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.

               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
                                                                              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

        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

        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
                                                                                      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).
     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

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