Full employment

From Academic Kids

In economics, full employment has more than one meaning. To many laypeople, it means zero unemployment. Most economists believe that the unemployment rate at full employment is higher than that, corresponding to the NAIRU (see below). The 20th century British economist William Beveridge stated that an unemployment rate of 3% was full employment. Other economists have provided estimates from 2% to 7%, depending on the country, the time period, and the economists' political biases. (Social liberals and social democrats see full employment as corresponding to a lower unemployment rate than do conservatives.) Some estimate a "range" of possible unemployment rates. For example, for the United States, the Organization for Economic Cooperation and Development give estimates of the "full-employment unemployment rate" of 4 to 6.4% in 1999; this is the estimated "structural" unemployment rate plus and minus the standard error of the estimate. The OECD also gives estimates for other countries.[1] (http://www.oecd.org/dataoecd/44/50/2086120.pdf)

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.

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) 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, classical, and Marxian 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 structural unemployment) do not exist. Only some frictional unemployment would exist, where workers are temporarily searching for new jobs. For example, Lord William Beveridge defined "full employment" as where the number of unemployed workers equaled the number of job vacancies available. He preferred that the economy be kept above that full employment level in order to allow maximum economic production.

Long before Friedman and Phelps, Abba Lerner (1951) developed a version of the NAIRU. Unlike the current view, he 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).

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.

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 was the first country in the world in which full employment in a free 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.

External Sources

The OECD on measuring the NAIRU (http://www.oecd.org/dataoecd/27/46/18464874.pdf)

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.

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.

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