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Full Employment

Full Employment

ECONOMIC THEORY

PUBLIC POLICY

BIBLIOGRAPHY

In a market economy, a resource is employed when engaged, in exchange for monetary payment, in the production or sale of goods and services. Therefore full employment refers most broadly to employing all the available resourcesthe productive land, labor, and capital on hand at a certain time and place. More often, however, full employment refers to the full utilization of labor inputs. The term full employment is closely connected to the concept of unemployment, and achieving a broad appreciation of these intertwined notions requires a historical look at both economic theory and public policy.

ECONOMIC THEORY

Macroeconomics, the study of national economic systems, is the realm of economics devoted to studying full employment and unemployment. Prior to the 1936 publication of John Maynard Keyness The General Theory of Employment, Interest, and Money (written as a response to the mass unemployment of the Great Depression), macroeconomics did not exist apart from the broader discipline of economic theory.

When Keynes published The General Theory, most economists believed that market economies were selfadjusting systems that usually operated at full employment and would, on their own, return to full employment after a period of adjustment to external disturbances. Keynes disagreed. The evidence indicates that full, or even approximately full, employment is of rare and short-lived occurrence (Keynes 1964, pp. 249250). Thus The General Theory was offered to contrast Keyness ideas about unemployment with the view of the periods conventional economists, which he called classical economic theory.

According to classical economics, there is no reason for the involuntary unemployment of workers. In this type of economics, wages adjust to equate workers supply of labor and employers demand for labor. The result is a state of full employment, though this does not mean that all workers will be continuously employed. In fact classical economic theory allows for three forms of voluntary unemployment in a full-employment economy. (This discussion of full employment and unemployment in economic theory draws on Galbraith and Darity [1994]. Readers interested in a more detailed discussion of the theoretical perspectives discussed in the present essay should consult that volume; most macroeconomics texts offer similar analyses.)

In classical theory, unemployment can exist when a worker moves between jobs, refuses to accept work at the market wage rate, or is prevented from taking a job because of a social decision that keeps wages above their equilibrium level. The first situation describes what is called frictional unemployment and is considered voluntary because classical theory assumes that a job is available for that worker at the equilibrium wage rate. (To be more precise, the key wage of interest to classical economists is the real wage, which is the actual or nominal wage adjusted for paycheck purchasing power by taking into account the general level of prices.) The second situation is viewed as voluntary because the unemployed person could find work by lowering his or her reservation wage and accepting employment at a lower than desired level of pay. The third situation, which exists when a collective-bargaining agreement or minimum-wage law sets a wage above the market rate, is considered voluntary because society as a whole could remove the institutions that interfere with market forces.

In The General Theory, Keynes shifts attention from the labor market to the economy as a whole. Since Keynes argued that the total level of employment is a by-product of supply and demand for economic output as a whole, he focused on what determines the economys equilibrium level of overall output. The key, he concluded, is total or aggregate spending by households, firms, and government (excluding considerations of international trade).

According to Keynes, the economys equilibrium output is achieved when aggregate spending (called aggregate demand) absorbs the income earned (called national income). Since this can occur at any number of levels of income, aggregate demand is the crucial determinant of national output and employment. While classical economists focused on labor-market dynamics and assumed that the labor-market always yields employment equilibrium consistent with equilibrium in the overall economy, Keynes argued there is no reason to assume these equilibriums will be compatible. Thus Keynesian economics maintains that the economy could remain indefinitely at a total level of employment that is far below the full-employment level that labor-market considerations alone would generate. In Keynesian theory, there is involuntary unemployment whenever overall economic equilibrium generates a level of employment that falls below the labor markets market-clearing, full-employment level.

Here it is worth noting a difference regarding how full employment is described in Keynesian economics and in a portion of Keyness The General Theory. In Keynesian economics, although there is no necessary connection between the equilibrium employment level generated by aggregate economic activity and the labor markets full-employment level, the labor market can at least be considered a conceptual benchmark, telling us whether or not we are at full employment (Galbraith and Darity 1994, p. 147). In a portion of The General Theory, however, there is no resort to full employment as this sort of conceptual notion (Keynes 1964, p. 26). Rather, full employment is a much more empirical construct: It exists when an increase in aggregate demand fails to result in more employment. James K. Galbraith and William Darity explain the latter view as follows: If an expansion of aggregate demand leads to a higher level of employment, then involuntary unemployment prevailed prior to the expansion. If not, then the economy already was at full employment (Galbraith and Darity 1994, p. 33).

Keynesian economics (and Keyness The General Theory ) suggests that closing the gap between actual and full employment involves boosting aggregate demand via fiscal or monetary policy. The problem, however, is that such macroeconomic policy alone often yields inflation, as economists recognized in the 1960s. At first Keynesians explained the trade-off between unemployment and inflation with reference to the Phillips curve, which plots inflation against unemployment for various moments in time and showed an inverse relationship between inflation and unemployment. This curve fit less neatly as an account of the 1970s, however, bolstering an emerging anti-Keynesian movement that eventually produced what is now called New Classical macroeconomics.

Edmund Phelps and Milton Friedman, whose work in the late 1960s suggested that there is no long-run trade-off between unemployment and inflation, offered an early challenge to Keynesian theory. The Phelps-Friedman analysis treats the long-run Phillips curve (again, inflation plotted against unemployment) as a vertical line rising upward from the natural rate of unemployment. Moreover the long run here does not require a vast period of time. Rather, government efforts to boost aggregate demand will increase inflation without reducing unemployment whenever workers correctly (observe or) expect an increase in prices and insist on an offsetting wage increase.

The doctrine of the natural rate of unemployment is a strong argument against activist macroeconomic management in pursuit of greater employment. In fact the Phelps-Friedman theory indicates that the result of such activism would be higher and accelerating inflation. According to their theory, the main way to reduce unemployment is to raise the rate of labor productivity growth, but since productivity growth stalled during the 1970s, economists estimates of the natural rate rose during that decadefrom about 5.4 percent in the late 1960s to just over 7 percent in the late 1970s (Bennett 1997, p. 275).

The natural rate of unemployment (which in the early twenty-first century is often called the non-accelerating inflation rate of unemployment) is widely believed to have fallen since the 1970s, but the precise rate is not really that important in New Classical macroeconomics. That is because New Classical theory restores the pre-Keynesian belief in an equilibrium alignment of the labor market and the overall economy. As a result of a notion called rational expectations, New Classical economics assumes that most observed variations in the unemployment rate are simply changes in the natural rate; since the only exceptions are temporary and random employment fluctuations in response to surprise events (such as a hike in the price of oil), the economy is, in effect, always at full employment. New Classical theory restores the laissez-faire viewpoint that dominated pre-Keynesian economics.

Among the contemporary economic theorists who have attempted to revive portions of Keyness macroeconomic policy insights are New Keynesians and Post-Keynesians. New Keynesians accept much of New Classical theory but introduce a number of reasons why wages nominal wages in some cases and real wages in others might nonetheless fail to adjust to ensure full employment. The result is a role for government to raise employment by removing wage rigidities or, at least temporarily, by increasing aggregate demand. While most New Keynesians explain unemployment in terms of sticky wages, some offer an explanation rooted in price inflexibility. See, for example, the discussion of New Keynesian economics in Galbraith and Daritys Macroeconomics (1994, pp. 315319).

Post-Keynesians go further than New Keynesians and reject the notion that wage levels are a significant determinant of employment. Indeed, unlike most New Keynesians, they argue that efforts to make wages more flexible can actually worsen unemployment. Like Keynes, meanwhile, Post-Keynesians emphasize the role of aggregate demand, which they see as liable to sudden fluctuations as a result of volatility in the expectations governing investment. Post-Keynesian theory indicates that the state has an inescapable role to play in stabilizing the economy and maximizing employment by judiciously managing the level and composition of public spending (Pressman 2001, pp. 104111).

PUBLIC POLICY

In response to the Great Depression, a number of economists in the United States and the United Kingdom offered policy-oriented volumes that presented strategies to achieve full employment. Among the most well known is William H. Beveridges Full Employment in a Free Society (1945). Other early books on full employment include Mordecai Ezekiel, Jobs for All through Industrial Expansion (1939), and John H. G. Pierson, Full Employment (1941). Beveridge defined full employment as follows: It means having always more vacant jobs than unemployed [workers]. It means that the jobs are at fair wages, of such a kind, and so located that the unemployed can reasonably be expected to take them; it means, by consequence, that the normal lag between losing one job and finding another will be very short (Beveridge 1945, p. 18).

Beveridge gave the public sector responsibility for influencing and supplementing private activity so as to achieve and sustain full employment. He outlined a three-pronged policy attack on joblessness: There must be enough jobs; industry must be encouraged to locate facilities with an eye to matching job opportunities to labor force skills; and workers must be provided with job vacancy information, relocation assistance, and perhaps even training or job-placement assistance. An annual public budget with outlays in five categories was identified as the main government tool: (1) funds for roads, schools, and other public goods; (2) investments in rail transit systems and other government-owned industries; (3) loans and other incentives to promote private investment (coordinated by a national investment board); (4) subsidies that reduce prices for essential consumer goods; and (5) income-redistribution programs, such as social security, to ensure robust consumer spending.

In 1946 the U.S. Congress passed the Employment Act, proposed by legislators with a view similar to that of Beveridge. According to the legislation, It is the continuing policy and responsibility of the Federal Government to promote maximum employment, production and purchasing power. The Employment Act included provisions establishing the Council of Economic Advisers to the President and requiring an annual Economic Report of the President, designed to track trends in economic performance, review existing economic policies, and recommend policy changes that would better enable the government to achieve its objectives (Bailey 1950, pp. 227232).

In policy circles, a distinction has long been drawn between three forms of unemployment: frictional, cyclical, and structural. As mentioned above, frictional unemployment exists when workers are between jobs. Cyclical unemployment exists when aggregate demand is insufficient to hire all who are actively searching for work. And structural unemployment exists when there is a skill or geographic mismatch between available workers and unfilled jobs. In the early 1960s the Council of Economic Advisers set an average annual unemployment rate of 4 percent as an interim target, reflecting their belief that this level was consistent with tackling cyclical unemployment. These and other economic analysts also believed that unemployment could fall further by means of worker training and additional efforts to attack structural and frictional sources of joblessness (Galenson 1966; Gordon and Gordon 1966).

By the mid-1970s, however, the U.S. unemployment rate exceeded 7 percent, leading a frustrated Congress to revise the Employment Act through passage of the Full Employment and Balanced Growth Act in 1978. The new law provided stronger language by substituting full employment for maximum employment as the nations employment objective and mandated a 4 percent unemployment rate as the countrys primary economic goal. However, in the absence of a requirement that the public sector must serve as employer of last resort when citizens are unable to find work, the 1978 change proved to have little practical impact on economic policy and performance.

Behind the U.S. employment legislation of 1946 and 1978 was a policy debate that continues in the early twenty-first centurya debate over whether citizens should have a publicly guaranteed right to a job. Whether there should be a right to work has long received academic and public attention, but President Franklin D. Roosevelt brought the issue to the fore in his 1944 State of the Union Address. In that speech, Roosevelt stated that the nation must be guided by a second Bill of Rights, including the right to a useful and remunerative job (Roosevelt 1944). (For a much earlier argument in favor of the right to employment, see John R. Commons [1899].)

A number of policymakers who worked on the 1946 and 1978 Employment Acts wanted to secure the right to employment by enabling the unemployed to turn to the federal government for some form of public works or public service employment. Since the Great Depression, such job opportunities have often been made available to the unemployed, usually on a rather limited basis, through various federal programs (such as the Works Progress Administration, created in 1935, and the Comprehensive Employment and Training Act of 1973). The current focus of U.S. employment policy, however, is on helping workers find training for private employment, and even that effort receives limited public funding. Public service employment and institutional mechanisms needed to establish government as the employer of last resort continue to receive attention from academics (Wray and Forstater 2004; Kaboub 2007), but these ideas have little backing from federal lawmakers.

SEE ALSO Business Cycles, Theories; Economics, Keynesian; Economics, New Classical; Economics, New Keynesian; Economics, Post Keynesian; Employment; Friedman, Milton; Full Capacity; Great Depression; Inflation; Involuntary Unemployment; Job Guarantee; Keynes, John Maynard; Monetarism; Natural Rate of Unemployment; Neutrality of Money; Phillips Curve; Unemployment; Unemployment Rate; Voluntary Unemployment

BIBLIOGRAPHY

Bailey, Stephen Kemp. 1950. Congress Makes a Law: The Story behind the Employment Act of 1946. New York: Columbia University Press.

Bennett, Amanda. 1997. Inflation Calculus: Business and Academia Clash over Economic Concept of Natural Jobless Rate. Journal of Socio-Economics 26 (3): 271276.

Beveridge, William H. 1945. Full Employment in a Free Society. New York: Norton.

Commons, John R. 1899. The Right to Work. Arena 21 (2): 131142.

Ezekiel, Mordecai. 1939. Jobs for All through Industrial Expansion. New York: Knopf.

Galbraith, James K., and William Darity Jr. 1994. Macroeconomics. Boston: Houghton Mifflin.

Galenson, Walter. 1966. A Primer on Employment and Wages. New York: Random House.

Gordon, Robert A., and Margaret S. Gordon, eds. 1966. Prosperity and Unemployment. New York: Wiley.

Kaboub, Fadhel. 2007. Institutional Adjustment Planning for Full Employment. Journal of Economic Issues 41 (2): 495502.

Keynes, John Maynard. 1964. The General Theory of Employment, Interest, and Money. New York: Harcourt Brace Jovanovich. (Orig. pub. 1936).

Pierson, John H. G. 1941. Full Employment. New Haven, CT: Yale University Press.

Pressman, Steven. 2001. The Role of the State and the State Budget. In A New Guide to Post Keynesian Economics, ed. Richard P. F. Holt and Steven Pressman, 102113. London: Routledge.

Roosevelt, Franklin D. 1944. State of the Union Address. January 11. http://teachingamericanhistory.org/library/index.asp?documentprint=463.

Wray, L. Randall, and Mathew Forstater. 2004. Full Employment and Social Justice. In The Institutionalist Tradition in Labor Economics, ed. Dell P. Champlin and Janet T. Knoedler, 253272. Armonk, NY: Sharpe.

Charles J. Whalen

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