MONETARISTS AND EMPLOYMENT

creates social hardship⁵⁵". This occurs as Government fiscal deficits are stabilized and public parastatals are restructured. This is a subject too long to be treated in depth here and the reader is referred to the texts cited in the previous two footnotes.

6. MONETARISTS AND EMPLOYMENT

Influential in structural adjustment theories is the role of monetarism. Again, labour markets are not central to monetary theory. Whether monetarism is Walrasian or not is a distinction used by Hahn⁵⁶to disentangle monetarist thought from other branches of economics. He suggests that monetarists are Walrasian because they believe that involuntary unemployment does not exist since the unemployed can always offer themselves at a wage lower than that even if it means rehiring all the work force again. Milton Friedman⁵⁷ writes that "I continue to believe that the fundamental differences between us and Keynesians are empirical not theoretical". Yet Friedman believes that all observed unemployment is a "natural" rate of unemployment - containing both frictional and structural unemployment. Clearly, then, there is a difference between Friedman and Keynes, the former being Walrasian (price adjustments) and the latter not (quantity adjustments).

Hahn does not attempt to define monetarism formally, and follows Friedman in agreeing that any definition is bound to impose a coarse division. Hahn, though, labels monetarists as believing that actual economies are only out of equilibrium for short periods. The dispute between monetarists and Keynesians does not turn on the role assigned to money. For instance both agree that the desired money stock is proportional to money income. However, according to Hahn, Keynes tended to ignore the fact that if bonds are issued to finance more government spending, interest rates will be higher. Further, if the government budget is not balanced the stock of financial assets would be changing and the economy would not be able to settle down to its long-run stationary equilibrium.

⁵⁵Stephen Mangum, Garth Mangum & Janine Bowen: "Strategies for Creating Transitional Jobs during Structural Adjustment", Education & Employment Working papers, (PHRD/World Bank, WPS 947, August 1992).

56 F. H. Hahn: “On Walrasian equilibria”, Review of Economic Studies, vol.45, pp1-17, 1978.

57 M. Friedman: Essays in Positive Economics, University of Chicago Press, 1953.

The overwhelmingly important postulate of the monetarists is that the invisible hand works and that it works pretty swiftly, although not instantaneously. This was, at one time, demonstrated

with reference to the "Phillips curve" pictured in figure 4.

The central message conveyed by this figure is that there is a trade off between fighting inflation and lowering unemployment. The negative slope indicates that, as the unemployment rate is lowered, the rate of inflation is increased. Thus the "cost" of lowering unemployment is a higher rate of inflation. Similarly, the "cost" of reducing the rate of inflation is that the economy must absorb a higher level unemployment.

Figure 4. Phillips curve

The Phillips curve and the Keynesian school were hurt by the fact that unemployment and high rates of inflation coexisted in the 1970s in the capitalist nations, despite greatly increased government expenditure. This was, according to Friedman⁵⁸, because the government's use of monetary and fiscal policy is designed to increase the demand for goods and services, thereby increasing the general price level and making labour's services more valuable. The result is that the demand for labour is increased and unemployment falls. While Friedman does not dispute these events, he believes the Keynesians end this story prematurely. He believes that when the workers find that their real purchasing power has been reduced due to the increase in prices, they will demand and receive wage increases that restore their previous purchasing power. But if wages rise by as much as prices, this removes the incentive firms had to expand employment initially, and the levels of employment and unemployment will return to their old levels. This is demonstrated in figure 5.

58 M. Friedman, op.cit.

Figure 5. Prices and unemployment

A spurt of inflation results (figure 5) in a reduction of unemployment as the real wage is lowered. This sequence of events corresponds to the "short-run" Phillips curve, segment AB.

Subsequently, as the previous real wage is restored, unemployment increases (the economy moves from B to C) and we are left with a higher rate of inflation but the old level of unemployment. Thus, the only change that is possible in the long run is from A to C. Friedman believes that the Keynesians err in recognising only the short-run nature of the movement from A to B, and ignoring the longer run movement from B to C.

The persistence of unemployment led to the notion of the ‘natural rate of unemployment’ (see Fine⁵⁹) which is that level of joblessness that is warranted even where the market is working

‘ideally’ because, for example, of the need for workers to look for new jobs or because of the random and unforeseen shocks to the economic system to which adjustment needs to be made.

The natural rate of unemployment (NRU) was also originally identified as that point at which inflation would not accelerate, or decelerate, along the vertical part of the Phillips curve. The persistence of unemployment and inflation in the 1980s led to the notion of the non-accelerating inflation rate of unemployment (NAIRU). This illustrates how economists moved away from Keynesian notions of full employment to concentrate upon inflation control first.

The two major causes of inflation are costs rising faster than increases in productivity and demand running higher than supply. Presumably, Friedman thinks that the latter works first and the former second. In a world that is not neo-classical, however, wage rises need not necessarily be financed through inflation but, for example, from profits and, if these were too low, from increased taxation of richer in favour of poorer workers. Workers do not necessarily demand wages in excess of productivity increases. They demand a wage which, at least does not fall in real terms. Hence, when information is poor concerning future inflation, workers will attempt to discount the future by asking for wage increases above the inflation rate plus productivity increases, thus contributing to a further bout of inflation. Certainly, the high real interest rates in

59 Ben Fine: Labour Market Theory, Routledge, London, 1998.

the 1990s contributed to breaking this vicious circle as inflation fell, growth increased and unemployment fell. However, outside of the USA, UK and a few other countries high levels of unemployment continue to remain persistent in many industrialised countries. Solow⁶⁰ was particularly scathing of the NRU and stated “The proper conclusion is not that the vertical long-run Phillips curve version of the natural rate hypothesis is wrong. I would suggest instead that the empirical basis for the story is at best flimsy. A natural rate that hops around from one triennium to another under the influence of unspecified forces, including past unemployment rates, is not ‘natural’ at all. ‘Epiphenomenol’ would be a better adjective!’