George Osborne's "commitment" to full employment poses the question: what's stopping us reaching it?
The standard answer is the Nairu; if unemployment falls below a particular rate, inflation will rise.
This answer, though, runs into a problem. Since the start of 1997 the correlation between the unemployment rate and CPI inflation in the following 12 months has been strongly positive - 0.46 in quarterly data. It is high unemployment that has led to higher inflation, not low. Falling unemployment in the early 00s led to low inflation, and the rise in inflation in 2007-08 followed a rise in unemployment. And the recent drop in inflation has followed a fall in unemployment.
This might tell us that inflation and unemployment have both been driven by supply shocks - a low China price in the early 00s and rising commodity prices in 07-08. Or it might just show that the idea of the Nairu doesn't make sense in an open economy. The standard undergrad macro textbook says:
In the closed economy there is a unique unemployment rate consistent with constant inflation. By contrast, in an open economy, there is a range of unemployment rates consistent with the absence of inflationary pressure. (Carlin and Soskice, p343)
However, it doesn't follow that we can achieve full employment simply through expansionary demand policies. There might be another constraint on this - the current account deficit.
Now, you'd expect there to be an inverse relationship between the current account balance and unemployment; when unemployment is high, domestic demand is weak and so imports should be low which should mean a current account surplus, and conversely the high demand that reduces unemployment should also suck in imports, causing a deficit.
However, last week's figures suggest that this trade-off has worsened. We had a near-record deficit of 5.4% of GDP in Q4, despite a jobless rate of 7.2%. In early 2009 the same jobless rate was associated with a deficit of just 1.4% of GDP, and in 1997 it was associated with a surplus.
This suggests that any attempt to significantly cut unemployment by higher demand would suck in even more imports causing an even bigger deficit. This might be sustainable for a while - we're starting with low net overseas liabilities - but it can't last forever.
Worse still, the two obvious solutions here are questionable.
One is for sterling to fall. However, the pound fell by 20% in late 2008 without a major stimulatory effect. And engineering a fall in sterling at a time when other nations are running loose monetary policies might be difficult.
The other is to simply let overseas demand rise. But this might not be sufficient. OECD data show that the volume of world trade in goods and services has grown by 29.5 per cent since it troughed in the second quarter of 2009. However, during this period the volume of UK exports of goods and services has grown by only 15.1 per cent. This warns us that stronger overseas demand might not be sufficient - because some mix of gravity or some supply-side failure is holding back exports.
Perhaps, then, there is a constraint upon how far we can reduce unemployment through demand policies. There are two implications of this.
The one that's friendly to Osborne is that he's right to see that full employment needs some kind of supply-side policies - though whether tax and benefit reform is sufficient is doubtful.
The less friendly implication is that Osborne (and I suspect Labour too) are giving us another example of cargo cult management. Announcing a target without any idea of how to achieve it is just, well...
However, the pound fell by 20% in late 2008 without a major stimulatory effect.
> there's a reason the car industry is doing so well.
Posted by: Alex | April 01, 2014 at 02:22 PM
"This might be sustainable for a while - we're starting with low net overseas liabilities - but it can't last forever."
It can last for a very long time - until the exporters decide to change their policy stand in fact, and at that point it may slowly decline over a very long time.
There is no basis for this belief that the trade deficit is 'unsustainable' at all. None whatsoever.
It is formed entire on the incorrect understanding of the causality - which in reality likely runs from the trade deficit to the budget deficit, for the fairly obvious reason that the trade deficit is caused by excess saving.
The way you have full employment is to declare the unemployed to be employed, pay them a living wage and get them something to do: http://www.3spoken.co.uk/2014/03/full-employment-is-when-everybody-has.html
It's called a Job Guarantee, and it's dead simple.
Posted by: Neil Wilson | April 01, 2014 at 05:20 PM
Perhaps he is promising but a political undertaking with no expectation of any impact on the economy. I suspect him of priming the ground to laud as a success for Conservative full employment policies, Community Work for Benefits, IDS’s proposed next step.
Posted by: e | April 01, 2014 at 06:44 PM
As you "free up" trade you lose your levers for controlling trade deficits. Throw in massive consolidation in manufacturing, but also digital services (there is only 1 Facebook and if you don't have it, you're paying a foreign body to advertise there) then there are structural deficits which are basically impossible to overcome…
Not sure where you go from there...
Posted by: Metatone | April 01, 2014 at 10:51 PM
There may be another explanation for the positive correlation between inflation and unemployment since 1997. Many of those in work on low wages would be better off unemployed and on benefits. Unemployment goes up, the incomes of the poorest in society increase, inflation rises. Unemployment falls the poor are worse off, inflation falls.
Posted by: Mark | April 01, 2014 at 10:51 PM
Slaves are usually fully employed. I take it that is the sort of full employment this regime want. But that is not really what it was taken to be under less reactionary governments.
Posted by: Keith | April 01, 2014 at 11:52 PM
You could use Import Certificates...
http://en.wikipedia.org/wiki/Import_Certificates
Posted by: Doc at the Radar Station | April 02, 2014 at 02:02 AM
Yes, but to implement such unilaterally we'd have to leave the EU. And UKIP aren't advocating this (or any other protectionist measures) AFAIK...
Posted by: George Carty | April 02, 2014 at 07:15 AM
The usual link to a graph showing how quickly and massively the UK has switched in the past few years from an oil exporter to an oil importer:
http://mazamascience.com/OilExport/output_en/Exports_BP_2013_oil_bbl_GB_MZM_NONE_auto_M.png
Note that consumption is going down, and yet imports are growing fast, and the latest data is not there, and it is much worse.
Posted by: Blissex | April 02, 2014 at 10:54 PM