Economics Myths, Part 3: Full Employment is Good

Some may be surprised to learn that ‘full employment’, as defined by a 0% or near 0% unemployment rate, is neither feasible nor economically desirable. The definition of ‘full employment’ can have many meanings, the definition accepted by economists generally allows for some unemployment, but for ‘full employment’ to occur anyone who wants to work can find a job, although some unemployed people may voluntarily choose not to seek work and may be counted as unemployed until they ‘fall off’ the statistic and are no longer counted (usually after 100 weeks when unemployment benefits run out). That’s how it’s possible to have very low unemployment yet a low labor force participation rate.

There are three types of unemployment: Cyclical, Structural, and Frictional

Cyclical, deficient-demand, or Keynesian unemployment, occurs when there is not enough aggregate demand in the economy to provide jobs for everyone who wants to work. Demand for most goods and services falls, less production is needed and consequently fewer workers are needed, wages are sticky and do not fall to meet the equilibrium level, and mass unemployment results.

What this means is the the economy, for various macro factors, is unable to provide enough jobs for everyone who wants a job. If the Luddite Fallacy stops being a fallacy, there may be situation where there won’t be enough jobs despite the economy otherwise being strong. This is related to Okun’s Law, an empirically observed relationship between unemployment and losses in a country’s production, that states that for every 1% increase in the unemployment rate, a country’s GDP will be roughly an additional 2% lower than its potential GDP. There is evidence that Okun’s Law may be failing in the United States economy, the result being a so-called ‘jobless recovery’ that has been especially obvious since 2008:

In past economic expansions, job growth tended to correlate better with economic growth.

These unemployed people ‘drop off’ the count and the total size of the labor force will shrink, creating a new, lower level of ‘full employment’ even though there are a lot of people not working.

The second type of unemployment is structural:

Structural unemployment occurs when a labour market is unable to provide jobs for everyone who wants one because there is a mismatch between the skills of the unemployed workers and the skills needed for the available jobs. Structural unemployment is hard to separate empirically from frictional unemployment, except to say that it lasts longer. As with frictional unemployment, simple demand-side stimulus will not work to easily abolish this type of unemployment.

This is the main reason why ‘full employment’ is neither attainable nor a good idea. As the economy and society evolves, jobs will be created and destroyed, but the result is the frontier of technology is advanced, resulting in new technologies and a higher standard of living. To turn off this job creation and destruction mechanism would result in ‘full employment’ due to no one having to learn new skills, but in the long-run it would cause stagnation. It’s analogous to a hunter-gatherer society that never advances to agriculture.

As with frictional unemployment, simple demand-side stimulus will not work to easily abolish this type of unemployment.

This is why the Obama stimulus failed. ‘Make work’ projects are a waste of money, since they are artificial (not market-driven) and don’t create enough long-term economic value to be profitable and self-sustaining. As soon as the stimulus ends, so to do the jobs. For an economic incentive to work, it must not be perceived as temporary; otherwise, companies will behave like it doesn’t exist. If the US corporate tax rate were dramatically lowered, companies would need to be confident that they would remain low for a sufficiently long time, before making the monetary commitment of hiring, expanding, and reorganizing under the new tax regime.

Not to make this too political, welfare liberals want to live in the past, protecting overpaid, obsolete factory and union jobs and attacking innovative companies like Uber, for example, instead of accepting that job loss is a necessary and unavoidable side effect of an evolving economy. Bernie Sanders ranting and raving about ‘greedy capitalists’ and exhorting the rich to ‘pay their fair share’ is not going to help create jobs, either, sorry. That makes perfect sense: attack the capitalists who create jobs, yet complain about the labor market being weak.

And finally, frictional unemployment, the third type of unemployment, describes unemployment that is voluntary, such as people quitting a job to look for another. Frictional Unemployment is another reason why ‘full employment’ will never be possible; there will always be people looking for a better job, and the ability and freedom to look for new, better opportunities is one of the advantages of having a flexible, dynamic economy. As an extreme example, under totalitarian regimes, it was not uncommon for saves to have a single type of job for their entire lives, until they either died of exhaustion or were killed.