Some limits to Keynesian policy

9780199390632Can Keynesian policies create full employment under capitalism? And what are the limits to such policies? Many economists in the Keynesian tradition, from Paul Krugman on the mainstream wing, to Wynne Godley and Marc Lavoie on the more left-wing heterodox one, have persistently argued that some mixture of monetary and fiscal policy should be used to manage aggregate demand and achieve and maintain full employment under capitalism. What this means in practice is subject to some debate: full employment is a more abstract idea than simply arguing over whether 3% or 5% unemployment represents what is ‘full’.

There have been periods during the history of capitalism across different countries and at different times when full employment has been achieved. The so-called Golden Age of Capitalism in the 1950s and 60s saw very low unemployment in much of Western Europe. Since then, it has been subject to significant rises and falls, often associated with changing degrees of economic growth and prosperity. It has fallen in many countries where wages for the poorest members of society have grown only slowly if at all. This has been associated with varying degrees of reform where labour markets have been deregulated, welfare states have become less generous, but also in certain countries with forms of tri-partism where there has been cooperation between employers, workers, and the government over wages, working conditions, employment levels and corporate restructuring. Particularly in Scandinavia, there has also been state assistance to the unemployed to re-locate and re-train in order to find new employment.

Thus in recent decades, there has been an emphasis from mainstream economists with regards to employment policy on reforms to labour markets to raise their ‘flexibility’ rather than simply monetary and fiscal expansions of aggregate demand, which was favoured during the Golden Age.

Drawing on the work of Richard Goodwin who in turn drew on Marx, Anwar Shaikh, in his recently published work Capitalism: Competition, Conflict, Crises, argues that profitability for the economy as a whole imposes a limit on the extent to which a policy-induced expansion of demand can lower unemployment and sustain it at some reduced level.

If expansionary monetary and fiscal policy raises the growth of aggregate demand, then the level of output can rise for a time, reducing unemployment to some degree. But if this reduction strengthens the power of employed workers and they manage to raise wages relative to productivity, then the wage share in the economy will rise and the profit share will fall, in the absence of higher inflation. Since according to Shaikh, output growth depends on investment and the latter on profitability net of the interest rate, then a fall in the profit share will reduce the funds available for investment, unless firms overcome this through increased borrowing. This fall in profitability will reduce the rate of investment growth and from there the growth rate of output. Slowing or falling output growth will tend to reduce the ‘tightness’ of the labour market, leading to reduced employment. Other things being equal, this will reduce the bargaining power of workers, and reduce the wage share in net output, increasing the profit share.

The implications of this analysis are that policies to expand aggregate demand can be effective, but if nothing else changes, this may only be the case over some limited period. A temporary rise in the level of output and employment can be followed by a fall in the rate of growth of output and employment over the longer term.

Of course, other things tend not to remain the same in a complex economy. There is the potential for a wages policy under tri-partism as mentioned above, to reduce the growth of wages relative to productivity even if lower unemployment strengthens workers’ bargaining power. Thus co-operation between different economic agents are one potentially effective additional policy.

Policies which increase productivity growth relative to wages can also prevent the wage share from rising and the profit share from falling in the presence of expanding demand. This could also help sustain growth rates in output and employment.

From a more right-wing perspective, policies which weaken the bargaining power of labour, which can take the form of deregulation and ostensibly increasing flexibility and economic efficiency, can be effective in reducing the rise in wages relatively to productivity and helping to sustain rises in demand and employment. This approach has become fashionable across the capitalist world since the 1970s. But it can be socially damaging and weaken growth in demand over the longer term, so that rising consumption can only be sustained through household borrowing, a process which has definite limits.

Overall then, this suggests the need for a package of policies to reduce unemployment at the macroeconomic level while sustaining growth in output and productivity. This has historically proved difficult to achieve. The effect of monetary and fiscal policies on employment over the longer term depends on the relationship between wages and profits, and productivity. In addition, the balance of power between capital and labour will shift over time according to changes in economic, social and political factors. The importance of the relationship between these three is clearly ever-present in economic analysis and policy.

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