Inflation & Unemployment I: Economic policies

Reducing unemployment and stimulating the economy has been one of the biggest, if not the only, concerns of governments since the dawn of economic science. Economic policies have been very much theorized, and by many doctrines.  As a result, a rich and plentiful literature has been developed on this topic. We will discuss the main economic policies:

1. Policies in order to reduce labour supply:

By reducing labour supply the government is reducing the number of people that are legally suitable to work, what is known as the labour force, and by doing so it indirectly reduces unemployment. This kind of policy is mostly effective when targeted over a group that has a higher unemployment rate than the average. If a country suffers from high unemployment amongst the young population, by increasing the minimum age of employment, governments will decrease unemployment levels. It will also be useful even if the targeted group has a low level of unemployment, as there will be new vacancies that unemployed can fill.  Other examples of this policy include retirement age reduction and the increase of military service duration. However, as it can be easily seen, these policies are what Frenchmen would call “trompe-l’oeil”, that is, they reduce or eliminate the symptom (unemployment), but without treating the disease (the economy malfunction).

2. Policies to stimulate labour demand:

There are different policies depending if they affect demand of labour by using demand-side policies or supply-side policies.

-Demand-side policies stimulate the economy by increasing the demand for goods and services, thus incentivising firms to produce more, which will result in firms hiring more workers. Expansive fiscal and monetary policies are the tools that governments can use. This kind of policies is considered by their different advocates (Keynesian economists would implement fiscal policies whilst monetarists would implement monetary policies) to be most effective at reducing cyclical unemployment during economic depression.

-Supply-side policies focus on firms and their production of goods and services, in order to increase the supply (output) of the economy. These policies aim at the costs of labour and the production function.  If the cost decreases there will be more money available to increase the workforce. This kind of policies is nowadays regarded by the latest economic doctrines as the only real possibility to ensure a perdurable economic growth. However, they are less attractive than demand policies since they need time to be implemented and to generate actual effects on unemployment and growth.

3. Structural reforms:

These policies aim at reducing real wages. With lower wages, the firms will be able to hire more workers. Examples of this policy are: minimum wage reduction, unemployment benefit reduction and removing differences between insiders and outsiders.

4. Income policies:

A pact between the firm and its workers allow for reduction of real wages, this way firms can hire more labour force, which reduces unemployment levels.

5. Labour distribution policies:

Employees will work fewer hours, they will earn less, and so a greater amount of employees will be able to be hired. Marginal productivity is also increased by these policies. However, these policies are not really popular.

It is important to notice that not all policies are effective in the same time frame nor their effects remain over the same period. While supply-side policies and structural reforms have an effect in the long term, the rest have an effect in a shorter time, being this the reason why they were thoroughly studied by Keynesians and monetarists. However, contemporary economic doctrines, such as New Classical Macroeconomics and New Keynesian Economics have proven their inefficiency, thus turning back to supply-side policies as the only plausible solution.