The economics of employment and growth looks upside down
3 min read 22 Mar 2023, 11:20 PM ISTTextbooks in economics link growth with employment, which sounds logical
PremiumTextbooks in economics link growth with employment, which sounds logical. Keynesian theory says that as a government spends money to alleviate unemployment, incomes would rise, leading to consumption and then investment, which through the multiplier effect would raise economic growth. Higher growth, thus, goes along with high employment. As an extension, the Phillips Curve showed that as employment rose beyond a point, inflation would result. The Friedman-Phelps theory argued that something called the ‘natural rate of unemployment’ exists and cannot be escaped in the long run. As central banks expand money supply to spur growth, it would lead to inflation while growth will increase marginally. Wages would increase in response, with job cuts and unemployment to follow. So monetary policy can’t always foster growth and employment together.
The Rational Expectations School made famous by Robert Lucas and Thomas Sargent had a different take, which said that policies cannot spur growth or employment. If information was symmetric and accessible to all agents, then everyone would respond rationally based on that data. Hence action would be predictable and there would be no real impact. As a corollary, the only way authorities could make an impact was to throw in surprises. But it would be temporary, so unemployment would be in equilibrium most of the time and would be similar to the ‘natural rate’.
This assumes relevance amid global talk of a recession, a situation of weak or negative growth with massive job losses. However, conventional theory has been turned upside down by developments in the world economy.
The US Federal Reserve has reiterated that a US slowdown has not led to higher unemployment. It is at a low level of 3.4% while the natural rate is considered 4.6%. Yet, GDP growth is down, at 2.1% in 2022. Contrast this to India, where GDP growth is expected to be 7%, the world’s highest. Yet, joblessness is at around 7.5%, having varied from 6.4% to 8.3% on a monthly basis during the past year.
This kind of ambivalence cuts across developed and emerging economies. Japan has GDP growth of 1.4% and an unemployment rate of 2.5%; Germany, 1.7% and 2.9%, respectively, and the UK, 4% and 3.7%. Slow growth there does not go along with job losses.
Data on emerging markets, though, gels more with theory; lower GDP growth rates are associated with high unemployment rates, as is the case with South Africa, Brazil and China, where joblessness rates are above 5% and GDP growth under 5%. Within Europe, Spain and Greece have double-digit unemployment but growth above 5%, as with emerging markets.
A possible explanation for this new picture in the West is that the covid pandemic moved people out of the labour force. This could be because of financial support provided, on account of health reasons, or a desire to work less, with fewer people looking out for jobs. Further, significantly, notwithstanding reports of job losses in the tech space, companies may have been lenient on layoffs in tough times. Firms expecting better prospects in the coming years would have decided to preserve their headcount even if it meant keeping excess staff benched. And last, related to the first two factors, the travails of demographic change have started to affect countries where the older population has moved out of the job market, thanks partly to government support.
This situation is ideal for the US Fed and other central banks that need to get inflation back under control, for they need not worry about increasing interest rates, as this action has had little bearing on jobs. Therefore, they can persevere with the monetarist view that inflation is always a monetary phenomenon.
India, however, has a different story. High economic growth in relative terms is expected in 2023-24 too. Yet, we face a constant problem of weak job creation. Interestingly, going by CMIE data, India’s average unemployment rate would be 7.3% if covid-year 2020-21 is excluded, and 7.8% if included. Just as the US has an estimated natural joblessness rate of 4.6%, India too might have one—at around 7%. And this may remain so high for a variety of reasons.
The country’s so-called demographic dividend means that more people will be progressively entering the workforce. Are we creating enough jobs for them? With India’s manufacturing sector struggling with slow growth, it is unable to enhance its absorption of labour. Jobs are being created more in the services sector, including logistics, construction, retail, where limited skills are needed.
The other challenge is that our labour participation rate has been coming down, which is a serious issue. It is down from around 46% in 2016-17 to 40% in 2021-22. This suggests that people are unwilling to migrate from their home-towns and villages in search of jobs and have probably ended up in farming.
All considered, one gets the impression that even though India’s nominal per capita income has gone up by 51% in the last 5 years, we face a distribution distortion. If large numbers of people are unemployed or opting out of the workforce, then economic growth translates into rewards at the upper end of our income pyramid, reflecting inequality. And this is certainly a problem.
These are the author’s personal views
Madan Sabnavis is chief economist, Bank of Baroda, and author of ‘Lockdown or Economic Destruction?’
