Unraveling Unemployment Theories: A Century-Long Debate

For a century, unemployment theories have witnessed a relentless clash between liberals and Keynesians, with one prevailing over the other depending on the era. From the Great Depression in 1929 to the oil crisis of 1973, Keynesianism triumphed, but since the 1980s, liberal theories have dominated the discourse.

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The Liberal-Keynesian Tug of War

Before the 1929 crisis, liberal ideology viewed the labor market as just another market. With flexible wages and no unemployment benefits, the market was believed to naturally gravitate towards equilibrium—full employment. If unemployment existed, it was deemed voluntary.

The 1929 crisis shattered this belief. Keynes revolutionized the perception of unemployment, asserting that the issue wasn’t resolved through wage reduction but required a robust demand for goods and services at a global level. Keynesianism advocated for maintaining wages, leading to the creation of minimum wages (SMIC) and unemployment benefits, enabling the unemployed to continue consuming.

In the 1970s, Keynesian approaches showed limitations, and Milton Friedman dismantled Keynesianism, particularly discrediting the Phillips curve. Since then, while some Keynesian elements persist (SMIC, benefits), liberal philosophy dominates employment policies, emphasizing flexibility and mobility.

Exploring New Avenues

Since the 1970s, new avenues have been explored, aiming to break the deadlock between liberals and Keynesians.

Two Unemployment Regimes

Edmond Malinvaud attempted to break free from the liberal/Keynesian dichotomy by introducing the concept of price rigidities, distinguishing between two unemployment regimes:

Keynesian Unemployment: Occurs when demand for goods and services is limited, leading to restrained production and employment despite the capacity to produce more.
Classical Unemployment: Arises when prices of goods and services are insufficient, jeopardizing profits. This scenario results in inadequate hiring, leading to unemployment.

The distinction suggests different remedies. Keynesian unemployment requires wage increases to stimulate demand, consumption, production, and hiring. In classical unemployment, limiting wages is crucial to restore profits and revive production. Correct diagnosis becomes essential, as an erroneous approach could exacerbate, rather than alleviate, unemployment.

Okun’s Law

Establishing a relationship between GDP growth and changes in the unemployment rate, Okun’s Law seemingly states the obvious: unemployment decreases only with economic growth. However, challenges arise in determining the threshold growth rate for unemployment reduction, varying across countries.

Insiders/Outsiders Model

Introduced in the 1980s by Assar Lindbeck and Dennis J. Snower, the insiders/outsiders theory posits that unemployment results from the dual nature of the labor market. Insiders enjoy favorable conditions (permanent contracts, relatively high salaries, good working conditions), while outsiders experience job insecurity (fixed-term contracts, internships, part-time roles) and lower salaries. Unemployment primarily affects the latter group, exacerbated by minimum wage regulations and social charges preventing wage reductions.

Read Also: How to Calculate Real Income

Efficiency Wage

Many economists highlight the role of efficiency wages in explaining unemployment. The idea is that companies pay higher-than-equilibrium wages to enhance productivity (Harvey Leibenstein, Janet Yellen). Joseph Stiglitz suggests that efficiency wages are paid to prevent the costs associated with turnover and the inherent risk of new hires (moral hazard).

Implicit Contracts

The theory of implicit contracts (proposed by Costas Azariadis) aligns with the efficiency wage concept. It explains the maintenance of wages above equilibrium by implying an implicit agreement between employers and employees—a pact to reduce uncertainty for both parties.

The End of Work?

Jeremy Rifkin’s perspective takes a more radical stance (The End of Work, 1995). According to the American essayist, unemployment is not a symptom of crisis but a consequence of economic success. Technological innovations (automation, robotics) allow envisioning a society liberated, at least partially or ultimately, from the biblical imperative “You shall earn your bread by the sweat of your brow.” Rifkin echoes Keynes’ anticipation in his 1930 letter to his grandchildren, foreseeing a society of abundance and a substantial reduction in working hours.

Unemployment Theories: Key Takeaways

Unemployment analyses are dominated by the clash between liberals and Keynesians.
The debate centers on whether the market should resolve the issue or if state intervention is necessary.
Numerous theories have emerged, including those suggesting that combating unemployment might be futile.

Conclusion

In conclusion, the century-long debate on unemployment theories reflects the ever-evolving economic landscape, where the struggle between liberal and Keynesian ideologies persists.

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