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Creative inefficiency

13 November 2013 By Edward Hadas

Unemployment is a problem in most developed economies. Any politician, central banker or professional economist in the United States or Europe will admit that the published rates are unacceptably high, that too many people have left the paid labour force and that young people starting out have a particularly bad deal.

Americans often say their problem was caused by the 2008 financial crisis. That isn’t exactly wrong. After the failure of Lehman Brothers, many indicators of labour market depression – for example, the proportion of unemployed people who have been unemployed for more than six months – jumped to the highest levels on record (generally since 1948). Most of these indicators have improved, but remain uncomfortably high.

However, I think that the recession only uncovered longstanding structural weaknesses, and the problems I have in mind are not exclusively American. They just showed up in European statistics much earlier. Unemployment rates there have been persistently high, especially among the young, for decades. And the recorded unemployment numbers are flattered everywhere by the expansion of what might be called the non-labour force: those classified as suffering from incapacity, involuntary students and healthy retirees. 

The problems all start with what I call labour market asymmetry: in advanced economies it is much easier to destroy jobs than to create them. On one side, hiring people is expensive and risky, thanks to generous wages, high taxes and the high cost of firing established employees. On the other side, additional employment often isn’t needed to increase production and consumption, thanks to the ever more efficient use of increasingly productive technologies.

In short, modern economies are always under job-destroying pressure. Of course, some forces work against what John Maynard Keynes called technological unemployment. Jobs are added by the spread of new products and by the increased production of existing goods and services. The trend to spend less time on the job – a trend which has stalled in the last few decades – spreads the available labour over more workers.

In most countries, the 2008 financial debacle so weakened the forces of job creation that job destruction swept through the economies like a bad storm. Most of the lost jobs are gone forever, because the productive side of the economy functions quite well without them. GDP is now close to or above pre-recession levels. If nothing changes, renewed GDP growth will gradually create substitute employment, but as the record of the last five years shows, progress is slow.

Unemployment could be eliminated much faster. There are more than enough beneficial jobs waiting to be done. To create them, though, a change in one fundamental economic idea is required. The limits of efficiency need to be recognised.

Labour efficiency – more output for less input – is a reasonable goal for harvesting crops or making cars. But labour inefficiency is often desirable. Small children basically flourish with more adult attention, schools improve with more teachers, sick people recover better with more nurses, and life is enriched by labour-intensive cultural and educational activities.

Creative inefficiency in the labour market would be good for the economy. Policymakers should recognise this and make the prime goal of economic policy finding ways for jobs which are socially beneficial but relatively unproductive to make economic sense. And it’s not hard to conceive of practical policies to achieve this.

Taxes are a good place to start. As consumption is ample and jobs are in short supply in modern economies, the current tax arrangements, which often penalise employment, are crazy. Taxes on employers and incomes should be cut and taxes on consumption can be raised. Tax breaks or direct government payments for employers could reduce the high cost and risk of job creation. Tax revenues could even be used to create government jobs directly.

Labour policies should be made more pro-employment. Some policies could encourage the unemployed to accept work. Others could reduce the cost of current workers, freeing up funds for new hires. That would be politically unpopular, since most voters have protected positions. However, this majority could be persuaded that they would ultimately live better in a less efficient economy where pay was spread more evenly. I admit, though, that in a world fixated on GDP and GDP growth, such a preference requires a radical change in values.

Today’s policy menu is insufficiently radical. Low interest rates, additional government benefits and the European tinkering with labour laws do not really address the profound labour market asymmetry. And while their firm support of the financial establishment does protect some highly paid, economically inefficient jobs, surely we could do better.


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