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April 24, 2013

'Unemployment and the Free Market'

Chris Dillow takes on the idea that free market policies can solve our unemployment problem:
Unemployment and the Free Market, Stumbling and Mumbling: Bryan Caplan deserves praise for calling on free market economists to pay more attention to the "grave evil" of unemployment. I fear, though, that he overstates what free market policies can contribute to solving the problem.
My chart shows the problem. It shows the UK unemployment rate between 1855 (when data begins) and 1914. You can see that the jobless rate was often high - it averaged 4% - and volatile.
Note: data comes from the Bank of England.
And this was during a period of as free markets as one could practically get. This undermines at least three "free market" explanations for unemployment:
- "Welfare benefits mean the unemployed have little incentive to get work." In the 19th C, though, the only state support the unemployed got was in the Workhouse - and even as late as in my lifetime, this was spoken of with terror.
- "Big government and taxes deter job creation." But public spending in this time averaged only around 10% of GDP, and labour market regulation except for a few Factory Acts was nugatory by modern standards.
- "Wages are too rigid". But wages fell in nominal terms in 13 of the 59 years here, and in real terms in 12 of these years. Average nominal wages fell by 9% between 1874 and 1879, which is consistent with some sectors seeing very large falls.
There is, though, an alternative theory that fits these data. It's that a free market will see large swings in aggregate demand and employment, and that unemployment cannot be prevented by wage reductions alone. This was pointed out most famously - well famous in my house anyway - by Michal Kalecki in 1935... [long quote] ...
There's a good reason why almost all major economies abandoned free market economics. It's that such economies didn't and couldn't avoid mass unemployment.
I'll concede - much more than most lefties - that there's a big place for free market economics. But the labour market ain't it.

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