and
encouraging ‘mild’ inflation (printing
money, public deficit spending). When
this recipe was tried in a major way in
Western countries in the 1970s, it failed
conspicuously. Trade unions had the
muscle to negotiate for inflation-adjusted
(real) wages and there were many
automatic inflation clauses in wage
contracts. The ‘Keynesian trick’ proved
Winter 2002 59
J OB D ESTRUCTION AND J OB C REATION
to be impossible. Australia’s Labor governments of practices, the tapping of new natural resources,
the 1980s and early 1990s nevertheless tried the technical innovation and structural changes. All
trick again: They concluded a political deal with the this is driven by enterprise, as long as there is
unions to control wage levels (‘The Accord’) and economic freedom and small government (low
went for cautious demand expansion. But rising taxation). Of particular importance is the removal
public debt levels, the government’s labour-market of counterproductive work practices (a deregulated
regulations, union influence and public resistance labour market). In a deregulated, dynamic
to inflation prevented the hoped-for drop in economy, the production function becomes an
unemployment numbers. upwardly mobile feast. This means at the same
The biggest and longest test of the Keynesian time that the demand for labour schedule shifts
recipe to ‘print jobs’ by inflating demand has been to the right (Graph 2). At the given real wage [w/
conducted by Japan since the late 1980s; one P]1, job offers increase to L2. Alternatively, higher
stimulus package after the other was launched—and real wages can now be earned if the workforce
the result has been rising unemployment. It is now remains at L1.
widely accepted that the Keynesian idea of demand The drawback for some is that everyone has to
injection, accompanied by nominal wage control, compete.1 Union powers and special privileges have
may work once, but that repeated injections work to be controlled and governments have to remain
like heroin—we become inflation addicts and get small and non-interventionist (no hand-outs in
less and less of a ‘lift’ from another demand injection. exchange for favours to the party in power). But
the advantages of this job creation strategy are
(c) Reduce labour supply: Labour supply is reduced if massive: a higher real wage (higher living standard)
people are paid for not working; that is, if is compatible with full employment.
unemployment is subsidised to help the jobless. Then, This approach to job creation has been tried,
the labour supply curve shifts to the left. This of course within limits, by successive Australian governments
makes the prevailing real wage more tenable—no since the 1980s: reduction of protection and
wonder organised labour unions favour taxpayer- subsidies, tax reform, less subsidisation to
financed subsidies to the unemployed. The dole yesteryear’s shrinking industries and regions, less
removes some low-cost competition for workers. favouritism and partial labour market reform. It
In recent years, successive Australian governments has led to a moderate ‘productivity explosion’ and
have reduced the eligibility for the dole and have made a new confidence and optimism.2 The 1990s have
it harder to remain unemployed. This has made a real reconfirmed that rising productivity is good for
contribution to improving the jobs situation. employment and that measures to raise the
Other ways to reduce labour supply is of course to production function (called ‘supply-side policies’)
cut the work week, to subsidise early retirement from are the most promising escape from
the workforce or to keep young people longer at school unemployment. Much more could be done,
or university. Both these types of labour market policy however.
reduce the capacity to produce and hence lower living
standards. Having reached this stage, the reader may ask: What
about the frequently heard assertion by politicians that
(d) Increase labour productivity and the demand for labour: the government created so and so many jobs? The fact
A fourth way to eradicate unemployment is to shift is that most jobs are created by private enterprises,
the demand-for-labour schedule to the right (Graph that is people with capital and ideas who employ
2 opposite). The assumption made so far was that others. Governments only create jobs when they put
there is a given production function, with given more bureaucrats or workers on the government
levels of skill, capital, resources, technology and payroll—and the taxes to pay their wages and salaries
enterprise. But this is a short-term and static view, are a burden on private employers and hence on private
and as such it is misleading. In reality, we live in a job creation. As we saw, the attempt to inflate demand
dynamic world of growth, where the production in order to ‘print jobs’ is largely discredited by
function is shifted upwards by investment in new experience and depends on workers tolerating a
tools, better human knowledge, skills and work surreptitious erosion of real wages. When governments
60 Policy vol. 18, no. 2
J OB D ESTRUCTION AND J OB C REATION
try to take credit for jobs growth (or are blamed for In a living economy, unemployment is also the
unemployment) that is based on tenuous and indirect difference between the ‘births’ and ‘deaths’ of jobs. There
connections, such as the removal of obstacles to is no deep mystery as to who causes still-born jobs that
employment by microeconomic reforms, as discussed never eventuate and who kills existing jobs. From what
in point (d) above. Beyond that, it is just ill-informed was said above, we can identify the chief culprits:
political propaganda.
(a) One major jobs killer is a wage explosion. When,
By way of a summary: who kills jobs? in the wake of booming demand, unions were able
Like a map, the simple model underlying the two graphs
to use their power to obtain massive nominal wage
abstracts from many time lags, frictions and increases in the early 1970s and in 1981, many
complications to assist us with navigation through a
jobs disappeared and unemployment rose—not
complex problem. In reality, job creation lags behind
because of a cyclical downturn but because of wage
the cyclical fluctuations in overall demand, so that
rises. Similarly, the judges engaged in Australian
watching unemployment figures as the key indicator of
industrial relations cases, who often display little
economic health is a bit like driving with your eyes
understanding for economic side effects, have time
fixed on the rear vision mirror. It is accident-prone. We
and again ‘granted’ wage rises far in excess of
must also be aware that behind such big aggregates as
productivity growth and thus killed jobs.3
‘job demand’ and ‘job supply’ is a diverse variety of
(b) Another big jobs killer is the social welfare state. By
different jobs and skills. diminishing the incentive to seek work, especially
at the lower end of the skills
range, easy access to social
Graph 2. Productivity Growth and High Employment
welfare reduces the supply of
labour and protects people from
re-skilling or moving to areas of
Aggregate Production Function high labour demand.
(c) Over the longer run, the
greatest jobs killer is the
regulatory system that inhibits
entrepreneurs from shifting the
production function upwards,
creating well-paying jobs: the
maintenance of obstacles to
foreign trade and investment by
the Federal government, the
many regulations of production
and trade, the support by elected
parliaments of favours to special
interest groups, subsidies to
uncompetitive industries and
Labour Market regions,4 and regulations of work
and production which hinder the
flexible adjustment and the skill
acquisition needed to cope with
changing circumstances. If some
State governments inhibit the
tapping of natural resources, for
example by unilaterally anti-
cipating Kyoto-style prohibitions
on burning our copious black
Winter 2001 61
J OB D ESTRUCTION AND J OB C REATION
coal, one of Australia’s greatest natural assets, then this
fixing, which has generated an entire ‘disadvantage
hampers the upward movement of the production industry’. If we had one generation of high employment
function and destroys jobs. and free labour markets, the apparent disadvantage
would vanish.
There may be good reasons why certain jobs will be There are, therefore, powerful grounds for arguing
killed, for example regulations to ensure public health for full labour market deregulation—abolishing
and safety, social compassion for poor people, political Australia’s odd and outdated industrial relations system,
opportunism to favour particular firms and regions, or where quasi-judicial officials set wage levels centrally,
intentions to protect the environment. Open political and withdrawing union privileges to
debate should in these cases explicitly form cartels and impose counter-
weigh up the employment productive work practices. Once
consequences with the other policy There are workers and employers are able to
objectives. But it is wrong to deny, as powerful negotiate freely for work conditions
is often the case, that the welfare state, throughout the economy (also with the
Greenhouse policies or the industrial grounds for full help of experienced agents), the
relations system create a dysfunctional labour market production function will shift upwards
labour market and cost jobs. sufficiently to give everyone a job
deregulation.
opportunity and rising real incomes.
The track record and the future The most important step in this
There has been some unemployment direction is that people learn to cut
throughout the 20th century, whereas there had been through interest group propaganda and think clearly
consistent labour shortages in the 19th century, partly about who the killers and the creators of jobs are—and
mitigated by the attraction of immigrants.5 The 1950s who deserves political priority: special, organised
and 1960s were a period of low unemployment, but interest groups or the population at large, including
the 1970s to 1990s, after the two above-mentioned the young.
wage explosions and Federal inflation policies, saw a
‘ratchet effect’: every recession brought a rapid rise in Endnotes
unemployment, followed by only a partial reduction 1 W. Kasper, Property Rights and Competition: An Essay on the
in the following upswing. The gradual economic Constitution of Capitalism, CIS Policy Monograph 41 (Sydney:
deregulation during the last two decades of the 20th The Centre for Independent Studies, 1998).
2
century, and the reduction of subsidies for being Productivity Commission, Microeconomic Reform and
unemployed, have in recent times helped to ease the Australian Productivity: Exploring the Links, vol. 1 (Canberra:
unemployment situation somewhat. Obviously, much 3 AusInfo, 1999), 23-33.
P. McGuinness, The Case Against the Arbitration Commission,
remains to be done.
CIS Occasional Paper 11 (Sydney: The Centre for
It is desirable to do more to raise labour demand, Independent Studies, 1985).
because unemployment is not only a disheartening 4 In politics and the media, there is a frequent confusion between
experience, but also unjust: a lack of a job is the single the preservation of certain employment structures (for example,
most powerful source of poverty. Unemployment by subsidy to a loss-making firm) and the fostering of high
inflicts burdens on many of those young people who employment levels. The former often undermines the latter
have poor job prospects and may indeed not get the aim, because resources are artificially channelled into declining
chance to get their foot on the ‘jobs-and-skill-learning activities, thus hindering the conditions for general jobs
ladder’. Arguably, the most important aspect of high 5 growth.
The evidence about whether immigration adds to
employment is that it empowers ordinary people. When
unemployment or leads to net job creation seems clear to me: on
labour and skills are short, willing workers are
balance, new immigrants add to aggregate demand and create
appreciated, and the ‘bosses’ compete amongst each more jobs, as long as they are skilled and willing to work. Immigrants
other to attract them. The long history of deficient also help with new ideas and make the production apparatus
employment opportunities and wage fixing in Australia more flexible, raising the production function. But this is a matter
led to persistent unemployment. Many observers of migrant selection: the case is less clear when the share of welfare-
conclude that this is the result of class warfare. The dependent refugees and family reunion migrants goes up and
reality is that it is an unintended consequence of price skilled and business migration goes down.
62 Policy vol. 18, no. 2
