The article mentioned below provides economists’ view on employment, full employment and unemployment in India.
Say’s Law and Employment:
Classical economists were of the view that there was always full employment in a free-market economy.
According to them, if there are lapses from the full employment level, then some forces would work automatically to restore full employment. Their view was based upon their faith in Say’s Law of Markets.
According to Say’s law, there is always enough expenditure or aggregate demand to purchase the total output produced with full-employment of resources. In other words, in their theory, the classical economists neglected the problem of deficiency of demand for purchasing goods produced at full-employment level of resources. Even when deficiency of aggregate demand arises, according to them, prices and wages would change in such a way that real production, employment and income will not decline.
J.B. Say was the famous French economist of the 19th century. Say’s Law is based on the fact that every production of goods also creates incomes for the factors of production equal to the value of goods produced by them. Incomes earned by the factors are spent on purchasing goods produced.
In other words, production of goods creates purchasing power for itself. Therefore, Say’s law is expressed as “supply creates its own demand”, that is, the supply of goods produced creates demand for it equal to its own value. As a result, the problem of general overproduction and unemployment of resources do not arise. In this way, in Say’s law, the possibility of lack of aggregate demand had been ignored.
We thus see that according to Say’s law, aggregate demand for goods will always be adequate so as to ensure that all resources are fully employed. The factors which participate in productive activity and earn incomes from it, spend a good part of their incomes on consumer goods and save some part of them.
But, according to classical economists, savings by the individuals are automatically spent on investment or capital goods. Therefore, since saving becomes another form of expenditure (that is, investment expenditure), in classical theory the whole income is spent, partly on consumption and partly on investment. There is thus no reason for any leakage in the income stream and therefore supply creates its own demand.
According to classical theory, it is the rate of interest which makes investment equal to saving. When savings of the people increase, rate of interest declines. As a result of fall in the rate of interest, demand for investment increases and in this way investment expenditure becomes equal to the increased savings. Hence, according to classical economists, it is changes in the interest rate that bring about equality between saving and investment and therefore Say’s law applies in spite of savings by the people.
This guarantees full employment of resources in the economy. In other words, it is changes in the rate of interest due to which the withdrawal of some money from the income stream as a result of savings automatically comes back to it in the form of investment expenditure and therefore income flow continues unchanged and supply goes on creating its own demand.
Flexibility in Prices and Wages and Full Employment: The View of Classical Economists:
Classical economists also proved the validity of the assumption of full employment with another reasoning. According them, especially the then living British Classical economist, A.C. Pigou, if changes in rate of interest somehow fail to bring about equality between savings and investment and as a result deficiency of aggregate demand or expenditure arises, even then the problem of overproduction and involuntary unemployment will not arise.
This is because they thought that the deficiency in aggregate demand would be made up by changes in the price level. When, due to the increase in savings by the people, the expenditure of the people declines, it will affect the prices of products. As a result of fall in aggregate expenditure or demand, prices of products would decline and at reduced prices their quantity demanded will increase. As a result, all the quantity produced of goods will be sold out at lower prices.
Thus, Classical economists thought that a free-market capitalist economy works in a self- correcting manner and when aggregate expenditure on goods or aggregate demand for them declines, then various sellers and producers will reduce prices of their products so as to avoid the excessive accumulation of stocks of goods with them. Hence, according to them, when aggregate demand declines due to investment expenditure falling short of saving the prices of products will decline, the level of production and employment remaining unaffected.
Further, to make their business profitable producers will have to reduce the prices of the factors of production such as labour. With a fall in wages of labour, all labourers who are willing to work at the new prevailing wages will get employment and all those who want to work at the lower wages will get employment.
If some workers do not want to work at lower wages, they will not get any job or employment and therefore will remain unemployed. But, according to Classical economists, those workers who do not want to work at lower wages and thus remain unemployed are only voluntarily unemployed.
This voluntary unemployment is not real unemployment. According to the classical thought, it is involuntary unemployment which is not possible in a free-market capitalist economy. All those labourers who want to work at the prevailing wage rate determined by market forces will get employment.
During the period 1929-33 when there was a great depression in capitalist economies, eminent classical economist A.C. Pigou suggested a cut in wage rates in order to remove huge and widespread unemployment prevailing at that time. According to him, the cause of depression and unemployment was that the Government and trade unions of workers were preventing the free working of the capitalist economy and were artificially keeping the wage rates at high levels.
He expressed the view that if wage rates were cut down, the demand for labour would increase so that all would get employment. It was at this time that J.M. Keynes challenged the classical theory and put forward a new theory of income and employment. He brought about a basic change in economic thought regarding the determination of income and employment. Therefore, it is often said that Keynes brought about a revolution in economic theory. Keynes made a genuine break and a basic departure from the Classical economics. His macro-economic theory is therefore called Keynesian Revolution or New Economics.
Keynes on Employment and Unemployment:
Towards the close of the nineteen twenties and early nineteen thirties (1929-33) free-market capitalist economies experienced severe depression rendering a large number of workers unemployed. For example, in the USA unemployment of labour increased from 3.2 per cent in 1929 to 25 per cent of labour force in 1933 and national income declined by 30 per cent during this period.
This huge unemployment of labour persisted for a long time and full employment did not get automatically restored. Therefore, it became evident that there was something wrong with Classical economics which believed in self-correcting nature of a free market economy to eliminate involuntary unemployment.
It was at this time that the English economist John Maynard Keynes challenged the classical theory of full employment, especially Say’s law and Pigou’s proposal to cut down wages to restore full employment. He put forth a new theory in his book “A General Theory of Employment, Interest and Money”.
Keynes laid a great stress on macro-economic analysis. He showed how incorrect was the view that involuntary unemployment could not prevail in a free-market capitalist economy. We explain below how he proved that Say’s law and Pigou’s view regarding wage-employment relationship was wrong.
Keynes challenged the correctness of Say’s law that supply creates its own demand. He also criticized Pigou’s view that a general cut in wages during depression and unemployment would restore full employment in the economy. As explained above, according to Say’s law, every supply of production creates its own demand. Therefore, problems of demand deficiency and unemployment do not arise.
It is, of course, true that supply creates demand for goods because the various factors which are employed in a productive activity earned incomes from it, which are spent on goods. But the incomes earn by the various factors of production are not wholly spent on the output of goods produced.
A part of the income that is saved does not create demand. If entrepreneurs do not invest equal to the desired savings by the people, then aggregate demand which consists of demand for consumer goods and capital goods, will not be enough to purchase available supply of output.
If aggregate demand is not sufficient to purchase the entire supply of goods, the producers would be unable to sell their whole output. As a result, their inventories of goods will increase beyond their desired level. This will cause the producers to reduce their level of production giving rise to unemployment in the economy.
Keynes showed that there was no guarantee that investment expenditure by entrepreneurs would be equal to the desired savings by the people. Saving and investment are generally made by two different classes of the people. While savings are done by individuals and households, investment expenditure is made by entrepreneurs.
Further, while savings depend on various subjective factors such as willingness to save for old age, for periods of sickness and unemployment, for education and marriage of their children, for amassing wealth to leave behind a large estate etc. Apart from these subjective factors savings depend on level of prices, rate of inflation, rate of interest, taxation policy of the Government, distribution of income and wealth in the society and expectations of future income.
On the other hand, investment by the entrepreneurs are determined by rate of interest and expected rate of profits in the short run and progress in technology, growth in population in the long run. Therefore, it is not likely that investment will be automatically equal to savings at full- employment level of income and output. As a result, problem of demand deficiency arises which causes involuntary unemployment.
Keynes also challenged the classical viewpoint regarding the impact of all-round cut in money wages on output and employment of labour. According to him, while in case of the analysis of price and output determination of an individual industry, it is justified to assume that a cut in wages by the industry would not significantly affect the demand for the product of that industry because most of the demand for the product of that industry comes from the workers and persons employed in other industries.
However, to assume that demand curve for output of all industries will remain unchanged when a simultaneous cut in wages in all industries together is made is not valid. In other words, to apply the result of micro analysis of the determination of price, output and employment in an individual industry to the economy as a whole is quite misleading and invalid.
This is because wages are not only costs for the individual industries, they also constitute incomes of the workers and these incomes determine the demand for the products of various industries. When all-round cut in wages is made in all industries, it will reduce aggregate demand for the products because workers would have now less incomes and therefore would spend less on goods and services. With reduced demand for the products of industries smaller output will be produced. As a result, smaller amount of labour will be demanded and employed.
Keynes explained that level employment was determined by aggregate demand and aggregate supply. He further showed that equilibrium level of income and employment could well be established at less than full-employment level of national income. Thus, according to him, lack of aggregate demand can cause involuntary unemployment of labour and un-utilised productive capacity.