Structural Unemployment and Working Poverty Are Not Inevitable

Written by Maximilian Held | April 19, 2010 | 1 Comment | Category: Opinion

The plight of structural unemployment and gaggles of working poor, it appears, are here to stay. But are they the inevitable consequence of economic liberalisation?They are not. If we balance the burden of economic transformation on labor and capital, and strengthen progression, we can have it both: near full employment and open borders.

The sentiment is right, but the policy is flawed. 

No, the answer is not a minimum wage. No, it’s not protectionism. No, it won’t hurt growth. But yes, it will require fundamental reform, hard work and international cooperation.Structural unemployment and working poverty require honest, if politically incorrect explanations. The questions they pose are not trivial: economic theory holds that perfectly competitive markets clear. At equilibrium prices, every worker should find employment. And yet, they do not, and if they do, frequently under dire conditions and low pay. What happened?

Return of Manchester-capitalism

At least three mechanisms are at play. The first is exploitation.

Mr Burns: eeexcellent, via Flickr, originally uploaded by fabriciuse 

If workers are not organized and able to credibly threaten strike, their collective bargaining power breaks down. Employers, often larger and better organized, can exploit the collective action problem of labor and pay lower wages than they otherwise would be ready to accept. This is the dynamic that plagued early, Manchester-style capitalism: individual workers, faced with the alternative of being replaced by someone else, will accept almost any wage, irrespective of their productivities. We may witness a sad resurgence of this dynamic in some sectors of the service economy (think security, cleaning, labor leasing). This is an outrage, to be sure. We need to ensure fair, collective bargaining as much we can and otherwise threaten with direct intervention (sectoral minimum wages). And yet, while exploitation is an easy sell politically, it is only a part of the story. The following argument concentrates on that other part.

Blame trade? (no)

The second culprit is trade and capital mobility.

Dismantled factory, via Flickr, originally uploaded by Martin Kimelsdorf

As borders become permeable, the global economy specialises, each according to national comparative advantage. In developed economies, this means that labor-intensive production of tradable goods is frequently outsourced or off-shored (FDI) abroad, where workers are in ample supply and willing to work for lower pay. Deindustrialisation sets workers free in the rich world, or may force them to accept lower real incomes. Again, a culprit that looks good on campaign posters. And yet, we have known since David Ricardo (1772 - 1823) that, at least in principle, trade increases overall welfare, and we have seen it work in practice. Ricardo, of course, assumed complete factor mobility, thereby ruling out structural unemployment. Our understanding of international economic transformation has grown since his time, and revealed more complex dynamics and empirical findings, featuring agglomeration effects, proximity to target markets, dependency theory, and costs of moving, to name just a few. But still, whatever happens in our labor markets occurs under the constraint of someone else, somewhere else being able to get it done for less.

Rage against the machine? (please, no)

The third cause is economic and technological modernisation. Fewer, but more productive workers replace many, less educated workers. This invisible hand of specialisation takes many forms. Sometimes, a machine is invented that renders human beings redundant in production (think microchip, not paper). Sometimes, organisations grow, integrate and evolve to do more with less people (think lean management, not Fordism). Sometimes, better educated workers find new, more efficient ways to do things (think engineering, not trial-and-error). Since early-industrial rage against the machine, specialisation has receded into the background of political conflict. It may be inopportune to say out loud, but it is nonetheless true: the latter two dynamics of trade and domestic specialisation are unambiguously positive for our economies as a whole. These painful throes of transition are the very carrots and sticks that make us prosper. Specialisation is, indeed, the key to the “Wealth of our Nations” (cf. Smith 1776).

We do need some education …

Structural unemployment and working poverty emerge from the dysfunctional interaction of economic transition and an inaptly intervening welfare state. Where precariously low wages are not a product of bargaining power asymmetries, they suggest that some people just do not produce enough value to partake in the riches of our economies. Similarly, structural unemployment arises when some workers are not productive enough to warrant pay at whatever we collectively deem a socially acceptable minimum income. Whether this minimum is implemented as a statutory minimum wage or as welfare transfers makes little difference. Whoever is below either of the two will not find a job.

“It’s a recession when your neighbor loses his job; it’s a depression when you lose yours.” (Harry Truman, 1884-1972)

The only genuine cure for the twin societal illnesses of structural unemployment and working poverty is education, and increasing social mobility. The first political imperative must be to ensure that at least the children of those struck in precarious conditions today will once be able to earn their living without the transfer payments, hardship and stigma of their parents. This will require colossal public resources, but also, fresh ideas. [caption id=”"

Don’t exit. via Flickr, originally uploaded by Ben McLeod

… but also: redistribution

But there is a second political, and moral imperative, really: relief for those suffering from the symptoms of structural unemployment and working poverty today. Additionally, unemployment and poverty today will make it harder for some families and children to ever escape their conditions in the future: structural unemployment and working poverty have a negative dynamic effect on future inequality and productivity. Likely (hopefully), low productivity as the cause of unemployment and poverty will never make it to the campaign posters, and rightfully so. The very notion is too easily perceived as an insult to human equality, or at best, as shoulder-shrugging cynicism. To escape the politics of TINA (there is no alternative), and to arrive at normatively justifiable suggestions how to move forward, we must deconstruct the basic economic categories of productivity, capital and labour and understand the choices of redistributive taxation.

Economics 101

Productivity is the amount of output created for any amount of input. For labour that means output per hour of work - and yet it has little to do with being lazy or diligent. Rather, labour-productivity is determined by human capital or education (think programming skills) and physical capital (think computer) available in production. Compared to a fully electronic invoicing solution, typing away even really fast on your pocket calculator will get you only so far in terms of productivity. It consequently seems dubious to construe productivity as a matter of individual responsibility. In unequal societies with limited social mobility (like Germany), it is not.

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Capital and labour feature prominently in production functions: to get anything done, at minimum, you need some instruments to do it, and some people to handle them. Labour is self-explanatory - whereas capital is not. It easily conjures up images of greedy sharks, private equity locusts, or otherwise dehumanised demons, from Marx to, sadly, today’s campaign posters. Today, “capital” is less of a class, and more of an abstracted promise for later consumption, a consumption cheque ideally backed by some kind of physical or human capital. It is widely distributed, sits both in the retirement account of an old lady, just as in the portfolio of a stock-market tycoon.  It is helpful to remember that the world economy, in the last instance, works like a household, only with a cast of billions.  In a household, capital can take the form of pre-cooked meals in the fridge to allow members to devote their time to refurnishing for a couple of days, in turn creating new, enhanced capital. For this mechanism to function, two conditions must be met: household members must believe that they will actually gain access to the pre-cooked meals (property rights), and they must be able in the first place to devote resources to pre-cooking meals (capital accumulation).Again, these two things are unambiguously positive, in spite of capital’s bad name: property rights are but another way of organizing cooperation, and capital accumulation means to enrich our world, with powerful factories, liberating technologies and empowering education.

“Poverty has no utility.” (Ferdinand Lasalle, 1825-1864)

In other words, capital as such is not the problem. The problem lies in the (re)distribution of consumption cheques, and in the incentives and taxes we place on different kinds of activities. Obviously, hard productive work and risky investment need their carrots: in a household of homo oeconomicus, if you receive no reward for refurnishing a room and living off pre-cooked meals, you are unlikely to do so. This battle of “efficiency vs. equity” has raged for decades, on the subject of structural unemployment, working poverty and elsewhere. The question still stands, however: just how large does the carrot have to be to incentivise desirable behavior?

Please don’t smash capitalism, via Flickr, originally uploaded by Jakob Huber

The hardships of structural unemployment and working poverty are good reasons to redistribute the carrots more than a little, to strengthen tax progression, both for normative and instrumental reasons. Where do we stand today?

A bad, bad fiscal configuration: taxing to pieces

Over the past decades, in many industrial countries, we have seen a shift towards regressive schedules on immobile tax bases. Taxes on capital (capital gains and associated corporate income taxes) have decreased, and the progression of the income tax has been reduced - mostly for fear of capital flight abroad. Taxes on labor (payroll) and, most dramatically, consumption taxes (VAT), have increased - because these tax bases cannot easily emigrate. This fiscal configuration may not only be regarded as unjust, it also exacerbates structural unemployment and working poverty. Payroll taxes and social insurance contributions further widen the gap between actual labor productivity and gross wages. Even fewer people will find gainful, let alone adequate employment. VAT hikes increase the effective socially acceptable minimum income by raising the costs of living. VAT is also, in truth, a regressive tax because poorer people spend more (all) of their income generating ability on consumption that richer people do, who can generate untaxed interest with their surpluses.

Progressive transfer is the answer

The solution to structural unemployment and working poverty lies in boosting progressive components of taxation. The least productive person must be taxed so little that she will still find gainful employment at adequate pay. For many, this may necessitate a negative tax rate (read transfers), as the prominently suggested (Friedman 1961) but never implemented negative income tax. Under the NIT, workers would receive progressive transfer payments for hourly market wages below the socially acceptable minimum. However, in contrast to current income supplements, real market wage increases are not entirely eaten up by transfer cuts: at any given level of income, earning more on the market will leave you with more net in the bank. For example, under a minimum acceptable hourly income of EUR 7.50 (current minimum wage proposal in Germany), moving from a EUR 2.00 market price to a EUR 4.00 market price job could increase your post-tax income from EUR 7.50 (transfer EUR 5.50) to EUR 8.50 (transfer EUR 4.50), always maintaining your incentives to earn more on the market. This may also help to counteract rent-seeking exploitation by low-paying firms.The NIT is one promising proposal to shift the burden of economic transformation away from the unemployed and working poor who now bear its brunt. It will get us closer to welfare-maximising full employment. Yet, it will be very costly, and, to the extent that it alleviates the material hardship of the working poor, it will include a zero-sum redistributive component. 

Bearing the burden, via Flickr, originally uploaded by Jaron

Deciding who should bear more of the burden and designing how to pay for it will not be easy. Just taxing capital and investment across the board would depress growth and redistribute from the future to today. If anything, progressive taxation of assets (read expropriation, estate tax) and consumption (think conspicuous consumption) appear to be promising candidates to maintain incentives and still raise enough revenue to redistribute. Either way, more progressive taxation will require strong international cooperation to avoid capital flight. Also, whenever resources are channeled from investment to people who are ill-equipped to be sufficiently productive that very redistribution of consumption may alleviate the very pressures we all need to adapt.

Live to work, not work to live (some Marx, at last)

For the goal must ultimately be to enable all people to participate gainfully in the mainstream of social and economic life,  to enable them to earn their living. As Marx wrote, man lives to work, meaningfully and adequately paid, one might add. No one should work to live, certainly not under some decommodifying transfer scheme that grants sustenance, but not gratification.And yet, for the time being, transfer is the answer. The plight of structural unemployment and hardship of working poverty are not inevitable, for no one. Balancing the burden of economic transformation with progressive taxation is of our own, collective choosing. If we do it right today, and never cease to improve education and social mobility for tomorrow, we can have it all: to prosperity and opportunity.

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