EMPLOYMENT, GROWTH AND SOCIAL STABILITY IN A DEVELOPING ECONOMY

Karl Theodore HEU , Centre for Health Economics, UWI February 2009

EMPLOYMENT, GROWTH AND SOCIAL STABILITY IN A DEVELOPING ECONOMY Introduction The apparent intractability of the employment problem in the Caribbean suggests that our basic conception of the problem may be flawed1. The standard analysis which, in spite of the work of Keynes, remains essentially neoclassical, speaks of a labour market framework where we identify an equilibrium level of employment corresponding to an equilibrium real wage rate. The thinking is that since the real wage is at once the inducement to give up leisure as well as the marginal cost of labour to the firm, there will always be a wage rate where those who are really willing to work will find employment. In this context prolonged unemployment is a bit of a conundrum. However, the observed unemployment will remain a conundrum only if we try to hold on to two implicit assumptions which are, to say the least, really questionable. The first of the questionable assumptions is that there is always enough factor substitutability in the production system to be able to produce a given level of output with more labour and, by implication, less capital. The more likely situation is one of a high degree of complementarity.2 What this means is that except in a case where the context is one of overall expansion in economic activity, which would clearly call for increased use of capital, there is no necessary connection between falling wages and increased employment. In fact, there have been periods in at least one country in the region where falling wages were accompanied by falling employment.3 The second even more seriously questionable assumption is the notion that there is no wage level below which it will not make economic sense for households to offer labour. The reality of the reservation wage is conveniently ignored. In fact it is this reality which provides the starting point for the present analysis.

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Dimensions of Wages and Employment As the more recently introduced concept of the social wage has suggested, the wage rate is more than the price of leisure and more than a marginal cost.4 For from the point of view of the individual, in addition to the subsistence dimension and the transactions cost dimension of the wage there is also an entitlement dimension which is related to the distribution of income in the society. In some societies people and their leaders believe that employment is a right since everyone has a right to the means of life. This merit good interpretation of employment is what gives employment a distributional, and therefore entitlement, dimension. Our contention is that the neoclassical concept of the wage rate, in true Pareto fashion, excludes this last dimension. What this has meant is that the merit-good influence on the labour market has either been omitted or always left as an after thought. Once we accept this latter dimension of employment we are then open to the possibility that employment may not be the homogeneous quantity it is assumed to be in the neoclassical analysis. In a trivial quantitative sense the homogeneity can be maintained by measuring the different types of employment using the same numeraire. However, in a qualitative sense what is being suggested is that different categories of employment reflect different behavioural phenomena. In a sense it can be argued that while on one level, employment is physically determined, on another level it is metaphysically determined. Put another way, we can say that on one level some of the employment we observe is linked to planned output and on another level there is employment that is linked to the distribution sensitivity of the society. In practice, the employment that is linked to planned output is determined by the profit motive of businessmen while the other category of employment is related to beliefs about the welfare and the stability of the society. What this has meant is that while the employment linked to planned output would mainly be private- sector generated, the employment linked to distribution concerns would mainly be a public sector phenomenon. If the prevailing set of community values uphold the view that everyone in

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the society is entitled to a decent standard of living, this would be reflected in the political decisions made in respect of those members of the society who tend to face consumption challenges. However, the concept of providing jobs for those who have no work need not be purely altruistic. Enlightened self-interest will lead the better-off sections of the society to recognize that blatant inequity coupled with a devil-take-the-hindmost attitude will provide ready fuel for tensions in the society. Such tensions have the potential to undermine the economic well-being of the more fortunate members of the society. The point that needs to be made is that whether it is done out of a brother’s keeper motivation or out of pure self-interest, the better-off in the society will be willing to pay a (distribution) premium to keep employment levels up. On this basis, one hypothesis which seems reasonable is that the society would be willing to use up some of its current economic surplus to provide additional (public) employment. This approach to the employment phenomenon allows us to relabel the two distinct components of total employment in relation to output. One category remains linked to planned output, as before, but the other is now linked to surplus output. In other words, one is based on plans the other based on outcomes. In the neoclassical model all observed employment reflects a demand for labour and is therefore all related to planned output. This is the homogeneity assumption that is being called into question. In a sense this may have been the point that Keynes tried to make. For his analysis refers to an employment component that is directly related to the labour market and another component which comes about after policy intervention or exogenous changes. It is important to note, however, that in the Keynesian analysis both employment elements were assumed to be responsive to aggregate demand. This made sense since the initial conditions Keynes had in mind were conditions of excess production capacity. He therefore saw the sense in inverting Say’s Law, allowing for demand to awaken supply.

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In the developing country context the situation is generally not one of excess capacity and more often than not employment creation has no supply-creation motives. In these situations where the maximum employment associated with profit-induced planned output has been attained at a level below the level of employment that is consistent with social stability, the society will feel justified in making the necessary policy injections to boost the level of employment, even if it means that supply will not increase. In a sense, the society will be operating with a trade off between increased employment and increased future supply. The fact that expansionary employment policy is generally always supported means that the society reckons the social cost of current unemployment to be greater than the value of the future output which the current surplus being used up would have made possible. Employment and Economic Growth From the previous discussion it is possible to develop two independent growth-related employment relationships which maybe used to describe employment equilibrium for the society. From the basic relationship between planned output and employment we would expect that employment in the current period would be a function of output in the current period and output in future periods. For present purposes we highlight the relationship between current employment and the change in future output. The thinking is that firms will know that they need to have their labour in place to meet production increases in a future period. So even in a case where there may be no aggregate production function to work with, probably because output is mainly made up of services, we would be able to identify a monotonic relationship between current employment and future output changes. This relationship summarizes for us how the growth process impacts on employment and is the relationship which reflects the behaviour of the private sector in the society. This is the first of the two relationships needed for the equilibrium picture and will be denoted by the line GG’.

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However, employment is also related to future output because of the behaviour of the rest of the society, reflected in the behaviour of the public sector. For it is the public sector that has the capacity to lay claim to any quantum of the society’s current surplus and it is the public sector that has the direct responsibility to protect the stability of the society. Clearly the more of the current surplus that is absorbed for purposes of employment creation, the less will be the savings of the society, and the smaller will be the society’s future output growth. Of course if the surplus is large enough to keep savings up as well as to create employment the slope of the implied trade off will be moderated accordingly. In this situation we arrive at a negative relationship between employment and the growth of output. This is the relationship which captures the impact of the social stability requirement on the society and will be denoted by the line SS’. In the diagram below we put together the two relationships described. Growth values are shown on the y-axis using the symbol, Ÿ, employment on the x-axis using the symbol, E.

Growth of Output, Ÿ

S G

Ÿ*

S’ G’ 0 E* Employment, E

Equilibrium Employment with Growth and Social Stability We have arrived at a position where there would be an equilibrium holding between what the private sector would like to do and what the public sector believes is necessary. In the

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diagram this is shown as the combination of current employment at E*, and output growth at Ÿ*. What are the properties of this equilibrium? Properties of the Equilibrium The first question which arises is whether the equilibrium is one of full employment. From the analysis above all we know is that this equilibrium is one where social stability is being maintained at an acceptable level while profitable production is being pursued. What this means is that this is an equilibrium which is consistent with any level of unemployment that the society is comfortable with. This could mean that the number of persons unemployed is small enough to ensure that the burden being carried (through welfare programmes) by the rest of the society is not an uncomfortable or an economically threatening one. Of course, it could also mean that the persons unemployed belong to a group not considered a threat to the society, probably because for some reason, they do not mind being unemployed. The point here is that in this context the equilibrium does not have purely economic properties. For as long as social stability remains the cradle within which economic well-being is nurtured, the employment equilibrium will be one where profit-making does not cause social instability and where stabilizing the society does not eliminate the possibilities for future output increases. One of the dangers is that if the amount of output that needs to be sacrificed keeps getting larger, at some stage the policy will become untenable. It will therefore be important to know how to avoid coming to this pass. We take this up in another section. At this point it maybe useful to reflect somewhat on the broader implications of the analysis above. To do this we ask the question: what is the theoretical basis of the politico-economic equilibrium described? What is the nature of the environment within which it will emerge?

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Outline of a Politico-Economic System

Before economics emerged as a social science, with a growing emphasis on its scientific dimension, the discipline which engaged the attention of those interested in how people in society went about building a standard of living for themselves and their loved ones was called political economy. Presumably this was because it appeared very obvious that major outcomes like income determination and the distribution of income did not emerge without some element of contention among the key stakeholders in the society. Karl Marx thought he was merely describing how the society operated when he posited that it was struggle that was the basis of all outcomes that were important to people.5 As we moved to the latter half of the nineteenth century, however, another approach to these questions gained ascendancy. This approach was dominated by the view that the economic system is best described as a system of markets which operate in a way to deliver all the answers which were being asked.6 We get wrong answers or sometimes we get no answers when there is a problem with one or more of the markets. The solution was then obvious: arrange to get the markets working as they should and create them when they do not exist. It is interesting that all these developments were taking place within the context of countries that eventually became labelled as ‘developed’ or ‘first world’. In general, it would seem that the development of the discipline of economics has served these countries well. With the recognition that most of the people in the world do not live in these developed countries, a special branch of economics – development economics – emerged to try to find answers to the big question: how can these countries provide for themselves the same kind of living standards which the developed countries were known to be enjoying? Although the answers came with varying degrees of sophistication the common thread seemed to be finding a way for these countries to accumulate a stock of capital which would generate the incomes required.7 In more recent times emphasis has grown on the human component of this desired capital stock.8

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While there is no doubt that the work of development economists has made a beneficial difference to some of the countries targeted – a subset of Asian countries, in particular – there is a sense that the majority of countries are yet to derive similar benefits. In some cases, it has become difficult to identify the ways in which the economic analysis offered today can meaningfully address the issues that seem to confront the ‘developing’ countries, as they have come to be called. Our interest of this study is the subset of Caribbean countries and while the suggestion that the aim must be to convert low-savings countries into high-saving countries is almost a logical truth, there remains a nagging sense that we have not yet accurately represented the way these economies work. Many pieces of the puzzle have been put out for our consideration but the knitting together remains to be done. The simple model that will be presented in this study is an attempt to set the knitting together in train. The model does this by harking back to the early days of our discipline when the political system was seen to be interwoven with the economic system. In fact the model makes the bold claim that the only general equilibrium configurations that make sense in contexts like those in the Caribbean are configurations that reflect consistency between objectives and constraints that invoke a combination of economic and political behaviours. The Essence of the Politico-Economic System The model begins with the assumption that all members of the society conscious enough to be aware of these things are interested in the acquisition of incomes. This desire for income is not for its own sake. For one set of citizens incomes are required so that they could have a decent or acceptable standard of living. For another set the acquisition of incomes serves their desire to accumulate capital. To this latter group, income for consumption is secondary. Interestingly, this latter group will not be able to engage in the capital accumulation process without making use of the labour that is owned by the group whose ultimate objective is a decent standard of living. Labour therefore becomes the first main economic link between these groups and since the labour has to be

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compensated, the quantum of compensation becomes the first potential bone of contention. In a system where compensation for labour becomes the means by which individuals will have access to the consumption levels they desire, the full employment of labour will be an economic as well as a political necessity. It will obviously be an economic necessity because of the link between income and consumption, and it will become a political necessity because of the link between consumption and social stability. This proposition leads us to the first assumption of the model, namely that, given the motivation of the capital accumulation group in the society, the system will not have a natural tendency towards full employment. Some writers like Kalecki argue that full employment is not in the interest of this group.9 In our case we do not need to take this position for the simple reason the since accumulation of capital - not full employment - is that aim of this group, the maximandum in their objective function will not be employment. What this means us that the rules they will follow in optimizing their objectives will have no bias towards maximizing employment. Employment will be an instrument for maximizing something else. Of course, this does mean that full employment cannot happen in this system. However, if it does it will be accidental, probably due to a favourable population scenario. This posture on the part of the capital accumulation group is an interesting one since, as we have suggested earlier, the political system requires full employment, or at the very least quasi full employment, which would have the same desired impact on social stability. In these circumstances it would be natural for the political system to fill the void created by the operations of the economic system. The mechanism for filling the void already exists in the form of the government’s fiscal instruments. The government as a political entity is the repository of the “coercive power” that can be used to get the resources required to fill the employment gap. The only issue that emerges is how it will use that power.

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This brings us to the motives of the government for using its coercive power. There would seem to be three such motives: i) ii) its political survival will depend on how it succeeds in maintaining social stability; where there is an exogenous source of income being enjoyed by the government, its sustainability may depend on the level of social stability; and iii) the class identity of the government will lead to an income distribution pressure which goes beyond merely providing access to consumption. In other words, there is no question that with the failure of the economic system to generate full employment, the government will act. The general principle is that when the economic system fails to impact positively on social stability, political pressures begin to build up for the activation of a distribution mechanism and political leaders will emerge to champion the cause. The result is that variables that begin with ostensible economic determination are now affected by political action and there will be no such thing as a purely economic equilibrium in this context.

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References Barro, Robert J. 1991. Economic Growth in a Cross Section of Countries. The Quarterly Journal of Economics, MIT Press, vol. 106 no.2: 407-443. Domar, Evsey. 1946. Capital Expansion, Rate of Growth and Employment. Econometrica. Friedman, Milton. 1962. Capitalism and Freedom. University of Chicago Press. Harrod, Roy. 1939. An Essay in Dynamic Theory. Economic Journal IL, pp. 14-33. Hayek, F. A. 1992. The Fortunes of Liberalism: Essays on Austrian Economics and the Ideal of Freedom. Edited by Peter G. Klein. Routledge. Health Economics Unit. 2006. Review of Socioeconomic Conditions in CAREC Member Countries (CMCs) Final Report. Kalecki, Michal. 1990. Collected Works of Michal Kalecki, Volume 1: Capitalism: Business Cycles and Full Employment. Edited by Jerzy Osiatynski. Oxford: Clarendon Press. Marx, Karl and Friedrich Engels. 2005. The Communist Manifesto. Filiquarian Publishing, LLC. Pantin, Dennis.1996. The Challenge of Youth Unemployment in the Caribbean: the Role of Youth Employment Training Programmes. International Labour Organisation. Rowthorn, R.E. 1999. Unemployment, Wage Bargaining and Capital-Labour Substitution. Cambridge Journal of Economics, Oxford University Press 23 no.4: 413-425. Saunders, Peter. 1987. Aspects of the Social Wage: a Review of Social Expenditures and Redistribution. The Australian Economic Planning Advisory Council (EPAC). Sefton, Tom. 1997. The Changing Distribution of the Social Wage. STICERD Occasional Paper 21. London School of Economics. Smith, Adam. 1976. An Inquiry into the Nature and Causes of the Wealth of Nations: Volumes 1 and 2. Oxford: Clarendon Press. Solow, Robert. 1956. A Contribution to the Theory of Economic Growth. Quarterly Journal of Economics 70: 65-94.

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Endnotes

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1 2

Refer to Pantin (1996). There are several pieces of econometric work which have confirmed the low degree of substitutability in a developing country context. See Rowthorn (1999) for example. 3 Refer to Roger Hosein’s work on the Macroeconomic Overview of the Caribbean Region with Emphasis on Income, Fiscal Balance, Employment and International Trade for the Health Economics Unit (2006). 4 Refer to Saunders (1987) and Sefton (1997) for example. 5 Refer to Marx and Engels (2005). 6 Refer to the work of free market economists such as Adam Smith (1976) Friedrich Hayek (1992) and Milton Friedman (1962). 7 Refer to the Solow Growth Model (1956) and the Harrod-Domar Model (1939, 1946) for example. 8 Refer to Barro (1991). 9 Refer to Kalecki (1990).

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