Unemployment Vs. Economic Efficiency

Nothing makes an argument more frustrating than when 2 people are using the same words to argue over 2 different things.  When discussing strategies to get out of the recession, market fundamentalists (usually conservatives) argue to let the markets work.  Others, usually liberals who sorta-kinda understand Keynesian economics, argue that we need more stimulus to jump-start the economy.  Then the market fundamentalists respond with “markets are more efficient than government” it is always better.  Then they give some example of the government, in fact, screwing something up.  Then the liberal Keynesian says, free markets got us into this mess, and then gives an example of a corporation, in fact, either screwing something up or doing something evil.  This goes back and forth and is never resolved because they are talking about two different things.

If you’re arguing for more stimulus or increased aggregate demand and end up arguing over how much governments and markets do or don’t suck, you’ve lost the argument or – at best – will stalemate.  The reason is that in most cases markets are more efficient than government trying to do it.  Be it selling shoes or setting apartment rent prices.  The liberal position is not to suggest otherwise.  The problem is that it has nothing to do with your argument for demand management.  An economy that is deficient of aggregate demand can not fix itself because it has nothing to do with an individual product or industry.

To understand why these are two different things, let’s take a look at a proto-typical private market.  Let’s say that you run a company that sells dish soap and one day people  buy less dish soap.  Pretty soon you’ll notice you’re selling less dish soap and will start making less of it.  You’ll now need fewer employees and equipment to make that dish soap.  You can either move those employees and equipment to make other things(like paper plates) or you can lay off your employees and sell the equipment.  In a good economy those employees and equipment would eventually go to a company making other things.  That is economic efficiency that government should stay out of.

What happens when people start buying less of everything?  Those employees that were laid off would have no where to go because all companies are making less things because they are selling fewer things.  That’s what happens during a recession.  Now you have high unemployment and nowhere for those employees to go.  It is the difference between micro and macro economics.  If one is thinking “micro” they will think that the economy will simply sort things out – “let the markets work”.  However, when one looks at the big picture you’ll see that private markets can’t sort it out because it has nothing to do with the efficiency that markets are good at.

Additionally, if one takes a micro approach to a recession and sees that workers are being laid off, they might (rightfully, in a “micro” approach) suggest that the workers need to take a pay cut to stay employed.  Take our dish soap example.  If consumers are buying only less dish soap, then workers could take a pay cut to keep everyone employed.  If workers demand less money, then it might be better for the company owner to hire people instead of buying and maintaining expensive machines and computers to do the same work.  If however, the problem is that consumers are buying less of everything, pay cuts for all workers will only make the problem worse.  If all workers in an economy take a pay cut, those workers will then turn around and buy less of everything because they now have less money.  That must then be followed by another pay cut which would then lead to another general drop in people buying stuff which would lead to another pay cut… etc…

To suggest that an economy needs increased demand does not require one to reject free enterprise.  The private market cannot deal with a drop in aggregate demand because no single company or person can control overall demand.  John Maynard Keynes was the first to show this systemic problem.  His recommendation was for the government to be that outside force that adds demand to the economy by doing social investment.  The idea was that government would give more people money to work, and then they would spend that money which would then cause people beyond the government to get jobs.  Doing this restored demand and had the bonus of providing public works that society could benefit from like parks and libraries.  Since his time, economists have come up with further refinements to his original recommendation.

For market fundamentalists of course, this is all heresy.  Instead, the market fundamentalists continue blaming the government for everything.  To any other reasoned person, you see a deep systemic problem that requires outside intervention to balance.  These two concepts don’t have to conflict.  You can advocate for private markets and government intervention to restore aggregate demand.  Only dogmatic market fundamentalists can’t see the difference between that and eliminating free enterprise.

Related posts:

1. Job Guarantee: Zero Unemployment Without Causing Inflation
2. Time to resurrect an old idea: Economic Rent
3. The Purpose of Taxes
4. The Cost of Unemployment