Almost two years ago, some of the most well known and well-respected
economists in the world pooled their collective wisdom in an article entitled
"An Economist's Manifesto on Unemployment in the European Union"
(henceforth, "the manifesto").1
When this group joined forces, the official unemployment rate in the European
Union (EU) averaged eleven percent. Although the unemployment figures have
improved since then, EU unemployment remains a serious problem in this
region.2 The authors of the
manifesto considered the high rates of unemployment, which prevailed at the
time they combined forces, to carry "damaging long run consequences,
especially for the young that represent, in most countries, the bulk of the
unemployment" (1998, p. 392). In addition, high levels of unemployment were
considered "degrading and demeaning for the unemployed" (ibid.). Thus,
their manifesto offered a number of policies designed to combat unemployment
in the European Union. The purpose of this essay is threefold. First, given
that the opinions contained in the manifesto derive from some of our
discipline’s most influential members, it is interesting to examine and assess
the manner in which they propose to cope with unemployment. Second, it is
intriguing to imagine how some of the great minds of the past (in particular
Lerner, Keynes, and Minsky) might have approached the same problem. Finally,
a host of alternative policies are proposed, and it is argued that a program
of direct job creation is likely to be the most efficacious full employment
A Cursory Look at the Manifesto's Stance on Unemployment
In assessing the manifesto, one might consider the degree to which the
authors proposed to alleviate unemployment. Also, one might consider how
quickly and at what "cost(s)" they were willing to pursue
a reduction in unemployment. Although the authors claimed that they were
proposing a "significant reduction" in unemployment, their plan actually
called for less than a 50% decline in the average rate. Specifically,
their goal was to "reduce unemployment by 4 or 5 percentage points"
(ibid., p. 359). The objective, then, was not to combat unemployment
in any meaningful sense (certainly not to eradicate it) but to bring it down
to some tolerable level.
Thus, despite its social and economic costs, the authors proposed a reduction
of only 4 or 5 percent points. Why not take a bolder stance? Why, for
example, not eliminate involuntary unemployment altogether? It seems that,
without explicitly stating it, the authors had some sort of a NAIRU in mind.
Such a creature appears to be lurking in the background, for the authors
repeatedly refer to a cautious pursuit of rising employment, lest the
beast rear its ugly head. For example, the authors reassured the reader that
their policies were designed to reduce unemployment "without compromising the
recent gain in subduing inflation" (ibid.). They also said, somewhat
cryptically, that "the bulk of European unemployment serves no useful
purpose whatsoever" (ibid., p. 332). The implication, of course, is
that some unemployment serves a "useful" purpose. Given its (stated)
ill effects on social and economic well being, must we not conclude that its
"usefulness" derives from its price-stabilizing effects? Perhaps the clearest
evidence of a NAIRU can be found in their argument that unemployment is not a
very potent instrument to control inflation when there is already plenty of
slack [in the labor market]" (ibid., pp. 347-8). Again, the
implication is that unemployment is a useful way to control inflation
once the labor market begins to ‘tighten’ so that some slack in the
labor market (i.e. some unemployment) will be useful in controlling further
price increases. The ultimate goal, then, was to achieve an (average) rate of
unemployment of 6 or 7 percent, but it was not to be done at the expense of
But there is another troubling aspect to their proposal, namely how quickly
were those lucky enough to fall outside the reserve army of the "degraded and
demeaned" supposed to secure employment? If adopted, the policies proposed in
the "manifesto" were designed to reduce unemployment "significantly in a
matter of a few years" (ibid., p. 328). So the overall objective
appears to have been to bring the (average) rate of unemployment in the EU to
its NAIRU in the next few years.
Combating unemployment, like combating any other economic ill, requires
identifying the cause(s) of the problem and then eliminating or
mitigating these causes. Viewing the problem from Minsky’s perspective, this
requires "understanding how a capitalist economy behaves," because its
behavior "will give us knowledge that will enable us to control and change it
so that its most perverse characteristics" can be controlled (1982, p. 32).
They key, of course, is in the analysis of the working or behavior of the
capitalist system, for the diagnosis reached at this stage will determine the
cure to be applied in the next stage. Just as different medications will be
prescribed to patients diagnosed with different illnesses, different policy
prescriptions will follow from differing diagnoses. First, let us examine the
manifesto’s diagnosis and prescribed cures.
For the authors of the "manifesto," the diagnosis was clear: the patient
suffered from high unemployment. The task, then, was to discover its cause(s)
in order to prescribe a set of medications (policies) aimed at reducing it.
The doctors ruled out a few potential causes in their preliminary analysis,
concluding that the illness was not induced by:
Having narrowed the list of potential ‘carriers,’ the doctors then searched
for a healthy system in order to gain some insight into the proper blend of
institutional diet and fiscal and monetary exercise. The UK and the
Netherlands passed their physicals and were considered healthy benchmark
economies. The doctors concluded that their good health was due, in part, to a
healthy ‘diet,’ achieved through the elimination of labor market fat.
Specifically, the proper diet called for: the restriction of strikes and
secondary picketing, the decentralization of wage bargaining, the
liberalization of hiring and firing restrictions, the reduction of the
duration of unemployment benefits and tightening of eligibility requirements,
and the abolition of minimum wage laws. Another important contributor to the
stellar physical health of the UK, they concluded, was exercise. By
‘exercising’ its right not to join European Monetary Union (EMU), the
UK was able to avoid the contagious effects of the convergence criteria, which
the authors (rightly) blame for at least some of the unemployment. The ailing
countries, the doctors concluded, were suffering from:
- Insufficient skills
- Lack of motivation to seek jobs
- Burden of taxes
- Rapid technical progress
- Competition from low-wage countries
- A crisis (inherent) in capitalism
Treating these, they argued, would heal the patient.
- Restrictive monetary and fiscal policy in order to prepare for the
- Minimum wages
- Job security legislation
- Work sharing and early retirement
The authors lamented the European Union’s focus on a supply side policy
approach to unemployment and argued that much greater reliance on demand
stimulus via fiscal and monetary policy was in order. Since the patient
already failed to ‘exercise’ its right to opt out of monetary union, the
doctors prescribed a limited exercise program, designed to put a bit
more hop in the patient’s step. Although some exercise was encouraged (e.g.
countries should ‘exercise’ their collective will to alter budget deficit
accounting practices so that investment in infrastructure, etc. is expensed
according to the rules of a capital budget, rather than being written off in a
single period), the doctors did not encourage them to seek complete freedom to
run as fast and as far as they like (i.e. run massive deficits). Still, they
concluded that the patient should do more exercise, so the following demand
management policies were prescribed:
Thus, to get around the 3% deficit-to-GDP limitation imposed by the Treaty,
countries were urged to call for a change of accounting practices so that they
could increase capital investment while upholding their obligation to conform
to the Maastricht criteria. This is surely a noble strategy, for numerous
studies have shown that public capital expenditures yield positive feedbacks
through increases in private sector productivity, profitability, investment
and employment (see Aschauer, 1989a, 1989b; Erenburg, 1993; and Mundell,
1990). Thus, capital outlays sustain the secular growth path of the economy
through their crowding-in effect on private investment and, through this
impact, stimulate additional private sector employment. In general, then, the
policy deserves support.
- Expand the rate of public sector investment through increased government
(capital) investment, concentrating on "specific infrastructures capable of
giving [competitive market] returns in the short-run" (Modigliani et al., p.
- Increase private sector investment through central bank (ECB) lowering of
But there is no reason to restrict the government to some narrow efficiency
criteria. Indeed, the government should evaluate individual projects on their
respective merits and allow the overall budget outcome to emerge as a
residual. This, of course, is consistent with Abba Lerner’s approach
to finance. Lerner dubbed his approach "functional finance" because it was
the ends (as opposed to the means) that were considered relevant (Lerner,
1943). Minsky clearly agreed, arguing that economic efficiency should never
be the aim of economic policy (1996, p. 10). Rather, he argued,
"policy should strive to assure the civilized standards of an open and
democratic society" (ibid.). Presumably, Keynes would have agreed -
paying people to dig holes surely would have failed any requirement to
undertake only those projects expected to yield a competitive market yield!
The point is, the (indirect) stimulus from public sector investment is too
important to allow arbitrary (and unnecessary) restrictions on public sector
project yields to dictate their undertaking. Especially if the (indirect)
stimulus from an interest rate reduction cannot be relied upon.
Now, it appears that the authors of the manifesto placed a great number of
eggs in the European Central Bank’s (ECB) demand-stimulus basket. Indeed, the
authors claimed that the ECB would become the "only institution with
substantial power to influence investments" (Modigliani, et al., p. 348).
This power, they suggested, was to be wielded through the use of its "long
acknowledged, classical tool of investment control," the rate of interest
(ibid., p. 346).
But can monetary policy be relied upon to stimulate private sector investment
and, thus, employment? Although the central bankers themselves argue that
they wield little, if any power in this area, Modigliani et al., accuse them
of underestimating their competence, arguing that their ability to influence
investment derives from their ability to control prices. In short, their
control over prices is supposed to give them control over demand and, thus, at
least some control over investment.3
Lerner, like Keynes expressed concerns about the effectiveness of monetary
policy as a stimulus to investment demand and, hence, employment. The
effectiveness of monetary policy was also weakened by the capital critiques,
which questioned the logical argument linking the interest rate (inversely) to
investment demand. Moreover, Fazzari (1993) has shown (empirically) that there
is no distinct link between these two variables. Despite these uncertainties,
half of the demand stimulus policies4 proposed in the manifesto relied on the (weak) link
between interest rates and investment demand.
In sum, for those countries that have subjected themselves to monetary union,
only fiscally sound‘exercise was allowed, perhaps an occasional brisk
walk. This sort of ‘exercise’ was encouraged in order to make the patient
feel a bit better, but the types of activities that would really get its heart
rate going were not prescribed. Ailing economies should feel better after a
bit of ‘exercise,’ but were cautioned not to overexert themselves, for any
injuries they might suffer would "burden future generations" (Modigliani, et
al., p. 344) who would be forced to nurse them back to health. Thus, despite
an apparent prescription for a heavy dose of demand ‘exercise,’
the patient was really asked to rely upon a more sensible ‘diet’ to supply
it with the right mix of resources.5
With the diagnosis and the demand-side prescriptions firmly in hand, the
doctors settled on a supply-side treatment: "we think that, in order to fight
unemployment, it is necessary and feasible to introduce a substantially higher
degree of flexibility in the European labor and product markets including,
where necessary, a relaxation of job security legislation, a reduction in the
coverage of collective bargaining agreements, and a reduction of barriers to
entry of firms and of barriers to geographic mobility of labor" (ibid.,
p. 349). The policies were designed to give greater "incentives" to both
employers (who are discouraged from hiring/firing at will) and prospective
employees (who are too well cared for on the dole to be bothered to accept a
job at a lower wage).
The problem, the doctors maintained, was that workers have engaged in a number
of unhealthy activities. Thus, unions, job security, and minimum wages, like
alcohol, cigarettes, and sweets, may be tempting, but partake in them and
you’re sure to suffer health problems. The patient has been gluttonous, they
agreed, so the solution was to improve its ‘diet’ by greatly reducing (if not
eliminating) these fats. The result would be a healthier, leaner European
The doctors prescribed a fistful of pills to treat the supply-side
For the authors of the manifesto, it was necessary to redesign the incentive
structure in order to increase both the number of jobs offered and the number
accepted. Minimum wage laws, they contended, were a "[potential] source of
unemployment" and were "inspired by a lofty ideal that anyone who wishes to
work should be able to secure a minimum decent living standard" (ibid.,
p. 336). They argued that these laws prevent (mainly young) people with no
experience and little "human capital" who would be willing to work for a wage
below the minimum wage from securing employment.
- Encourage fixed-term and part-time jobs favoring women and the young
- Reform job security legislation - Make it easier (i.e. less costly)
for firms to fire workers
- Adopt job-creation policies - Create jobs, either in the private or public
- Restructure minimum wage legislation - Devise a‘special’
(sub-minimum) wage for the least employable
search-promoting policies (e.g. Restart Program in UK)
- Promote policies to stimulate worker mobility (e.g. portable health
insurance and pensions)
- Reform unemployment benefit programs Provide incentives to take
available jobs and aid when jobs are unavailable
- Allow conditional negative income taxes - An alternative to
- Support a benefit transfer program - Take money that is currently
spent on unemployment benefits and give it to firms as subsidies
- Auction off unemployment benefits and employment vouchers
In evaluating the author’s proposal, one must consider whether nominal wage
reductions are really likely to improve the patient’s health. Surely it is
possible that a reduction in the nominal wage will reduce the money demand for
consumption, which might cause firms to adjust their profit expectations and,
hence, reduce their demand for labor. That is, there may be a positive
relationship between changes in nominal wages and changes in employment. On
the issue of job security legislation, the authors argued that firms will
"eventually find it advantageous to shrink their labor force" and that it is
inefficient to prevent them from doing so (ibid., p. 337). Consider,
however, a firm that notices a decline in its sales revenue and decides to
reduce its labor force. This firm will gain (or minimize its losses) only if
other firms do not take similar action. If, however, other firms follow suit,
the result could be a downward spiraling of aggregate demand. It is possible,
then, that job security legislation may actually protect firms from
themselves by preserving consumption demand.
For Lerner (1951), the pursuit of full employment would promote economic
security, which was considered an important benefit in and of itself. Indeed,
Lerner maintained that job security was an even more important benefit to full
employment than the benefit from increased output. James Galbraith and Tom
Ferguson would echo Lerner’s concerns. They stress the importance of
improving working conditions as well as solidifying people’s grip on jobs,
income and hours (Ferguson and Galbraith, 1998). Although Minsky would have
agreed with a number of the supply-side policies promoted in the "manifesto,"
he, too, would have opposed any attempt to reduce economic security, for he
argued that "capitalism can be successful only if economists and policymakers
recognize that people have a limited tolerance for uncertainty and insecurity"
(1996, p. 9).
Moreover, the manifesto’s proposed cut in current outlays should, by its own
logic, be unnecessary. That is, the proposed increase in capital outlays
(what Argyrous (1998) calls ‘autonomous’ spending) is designed to feed back as
a decrease in the quantity of current (or what he calls ‘endogenous’) outlays.
Thus, tightening unemployment eligibility criteria, shortening the length of
coverage, etc. should not be part of the "manifesto," as these forms of
spending should automatically decline as ‘autonomous’ outlays increase. But as
we have seen, the authors proposed restricting ‘autonomous’ outlays to those
projects expected to yield a competitive market return. Because of these
restrictions, the feedback mechanism may fail to stimulate sufficient private
sector activity, leaving unemployment too high. This, of course,
strengthens the argument to leave automatic stabilizers in place (in
full force) so that incomes will be prevented from spiraling downward. Thus,
if additional capital expenditures successfully stimulate private sector
investment, transfer payments will decline; if they are unsuccessful, at least
the entitlement program will help to mitigate the effects of depressed
Finally, the manifesto opposed work-sharing and early retirement on the
grounds that "there is no justification for the government to provide
incentives for people to work shorter hours or retire earlier" (Modigliani, et
al., p. 388). Galbraith and Darity make a number of compelling justifications
for government intervention, including positive social, psychological,
physiological, and economic benefits from work-sharing and early retirement.
Keynes certainly thought that a shortened workweek was possible. In
Economic Possibilities for Our Grandchildren, he suggested that within
"one hundred years" we would witness a different form of economic organization
in which all would earn sufficiently high incomes while working a fifteen-hour
week (1930 , pp. 328-9).
Some (Further) Problems With the Proposed Policies?
The authors of the manifesto relied on three policies in order to stimulate
employment. The first policy was to increase public sector investment
as a means of increasing private sector investment in order to
stimulate employment. The second policy was to encourage the central bank to
lower the interest rate as a means to stimulate private sector
investment in order to increase the demand for labor. The final policy (set
of policies) was to increase work ‘incentives’ (to firms and workers) as a
means of increasing employment. With regard to the second proposal, it
should be noted that if firms are currently operating with substantial excess
capacity (as they likely are), targeting employment via private sector
investment may not be the best short-run strategy. This, as Minsky explains,
is because investment decisions depend upon profit expectations over a longer
time horizon. In order to induce private sector investment, then, something
must be done to impact (favorably) long-run profit expectations. This, most
likely, will require increasing actual or realized profits in
the short-run, so that longer-run expectations will be revised upward.
From the Kalecki-Levy profit equation, we know that:
After Tax Profits = Investment - Non-Business Saving
Given that firms are normally operating with excess capacity, and that
inducing new investment will require increasing realized profits in the
short-run, the best short-run strategy is the one that boosts deficit spending
(i.e. reduces non-business saving) and, hence, actual profits. Thus,
of the two demand-side policies designed to increase employment, only the
proposal to increase public sector investment (financed by deficit
spending) is likely (through its impact on short-run profits) to induce
additional hiring in the short-run. This, as Minsky explains, is because in
the short-run, firms are motivated to increase output and employment "on the
basis of the profits they expect to earn by using labour and the existing
capital assets to produce and distribute consumption and investment
output" (1982, p. 34; my emphasis). Thus, firms will hire more workers as
their short-run profit expectations increase, but lower interest rates will
not induce them to undertake new investment until some optimism has been
generated. The latter will occur only after (realized) short-run profits
cause an upward revision of long-run profit expectations.
Similarly, the set of ‘incentive’ policies are likely to succeed at inducing
additional hiring in the short-run only to the extent that they improve firms’
short-run profit expectations. If firms view the proposed subsidies, hiring
and firing freedom, etc. as sufficiently large cost-reducing measures, they
may indeed increase their demand for labor. But note that this depends
entirely on the firm. Activist ‘entrepreneurs’ hire passive workers. The
aggregate supply schedule for labor may not exist so that aggregate demand,
alone, determines employment (Galbraith, 1997).
An Alternative Diagnosis
For Minsky, the patient would be diagnosed as suffering from a virus with
recurring symptoms. Sometimes the patient looks and tests healthy, but this is
always a transitory phase. Eventually, a sore throat followed by a
fever and, possibly a full-blown flu will develop. In other words, the system
itself is prone to generate periodic (and lasting) ills (e.g. unemployment).
In order to keep the patient alive, Minsky would have written a prescription
for a shot of carefully crafted institutional reform to be followed (as
needed) by occasional shock therapy.
Again, Minsky’s treatment would differ because his diagnosis would differ.
Keynes, Lerner and Galbraith would, presumably, also write prescriptions that
differ significantly from the one written by the authors of the manifesto. In
part, this stems from their fundamentally different position regarding an
individual’s right to work. For the author’s of the manifesto, it will
be recalled, the belief that all who are ready, willing and able to work
should be afforded a decent job at a decent wage derives from a "lofty ideal"
that cannot possibly be accommodated. Lerner, Minsky and Galbraith agree with
S. Jay Levy who argues that to deny a job to a person who is willing and able
to work is a gross inequity (1998). As Minsky put it, "the economic and human
costs of unemployment - to individuals and the nation - are too great to be
tolerated in a society replete with unmet needs" (1996, p. 11).
Alternative Policies to Stimulate Employment:
Monetary Union is a creative (if flawed) institution. If, as the authors
of the manifesto suggest, its adoption is largely responsible for the current
state of unemployment in EMU countries, it is probably going to take some
creative policies to successfully combat the problem. In other words,
textbook supply- and demand-side policies may not suffice. Below are a
handful of policies that might be considered in their stead.
- Government housing projects - This proposal is based on S.J. Levy’s
observation that "since 1990 in the EU the cost of shelter has increased twice
as fast as the consumer price index in every major economy except the UK. The
beneficiaries of this increase are the owners of rental property and the
holders of mortgage loans, who realize gains without making any additional
contributions to the production of goods and services and therefore to
employment. Those who must spend more for their housing have less to spend in
stores and their suppliers need fewer employees" (1998, p. 10).
- Wage and price floors - Deflation, rather than inflation, is the current
threat to world economies. As Papadimitriou and Wray (1998) argue, deflation
discourages investment because firms cannot be sure that their expenditures
will be recovered in an environment of falling prices. Something similar to
the New Deal wage and price controls, which set ‘floors’ to workers’ and
firms’ incomes, could prevent EMU countries from sliding into a deep recession
- Public investment - Spending on education and training (upgrade
facilities, provide supplies, reduce class sizes, etc.), science and
technology, and infrastructure should be increased.
- Private investment - Taxes and subsidies should be used to encourage
individuals and firms to enhance productivity through training and upgrading
- Community development banks - They should be designed to increase
investment in communities where needs are not being serviced by existing
banks. Both the authors of the "manifesto" and Minsky (1992) proposed
something similar to this.
- Encourage the production of consumption goods - Minsky suggested that
policy emphasis should shift from the encouragement of growth through
investment to the achievement of full employment through consumption
production. This, of course, complements his Financial Instability Hypothesis,
since a less capital-intensive economy will be less susceptible to financial
- Direct job creation - Lerner argued that the maintenance of full
employment, through its impact on business expectations and confidence, would
help to impart stability. Of course for Lerner, as for Minsky, full employment
did not mean unemployment at the non-accelerating inflation rate! Lerner
viewed full employment as a fundamental macroeconomic goal and believed that
it was the responsibility of the State to promote its attainment (Forstater,
1998). Both Lerner and Minsky supported a program of direct job creation in
the form of public works in order to achieve true full employment (i.e. zero
involuntary unemployment). Such a scheme, modeled on the WPA, NYA, and CCC,
could be used as a prototype for a similar employment program in the EU. (See
The proposal for direct job creation is, perhaps, the most promising solution
to the unemployment problem in the Eurozone. That said, it is also true that
under the current institutional framework, it would be impossible to implement
such a program. This is because a variety of constraints – including those
imposed by individual member states themselves, those imposed under the
Stability and Growth Pact, and those imposed by financial markets -
will serve to restrict deficit spending below the level that would be required
to sustain a federal job assurance program. One way to resolve this fiscal
constraint is for member states to unite politically (Kregel, 1999). In Wynne
Godley’s opinion, political unification is the most appropriate means by which
to return fiscal freedom to the Eurozone (1992, p. 40). Another option might
be the establishment of a European institution that would guarantee all bonds
issued for the purpose of financing such a program (Berglund, 1999). Under
current arrangements, member states must compete with other borrowers when
they float bonds on the capital market. This subjects them to financial
market discipline and leaves them unable to run the kinds of deficits that a
federally funded job assurance program would require. Either way, something
more must be done.
While the manifesto’s authors recognize that EU unemployment is a problem,
they do not propose the kinds of fundamental reforms that Lerner, Keynes or
Minsky would have supported. The difference, of course, derives from their
differing assessment of the problem. Moreover, the "prescriptions" that each
group would write for these ailing economies differs according to their
diagnoses. As economists, we must pay attention to history, institutions,
culture, etc. If our diagnoses are flawed, we are likely to prescribe the
See Modigliani, et. al, BNL Quarterly
Review, no. 206, pp. 327-61, 1998.
Using the revised unemployment
rates from the OECD, the 1998 average rate of unemployment within the Eurozone
was 8 percent, and the average rate in 1999 was 7.2 percent.
Ironically, this argument
follows a previous concession that the ECB has "very little control over the
price level" (p. 347).
If the interest rate-investment
link proved sufficiently weak, fully half of the demand side policies would
The manifesto could easily fool
a reader into believing that demand side policies are far more important than
they actually are. In fact, monetary policy is the key to the proposed
demand side policies, and yet its only discussion occurred on page 348.
The only other demand side policy was a constrained proposal to
increase capital investment spending.
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