Full employment

Diagram of macroeconomic circulation. L_S ≤ L_D is the full employment situation, one in which the rate of unemployment is zero or negative (corresponding to a labor shortfall).

Full employment, in macroeconomics, is the level of employment rates when there is no cyclical or deficient-demand unemployment. It is defined by the majority of mainstream economists as being an acceptable level of unemployment somewhere above 0%. The discrepancy from 0% arises due to non-cyclical types of unemployment. Unemployment above 0% is seen as necessary to control inflation, to keep inflation from accelerating, i.e., from rising from year to year. This view is based on a theory centering on the concept of the Non-Accelerating Inflation Rate of Unemployment (NAIRU); in the current era, the majority of mainstream economists mean NAIRU when speaking of "full" employment. The NAIRU has also been described by Milton Friedman, among others, as the "natural" rate of unemployment.

The 20th century British economist William Beveridge stated that an unemployment rate of 3% was full employment. Other economists have provided estimates between 2% and 13%, depending on the country, time period, and their political biases. For the United States, economist William T. Dickens found that full-employment unemployment rate varied a lot over time but equaled about 5.5 percent of the civilian labor force during the 2000s.

The concept of full employment of labor corresponds to the concept of potential output or potential real GDP and the long run aggregate supply (LRAS) curve. In neoclassical macroeconomics, the highest sustainable level of aggregate real GDP or "potential" is seen as corresponding to a vertical LRAS curve: any increase in the demand for real GDP can only lead to rising prices in the long run, while any increase in output is temporary.

Economic concept

What most neoclassical economists mean by "full" employment is a rate somewhat less than 100% employment. Others, such as the late James Tobin, have been accused of disagreeing, considering full employment as 0% unemployment. However, this was not Tobin's perspective in his later work.

Some see John Maynard Keynes as attacking the existence of rates of unemployment substantially above 0%:

"The Conservative belief that there is some law of nature which prevents men from being employed, that it is 'rash' to employ men, and that it is financially 'sound' to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable - the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years. The objections which are raised are mostly not the objections of experience or of practical men. They are based on highly abstract theories – venerable, academic inventions, half misunderstood by those who are applying them today, and based on assumptions which are contrary to the facts… Our main task, therefore, will be to confirm the reader’s instinct that what seems sensible is sensible, and what seems nonsense is nonsense."

– J.M. Keynes in a pamphlet to support Lloyd George in the 1929 election.

Most readers would interpret this statement as referring to only cyclical, deficient-demand, or "involuntary" unemployment (discussed below) but not to unemployment existing as "full employment" (mismatch and frictional unemployment). This is because, writing in 1929, Keynes was discussing a period in which the unemployment rate had been persistently above most conceptions of what corresponds to full employment. That is, a situation where a tenth of the population (and thus a larger percentage of the labor force) is unemployed involves a disaster.

One major difference between Keynes and the Classical economists was that while the latter saw "full employment" as the normal state of affairs with a free-market economy (except for short periods of adjustment), Keynes saw the possibility of persistent aggregate-demand failure causing unemployment rates to exceed those corresponding to full employment. Put differently, while Classical economists saw all unemployment as "voluntary," Keynes saw the possibility that involuntary unemployment can exist when the demand for final products is low compared to potential output. This can be seen in his later and more serious work. In his General Theory of Employment, Interest, and Money, In chapter 2, he used a definition that should be familiar to modern macroeconomics:

This state of affairs we shall describe as ‘full’ employment, both ‘frictional’ and ‘voluntary’ unemployment being consistent with ‘full’ employment thus defined.

The only difference from the usual definitions is that, as discussed below, most economists would add skill/location mismatch or structural unemployment as existing at full employment. More theoretically,Keynes had two main definitions of full employment, which he saw as equivalent. His first main definition of full employment involves the absence of "involuntary" unemployment.

the equality of the real wage to the marginal disutility of employment ... realistically interpreted, corresponds to the absence of ‘involuntary’ unemployment.

Put another way, the full employment and the absence of involuntary unemployment correspond to the case where the real wage equals the marginal cost to workers of supplying labor for hire on the market (the "marginal disutility of employment"). That is, the real wage rate and the amount of employment correspond to a point on the aggregate supply curve of labor that is assumed to exist. In contrast, a situation with less than full employment and thus involuntary unemployment would have the real wage above the supply price of labor. That is, the employment situation corresponds to a point above and to the left of the aggregate supply curve of labor: the real wage would be above the point on the aggregate supply curve of labor at the current level of employment; alternatively, the level of employment would be below the point on that supply curve at the current real wage.

Second, in chapter 3, Keynes saw full employment as a situation where "a further increase in the value of the effective demand will no longer be accompanied by any increase in output."

In the previous chapter we have given a definition of full employment in terms of the behavior of labor. An alternative, though equivalent, criterion is that at which we have now arrived, namely a situation, in which aggregate employment is inelastic in response to an increase in the effective demand for its output.

This means that at and above full employment, any increase in aggregate demand and employment corresponds primarily to increases in prices rather than output. Thus, full employment of labor corresponds to potential output.

Before Milton Friedman and Edmund Phelps, Abba Lerner (Lerner 1951, Chapter 15) developed a version of the NAIRU. Unlike the current view, Lerner saw a range of "full employment" unemployment rates. He distinguished between "high" full employment (the lowest sustainable unemployment under incomes policies) and "low" full employment (the lowest sustainable unemployment rate without these policies).

Whilst full employment is often an aim for an economy, most economists see it as more beneficial to have some level of unemployment, especially of the frictional sort. In theory, this keeps the labor market flexible, allowing room for new innovations and investment. As in the NAIRU theory, the existence of some unemployment is required to avoid accelerating inflation.

Technical terms

"Ideal" unemployment

An alternative, more normative, definition (used by some labor economists) would see "full employment" as the attainment of the ideal unemployment rate, where the types of unemployment that reflect labor-market inefficiency (such as mismatch or structural unemployment) do not exist. That is, only some frictional or voluntary unemployment would exist, where workers are temporarily searching for new jobs and are thus voluntarily unemployed. This type of unemployment involves workers "shopping" for the best jobs at the same time that employers "shop" for the best possible employees to serve their needs. Its existence can allow the best possible correspondence between workers and jobs from the points of view of both employees and employers and thus promotes the economy's efficiency.

Unemployment at Beveridge Full Employment

Lord William Beveridge defined "full employment" as where the number of unemployed workers equaled the number of job vacancies available (while preferring that the economy be kept above that full employment level in order to allow maximum economic production). But the point is that this definition allows for some unemployment. To see this, assume that frictional and mismatch unemployment can be separated. At Beveridge full employment, in the case of frictional unemployment the number of job-seekers corresponds to an equal number of job openings: as discussed above, the unemployed are "shopping" for the best possible jobs (as long as the cost of job-search is less than the expected benefit) at the same time that employers are "shopping" for the best possible employees to fill the vacancies. Similarly,at Beveridge full employment, the number of people suffering from mismatch or structural unemployment equals the number of vacancies. The problem here is that the the skills and geographical locations of the unemployed workers does not correspond to the skill requirements and locations of the vacancies. In theory, Beveridge's concept full employment corresponds to that of Keynes (discussed above).

The situation with less that full employment in Beveridge's sense results either from "Classical" unemployment or "neoclassical" unemployment or from Keynesian deficient-demand unemployment. In terms of supply and demand, Classical or neoclassical unemployment results from the actual real wage exceeding the equilibrium real wage, so that the quantity of labor demanded (and the number of vacancies) is less than the quantity of labor supplied (and the number of unemployed workers). In the Classical theory, the problem is that real wages are rigid, i.e., do not fall due to an excess supply of labor. In theory, this might happen because of minimum wage laws and other interference with "free markets" that prevent the attainment of market perfection. Classical economists favor making labor markets more like the ideal competitive market -- and so making real wages more flexible -- in order to deal with this kind of unemployment.

The neoclassical theory, in contrast, follows John Maynard Keynes and more importantly, Milton Friedman to blame inflexible money or nominal wages for low employment relative to full employment. If the money wage is fixed, the real wage is fixed for any given average price level, so that rigid money wages have the same effect as rigid real wages when the price level is given. In this case, however, real wages can be depressed (and Beveridge full employment restored) if prices rise relative to nominal wages. Alternatively, people could wait for the persistence of high unemployment to eventually cause money wages to fall. This would have the same effect, reducing real wages and increasing the quantity of labor demanded. One of the big debates in macroeconomics is whether it is better to deal with neoclassical unemployment using a small amount of inflation or by waiting for markets to adjust.

In contrast, Keynesian deficient-demand unemployment (as explained by Don Patinkin) sees a situation with less than full employment (following Beveridge's definition) as possibly prevailing even if the actual real wage is equal to the equilibrium real wage at full employment. The problem is that the demand for final products is limited by aggregate demand failure. Low demand for products (below potential output) implies that there is a sales constraint on the labor market to the left of equilibrium so that the quantity of labor demanded is below the amount that would be demanded if the aggregate demand for products was sufficient (what Robert Clower called the notional demand for labor). In terms of neoclassical theory, the prevailing real wage is less than the marginal physical product of labor in this situation. In the absence of the sales constraint, profit-maximizing employers would hire unemployed workers as long as this inequality is true, moving the labor markets toward full employment. However, the sales constraint means that the extra product of these workers could not be sold. Thus, employers would not hire the unemployed until aggregate demand role, which would shift the sales constraint to the right, allowing more employment of labor. In this situation, Keynesians recommend policies that raise the aggregate demand for final products and thus the aggregate demand for workers.

NAIRU

Main article: NAIRU

Phillips Curve before and after Expansionary Policy, with Long-Run Phillips Curve (NAIRU)

The following should be understood in discussions of NAIRU: governments that follow it are attempting to keep unemployment at certain levels (usually over four percent, and as high as ten or more percent) by keeping interest rates high. As interest rates increase, more bankruptcies of individuals and businesses occur, meaning less money to hire staff or purchase goods (the making and distributing of which requires workers, which means jobs). It might also be noted that the main cause of inflation is not high employment, but rather the ability of banks to make money with little to no backing with things of value (commodities such as gold and silver are some examples), thus flooding the market with money and decreasing the value of each dollar already issued in the process, assuming the economy has not kept up to this increase in issued loans. Though economists such as Milton Friedman and Dr. Ravi Batra have theorized ways that a modern economy could have low inflation and near full employment (as in close to 100% of those who are not students and are healthy enough to work, and who wish to work at any given point in time), these have yet to be widely disseminated through the press or introduced by most governments. Paul Martin – former finance minister and past Prime Minister of Canada – once held that full employment could be achieved, yet let go of this idea after gaining power.

Friedman's view has prevailed so that in much of modern macroeconomics, full employment means the lowest level of unemployment that can be sustained given the structure of the economy. Using the terminology first introduced by James Tobin (following the lead of Franco Modigliani), this equals the Non-Accelerating Inflation Rate of Unemployment (NAIRU) when the real gross domestic product equals potential output. This concept is identical to the "natural" rate but reflects the fact that there is nothing "natural" about an economy.

At this level of unemployment, there is no unemployment above the level of the NAIRU. That is, at full employment there is no cyclical or deficient-demand unemployment. If the unemployment rate stays below this "natural" or "inflation threshold" level for several years, it is posited that inflation will accelerate, i.e. get worse and worse (in the absence of wage and price controls). Similarly, inflation will get better (decelerate) if unemployment rates exceed the NAIRU for a long time. The theory says that inflation does not rise or fall when the unemployment equals the "natural" rate. This is where the term NAIRU is derived.

The level of the NAIRU thus depends on the degree of "supply side" unemployment, i.e., joblessness that can't be abolished by high demand. This includes frictional, structural, and classical unemployment.

Phillips curve

Ideas associated with the Phillips curve questioned the possibility and value of full employment in a society: this theory suggests that full employment—especially as defined normatively—will be associated with positive inflation. The Phillips curve tells us also that there is no single unemployment number that one can single out as the "full employment" rate. Instead, there is a trade-off between unemployment and inflation: a government might choose to attain a lower unemployment rate but would pay for it with higher inflation rates. In 1968, Milton Friedman, leader of the monetarist school of economics, and Edmund Phelps posited a unique full employment rate of unemployment, what they called the "natural" rate of unemployment. But this is seen not as a normative choice as much as something we are stuck with, even if it is unknown. Rather than trying to attain full employment, Friedman argues that policy-makers should try to keep prices stable (a low or even a zero inflation rate). If this policy is sustained, he suggests that the economy will gravitate to the "natural" rate of unemployment automatically.

Structural unemployment

Main article: Structural unemployment

Some Economists estimate a "range" of possible unemployment rates. For example, in 1999, in the United States, the Organisation for Economic Co-operation and Development (OECD) gives an estimate of the "full-employment unemployment rate" of 4 to 6.4%. This is the estimated "structural" unemployment rate, (the unemployment when there is full employment), plus & minus, the standard error of the estimate. (Estimates for other countries are also available from the OECD.) [4]

Full employability

Full employability indicates an attempt by government to make people "employable" by both positive means (e.g. training courses) and negative means (e.g. cuts in benefits). It does not necessarily create full employment.

Technical issues

Whatever the definition of full employment, it is difficult to discover exactly what unemployment rate it corresponds to. In the United States, for example, the economy saw stable inflation despite low unemployment during the late 1990s, contradicting most economists' estimates of the NAIRU.

The idea that the full-employment unemployment rate (NAIRU) is not a unique number has been seen in recent empirical research. Staiger, Stock, and Watson found that the range of possible values of the NAIRU (from 4.3 to 7.3% unemployment) was too large to be useful to macroeconomic policy-makers. Robert Eisner suggested that for 1956-95 there was a zone from about 5% to about 10% unemployment between the low-unemployment realm of accelerating inflation and the high-unemployment realm of disinflation. In between, he found that inflation falls with falling unemployment.

Worse, the NAIRU doesn't stay the same over time—and can change due to economic policy. For example, some economists argue that British Prime Minister Margaret Thatcher's anti-inflation policies using persistently high unemployment led to higher structural unemployment and a higher NAIRU.

Policy

The active pursuit of national full employment through interventionist government policies is associated with Keynesian economics and marked the postwar agenda of many Western nations, until the stagflation of the 1970s.

Australia

Australia was the first country in the world in which full employment in a capitalist society was made official policy by its government. On May 30, 1945, The Australian Labor Party Prime Minister John Curtin and his Employment Minister John Dedman proposed a white paper in the Australian House of Representatives titled Full Employment In Australia, the first time any government apart from totalitarian regimes had unequivocally committed itself to providing work for any person who was willing and able to work. Conditions of full employment lasted in Australia from 1941 to 1975. This had been preceded by the Harvester Judgment (1907), establishing the basic wage (a living wage); while this earlier case was overturned, it remained influential.

United States

The United States is, as a statutory matter, committed to full employment (defined as 3% unemployment for persons 20 and older, 4% for persons aged 16 and over); the government is empowered to effect this goal. The relevant legislation is the Employment Act (1946), initially the "Full Employment Act," later amended in the Full Employment and Balanced Growth Act (1978). The 1946 act was passed in the aftermath of World War II, when it was feared that demobilization would result in a depression, as it had following World War I in the Depression of 1920–21, while the 1978 act was passed following the 1973–75 recession and in the midst of continuing high inflation.

The law states that full employment is one of four economic goals, in concert with growth in production, price stability, balance of trade, and budget, and that the US shall rely primarily on private enterprise to achieve these goals. Specifically, the Act is committed to an unemployment rate of no more than 3% for persons aged 20 or over and not more than 4% for persons aged 16 or over (from 1983 onwards), and the Act expressly allows (but does not require) the government to create a "reservoir of public employment" to effect this level of employment. These jobs are required to be in the lower ranges of skill and pay so as to not draw the workforce away from the private sector.

However, since the passage of this Act in 1978, the US has, as of 2012 never achieved this level of employment on the national level, though some states have neared it or met it, nor has such a reservoir of public employment been created.

Job guarantee

Main article: Job guarantee

Some, particularly Post-Keynesian economists have suggested ensuring full employment via a job guarantee program, where those who are unable to find work in the private sector are employed by the government, the stock of thus employed public sector workers fulfilling the same function as the unemployed do in controlling inflation, without the human costs of unemployment.

See also

• Career
• Chapter IX of the United Nations Charter
• Corporatism
• Deflation
• Employment
• False Consciousness
• International labour standard
• Job guarantee
• Labour (economics)
• Marxism
• Profession
• Reserve army of labour
• Say's law
• Wage slavery

External sources

• The OECD on measuring the NAIRU
• Devine, James. 2004. The "Natural" Rate of Unemployment. In Edward Fullbrook, ed., A Guide to What's Wrong with Economics, London, UK: Anthem Press, 126-32.
• Eisner, Robert. 1997. A New View of the NAIRU. In Paul Davidson and Jan A. Kregel, eds. Improving the Global Economy. Cheltenham, UK: Edgar Elgar, 1997.
• Friedman, Milton. 1968. The Role of Monetary Policy. American Economic Review. 58(1) March: 1-21.
• Lerner, Abba. 1951. Economics of Employment, New York: McGraw-Hill.
• McConnell, Brue, and Flynn. Microeconomics 19th edition. 2012.
• Staiger, Douglas, James H. Stock, and Mark W. Watson. 1997. The NAIRU, Unemployment and Monetary Policy. Journal of Economic Perspectives. 11(1) Winter: 33-49.