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Business cycle and growth policy

Chapter 2: The aim of the full employment

Outline:

01st Restriction to the production factor labour

02nd The different dimensions of the employment level

03rd Full employment in the sense of equilibrium

04th Full employment in the sense of a certain level of employment

05th The problem of the long-term unemployment

06th Ascertainable versus necessary economic data

07th Self-affirmation and self-refutation of prognoses

08th The problem of a differentiating economic diagnosis

09th On the problem of the leading indicators

10th The economic barometer of the council of experts

11th Socio-political reasons

12th Growth policy reasons

13th State political justification

14th Conflicts between full employment and monetary stability

15th Conflicts between full employment and income distribution

01st Restriction to the production factor labour

The demand for full employment is synonymous with the aim of achieving equilibrium in the labour market. This equilibrium demand applies actually to all production factors. Here, though, we confine ourselves to the factor labour.

In the context of the labour factor, additional social aims apply compared to the other factors of production. In the case of the other production factors, full employment is especially desirable because without full employment a waste of scarce resources takes place. A full employment of the factor labour is additionally desirable as an end in itself. The right to work of every employee corresponds to the human dignity protected by the basic law.

Thus, with regard to manpower it is not just a question of avoiding wastage of scarce resources; the right of every single employee for a work of his choice preferably at free option is striven for his own sake.

02nd The different dimensions of the employment level

The aim of full employment refers initially to the number of employees. The equation applies:

N = A * a

· N: Total number of demanded working hours

· A: Number of employees

· a: Work time per employee

But the aim of full employment continues and refers to several characteristics.

The aim of full employment relates for one thing to the number of employees, but also to the work time per employee. A low labour demand could still be distributed in a way that every worker finds work, only that each worker has fewer hours of work than he actually wants. The demand for full employment, however, does not only refer to the aim of finding a workplace for every worker, but also to the further aim that every worker, only as long as he desires, fills a complete workplace also. The aim of full employment thus also relates to the work time per employee.

The work time per employee can for its part be changed in different ways. A variation of the effective work time per employee is possible.

· by changing the legal or collective working hours,

· by changing the average number of overtime hours,

· by increasing or decreasing short-time work, as well as

· by expansion or restriction of part-time work.

But with regard to the work time per employee it is not just a matter of ensuring that every worker can achieve as much work time as he wishes; in the foreground of the political efforts there is often the opposite aim, not of working as long as possible, but quite the contrary, to reduce the average work time.

In general, the realised welfare is measured not only in terms of average income, but also in terms of the extent of leisure time. Thus, the unions will not only fight to raise wages for their members, but also to secure a given wage income with as few working hours as possible.

The aim of reducing the number of working hours is particularly important because the individual employee is generally not free at all to decide how much working hours he has to do. He is usually faced with the alternative of either accepting a labour supply with a predetermined number of hours that can not be influenced by the employee, or of abandoning the whole offer.

In addition, it is assumed that the activity of the employee, as opposed to that of a self-employed person, is largely other-directed, so that an increase in leisure time, in which the individual can determine by himself how to shape his own leisure time, is usually regarded as a welfare gain.

Now we must assume, though, that the ideas of the individual employees about the desired distribution of their time into work time and leisure time differ greatly. A reduction in working hours is a welfare increase for one person, because he can achieve greater benefits in his free time than by being able to achieve a higher income by more work. For another one, though, the same decrease in the number of working hours is a welfare loss, since he could achieve a higher benefit increase rather by a higher income, which he could afford with more working hours, than by more free time.

This conflict, that one and the same change in the working hours influences the individual welfare for the single employees in different directions, is generally regulated by the fact that collective or statutory wage rates are binding in the sense that every employee is entitled for the amount of leisure time provided by collective agreement, but by way of overtime hours, those employees who prefer less leisure time, have the opportunity to effectively work more hours than provided by law.

Due to the different needs structure of individual employees, an optimal distribution of work time and leisure time would only be guaranteed, if each employee could decide for himself how he divides his entire time into work time and leisure time. However, since the prevailing production technique does not allow such freedom of choice, and presumably if such techniques were possible, then productivity would fall sharply, the current regulation on the determination of the standard work time combined with the possibility of working overtime if necessary represents a second-best solution after all.

03rd Full employment in the sense of equilibrium

It could firstly be spoken of full employment at a match between supply and demand in the labour market in the sense of total equilibrium. Every person willing to work will find employment in this case. Every free workplace can also be filled in this case.

The starting point is the number of all employees in a national economy. A deduction of the incapacitated is made and of those who are able to work but unwilling to work. There remains: the number of persons able to work and willing to work who are employed (the employees) as well as the unemployed.

The degree of employment is here defined as the ratio of employed persons to all workers: B/A.

B: Total number of employed persons

A: Total number of employable workers willing to work

However, there are differences between factual and registered unemployment: persons registered as unemployed can work on the side. Or out of unconsciousness and misconceived social prestige, unemployed people do not report unemployment. Furthermore, due to the protection against dismissal, some employees can not be dismissed although they can not be employed effectively.

In addition, it may be more advantageous for an entrepreneur to not dismiss skilled workers despite a lack of demand than to dismiss them and to search and train new skilled workers again in future needs.

It must also be reckoned with a different development of unemployment on partial labour markets. The most important reason herefore is an overlay of cyclical and structural crises.

Other causes also require other therapies. Therefore, it is secondly appropriate to limit the concept of full employment to the macroeconomic equilibrium. A possible benchmark for this second term is the ratio of the number of job vacancies to the number of unemployed persons. At the determination of the number of vacancies arise difficulties, though. Enterprises are indeed not obliged to report vacancies to the employment office. What's more, enterprises partly exert demand for labour force based on suspicion. There may be no acute need yet, but one wants to get an overview of the market situation and also conduct interviews, so that when there is a demand for new labour force, one can immediately hire already tested candidates.

04th Full employment in the sense of a certain level of employment

By contrast, William Beveridge had spoken of a breach of the full employment aim if the unemployment rate exceeded 3%.

The starting point is formed by the following thought: There is a structurally conditioned long-term residual unemployment which is largely consistent. Thus, it will not be able to reduce this residual unemployment by way of employment policies. Then it is appropriate to speak of a need for employment policy only when the actual unemployment exceeds this mark of 3%. The attempt to reduce the residual unemployment would be unsuccessful in the short-term. But then it is also appropriate to refer the concept of full employment only to workers for whom unemployment can actually be reduced politically.

The residual unemployment can also be fought in the long run, however. But there are usually other causes that determine the extent of residual unemployment. Other causes, however, require also other measures. So it still makes sense to distinguish between the unemployment which is due to lack of demand for goods and structural unemployment which has to do e.g. with an insufficient education level of some unemployed persons. While the unemployment which is based on insufficient private demand for goods may be combated with an expansion of government expenditure, this measure would have no impact on the structural unemployment, if e.g. additional government expenditure would be used to develop the transport network.

In fact, there has been a change in the ideas about the extent of residual unemployment in the recent decades. Herbert Giersch, chairman of the Council of Economic Experts in the 1970s, suggested due to the strong decline in unemployment that it should not be spoken of full employment until the unemployment rate has fallen below 0.8%.

Possible causes of this change according to Giersch are:

· the bad weather allowance regulation of 1957,

· an increased mobility,

· the active labour market policy,

· the role of the guest workers,

· a too low education as a cause of unemployment.

Since the 1990s, the unemployment rate has risen again so sharply that one would now be speaking of full employment if the unemployment rate had fallen to 3%.

As causes of this change since the 1990s apply: The reunification brought about a substantial increase in production costs by way of the solidarity contribution and therewith deterioration in the competitiveness of the German economy, which was reflected in an increase in the unemployment rate.

At the same time, globalisation and the involvement of some emerging economies had worsened international competition, which in turn has led to an increase in the unemployment rate.

It is therefore entirely justified to refer to the concept of full employment solely to cyclical induced unemployment and to refer to unemployment which can be attributed to structural factors as residual unemployment which can not be combated with traditional economic stimulus programmes. In any case, though, it must be recognised when it was achieved to reduce the extent of residual unemployment. In this case, the aim of full employment is also achieved at a different level of unemployment.

05th The problem of the long-term unemployment

It is furthermore necessary to differentiate in the duration of unemployment. Long-term unemployment according to common understanding is when unemployment lasts more than a year.

Short-term unemployment as a consequence of welfare-enhancing structural change is hardly avoidable and is quite tolerable in terms of the consequences. A welfare increase is only conceivable with a change in technology as well as in the demand. If the hereby resulting unemployment lasts only for a few months, then the hereby resulting welfare loss will have to be assessed less than the welfare loss which would have to be expected if one did not want to allow any change in demand or any technical improvement.

But long-term unemployment is associated with serious social consequences: Above all, the reemployment opportunity of the workers who are long-term unemployed is reduced. An international comparison of long-term unemployment shows: for a long time, about 14% of the unemployed in the US were long-term unemployed, while in Europe about 40% and above are long-term unemployed.

06th Ascertainable versus necessary economic data

As a starting point, we have to realise that different economic phases require different measures also. Therefore, a situation analysis and prognosis is necessary, which informs us in which economic phase we are currently. In times of economic downturn, measures are needed to increase demand for goods while measures to curb demand are getting necessary in times of overheated economic upturns, in which demand increases are hardly leading to an increase in the quantity of goods and therefore fizzle out largely in price increases.

This situation analysis is in practice made more difficult now by the fact that the economic policy measures take their effect only after a certain time. We can not assume that e.g. an increase in demand caused by increases in government expenditure will instantly lead to an increased employment and thus to a reduced unemployment. Rather, some time will pass until the increased demand on the goods markets results in an additional demand on the labour markets. Here, one speaks of time lags.

That these are by no means very short and therefore negligible times has been shown by Milton Friedman, who pointed out that it would take about one and a half years between the time when politicians realise that they should stimulate the economy by employment programmes until these programmes take effect on the labour markets.

This fact makes it necessary, though, that any economic stimulus programmes must not only be adopted at the moment when a change in the economic cycle seems necessary, but just 1 1/2 years earlier.

And in this context arise two fundamental problems. Problem no. 1: in this case, it is obviously not sufficient, that in the context of a situation analysis we ask ourselves what the current level of unemployment is and to what extent this unemployment is contingent on the economic situation. We rather need a prognosis that provides information about how unemployment will be in 1 1/2 years, namely then, when the measures introduced today will take effect on the labour market. Problem no. 2: Are the politicians not overcharged, if they should initiate e.g. a policy of contraction at a time when there is still a considerable unemployment.

Here emerges the fundamental question of whether prognoses within the framework of the sciences are possible at all. The majority of economists is in fact convinced that it is possible to make prognoses with scientifically sound methods. Nevertheless, the prognoses of scientists differ greatly from the prophecies. Whereas prophecies are formulated namely as unconditioned statements, the prognoses made by science apply always under certain conditions only.

The Prophet claims that very specific events will occur at a quite particular time. The scientist, on the contrary, formulates his statement much more cautiously. He cannot predict with certainty the event to be prognosticated. The prognoses are only valid on the condition that very specific conditions are met. For example, that there are no major upheavals in the political system or that it has not to be reckoned with bad harvests, either. The prognosis applies no longer, if one of these conditions has changed.

Furthermore, the scientific prognoses mean that the forecasted event is only to be expected with a certain probability. Prognoses in the sense that a certain event will occur with absolute certainty at the presence of certain conditions, are not possible at all in the context of science. We do not have absolute knowledge; our knowledge of reality is always more or less imperfect. In principle, we can indeed falsify universal quantifications (for example, all entrepreneurs maximise their profits) if we find only one entrepreneur who behaves differently. Thus, in this case it can no longer be said that all entrepreneurs maximise their profits.

But it is not possible to verify a hypothesis. Only if we could not achieve to successfully falsify a hypothesis in several empirical studies, we can speak of a provisionally confirmed theory. But this theory remains always provisional. We have no possibility of clearly determining whether we have already gathered all the factors that influence the variable that is to be explained; we must always reckon with the possibility that certain factors will be found in the future that will influence the result decisively but have not been recognized yet, even though they already existed or have not even occurred at all.

Now a few words about the question to which extent the politicians may be overstrained with initiating dampening measures already 1 ½ years before the expected overheating, at a time when unemployment is still present to a high extent.

No difficulties would probably be expected if we could assume that almost all voters had sufficient knowledge of the economy and would act in a completely rational way. In this case, it would be clear to everyone that the elimination of cyclical unemployment is only possible if employment policy measures are initiated in due course, that means at a time when unemployment is still present.

But in reality, we can not assume that a large section of voters has this knowledge. The economic connections are so complicated that without economic knowledge, this insight can not be expected for the majority of the voters.

Under these circumstances, irresponsible populists can exploit this ignorance of the voters and fight politicians who are already inducing measures that dampen economic activity at a time when there is unemployment still present.

And in such a situation, it has to be feared that politicians will not take these measures necessary for success, even if they themselves believe that these dampening measures are necessary, simply because voters would abandon these politicians in such a situation. In this situation, the political survival of the parties is more important than appropriate solutions.

Problems at the determination of the economic situation exist in detail due to:

the lagging behind of the statistics,

the distinction between inside lags and outside lags,

the distinction between recognition lags, decision lags and realization lags.

We have to assume that there will always pass a certain amount of time until certain deficiencies are identified. Unemployment statistics, for example, assume that enterprises which have dismissed an employee report this to the statistical offices. But we can not expect that such decisions will be communicated hourly. It has to be clarified also whether these are permanent decisions. For example, if a casual labourer without a permanent job has not found work on a particular day, then this does not indicate that the worker's situation has already changed fundamentally. It would be quite conceivable that this labourer works only every second or third day on average, so that the determination of a day off does not say anything definitive at all about possible changes in the employment of this employee.

The following diagram gives an overview of the different time lags:

07th Self-affirmation and self-refutation of prognoses

Prognoses have effects on the data that is to be forecasted. When the predicted effects occur due to the prognosis, then we speak of the self-affirmation of a prognosis. The example of an induced price increase is present, if a price increase is predicted. Here, the demand increases due to the prognosis and the prices rise along with it.

Whereas we speak of the self-refutation of a prognosis if the predicted effects do just not occur due to the prognosis. The example of an avoided overcapacity is present if an overcapacity of production equipment is forecasted. A reduction of the investment occurs here due to the prognosis and with it the production capacity decreases.

Prognoses jeopardise the success of policies when unwanted effects are induced. For example, the success of the stabilisation policy would be called into question if the prices would already increase simply on the basis of prognoses.

Prognoses can also be used as an economic policy tool if prognoses induce desired effects. For example, the suggestion that overcapacity could be expected in the industry could already be seen as a means of working towards a reduction of overcapacities.

08th The problem of a differentiating economic diagnosis

The extent of unemployment is - as already mentioned - dependent on different causes:

There are:

· economic,

· seasonal,

· frictional and

· structural causes.

Therefore, a theory is required in order to relate unemployment with the individual causes.

Firstly, a distinction between structural and economic causes is necessary: The long-term average of unemployment corresponds to the structural unemployment; the fluctuations around this long-term path refer to the economically caused unemployment.

A distinction between the seasonal and other causes of unemployment can be made on the basis of experience values: As an example, the above-average unemployment in the winter months is predominantly seasonal. Since most of the work in the construction industry is done outdoors, production can not be maintained, at least when using traditional production methods and at low temperatures.

Furthermore, the duration of the average job search can be considered as a benchmark of frictional unemployment. The term frictional unemployment refers to a worker who remains without a job for a short time at the event of a job change. If, therefore, the average duration of the job search increases (that is, the time that elapses from leaving the previous job until starting at the new job), then the frictional unemployment increases.

The extent of this frictional unemployment is mainly determined by two factors. On the one hand, frictional unemployment increases when, with the average duration of job search remaining constant, more workers change jobs or workplaces are changed more frequently on average.

On the other hand, the extent of frictional unemployment also depends on the notice periods. For example, if the deadlines by which employees can be dismissed are extended, then the dismissed workers will be able to start their job search already at a time when they are still employed in their current job. (Of course, the cancelled workers must also be given the time to look for new jobs.) The time that elapses here between leaving the previous job until the start of the new job, can be significantly reduced in this way, which leads automatically to a reduction in frictional unemployment.

09th On the problem of the leading indicators

Historic example of a leading indicator was the Harvard Barometer (W.M. Persons C. J. Bullock). The Harvard Barometer consisted of three time series:

the speculative curve (dividends and sales of certain shares)

the goods curve (pig iron production, general price index)

the money market curve (discount rate, credit volume etc.)

The precondition for the expediency of a leading indicator is the presence of clear, dynamic laws:

Wage increases lead e.g. to price increases, but price increases can also induce wage increases. But we can not assume that the ratio of increases in wage rates and prices of goods is always the same regardless of whether wage increases trigger price increases or, conversely, price increases trigger wage increases. Basically, these relations are based on very different connections, which have nothing to do with each other.

If increases in wage costs lead to price increases, then it is because entrepreneurs endeavour to include all costs in the price of goods. After all, they produce goods in order to make profits in this way. Therefore, they will in any case try to pass on all cost increases to the price of goods, if possible. But whether they succeed in any case, also depends on other conditions, for example, whether the competitors are also facing the same cost increases and are therefore also passing on the costs to the consumers.

On the other hand, if price increases lead to wage increases, then this connection is related to the behaviour of the trade unions, their aims of defending the share of the wage incomes and the real level of the previous incomes. Furthermore, the strength of the trade unions, which is reflected, among other things, in the degree of organisation, also determines the extent to which trade unions succeed in achieving their aims also.

Just because of these different connections, the scepticism prevails today over the attempt to reliably predict the economic development on the basis of leading indicators.

10th The economic barometer of the council of experts

Here, one confines oneself to the diagnosis and refrains consciously from making a prognosis.

In a first step, a selection of the economically relevant individual indicators is made. For example, prices, wages, interest, revenue, unemployed persons, are selected as indicators.

In a second step follows the normalisation of the economic cycle: The normalisation is done here via the numbers 1 and 2: The normalised variable values are increased or decreased by 1, provided that the variables move within the normal deviations. Conversely, a change of +/- 2 is chosen if the deviations in the individual variables are greater than normal. Which deviation is considered normal can be determined by means of the average of the past values.

In a third step, an overall indicator is formed as a moving average of the individual indicators.

On the criticism of this economic indicator the following can be said:

The indicator is not sensitive enough for changes.

It is unclear, for example, what amount of money should be selected: M1, M2 or M3; M1 refers here to the amount of banknotes and coins, M2 includes in addition the bank deposits created by private banks (time deposits) as well as the savings accounts, M3 finally considers additionally also other near-money securities.

Furthermore, it is unclear which wage rates should be used, the effective earnings or the standard wages? For the use of standard wages is indicative that the individual data can be taken relatively easily from existing collective agreements. The collection of data is further simplified by the fact that the number of concluded collective bargaining agreements is relatively small.

The collection of wage data on the basis of the effective earning is in contrast much more laborious. On the one hand, the data must be obtained from the large number of individual enterprises, on the other hand, these surveys do not inform clearly about the extent of the wage shares, which are granted on a voluntary basis by individual enterprises.

The wage agreements are sometimes so detailed that, for reasons of simplification, some benefits which are granted on the basis of a collective agreement are not surveyed in the official tariff statistics. But since all benefits are included in the statistics on effective earnings, the benefits that are above the payment agreements are overstated to the extent that the standard wage statistics do not consider some collectively agreed benefits.

The economic indicator proposed by the council of economic experts becomes a problem, especially in the case of stagflation: In such a situation quantity sizes and price sizes cancel each other out; a non-existent stability may possibly be simulated! Stagflation is known as a situation where general price increases (inflation) and unemployment (stagnation) occur at the same time.

This danger can be encountered, though, by identifying the price movements and quantity movements separately and thus preventing that both movements compensate each other.

Continuation follows!