Involuntary Unemployment

BIBLIOGRAPHY

Unemployment is a labor-market state in which a person is without a job and is actively looking for work. There is nothing, however, in this definition to suggest whether the person is unemployed voluntarily or involuntarily. Prior to the publication of John Maynard Keynes’s General Theory of Employment, Interest, and Money in 1936, mainstream economists within the “classical” (or, more correctly, the “neoclassical”) tradition categorized unemployment into two major types, both relating to the supply side of the labor market. Unemployment could be conceived as a short-term equilibrium phenomenon arising from the choice of workers to participate in the labor market and engage voluntarily in job search—a situation in which individuals could find themselves temporarily “between jobs” and in a state of “frictional unemployment.” On the other hand, unemployment was also construed as a disequilibrium phenomenon arising from the existence of institutional barriers in the labor market, such as trade unions, government fiscal and monetary policy, and the market power of firms, which were presumed to prevent the downward adjustment of real wages to shortfalls in labor demand. In this latter case, individual workers could be said to be involuntarily “off their labor supply function” because of labor-market imperfections. If only wages could be left to adjust freely to fluctuations in labor demand and supply, it was believed that competition would clear the labor market and result in a state of equilibrium at full employment compatible with the presence of only voluntary and/or frictional unemployment. From this orthodox analysis, it ensues that the existence of job scarcity in the labor market could never be a long-term phenomenon, unless institutional forces persist to prevent market clearance.

Keynes challenged this particular conception of the labor market. While recognizing the existence of frictional unemployment, he questioned the neoclassical view of unemployment as a supply-side phenomenon resulting from wage rigidity. For Keynes, the labor market cannot be analyzed in isolation but, instead, is itself dependent on conditions in the overall product market. Through derived demand for labor, it is the state of aggregate effective demand for goods and services in the economy that ultimately sets the constraint on the level of employment, and not the lack of a mechanism of competitive downward wage adjustment in the labor market that generates unemployment. Furthermore, even the most unlikely situation, where workers accept a reduction of their money wage, would not necessarily guarantee a reduction of their real wage. Indeed, Keynes argued that because of the negative feedback effect on current and expected future sales proceeds, a cut in wages could only make matters worse and result in even higher (rather than lower) unemployment.

Keynes dubbed this type of unemployment endemic to a demand-constrained economy stuck in a state of underemployment equilibrium—“involuntary unemployment.” In chapter 2 of the General Theory, Keynes provides a test for the existence of involuntary unemployment:

Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. (Keynes 1936, p. 15, emphasis in original)

In short, if the gap between labor demand and supply persists with a fall in the real wage (brought about by a rise in prices), individual job seekers would be considered by Keynes to be in a situation of involuntary unemployment—a state associated with a nonzero elasticity of employment and output with respect to changes in aggregate demand (Darity and Young 1997, p. 26). In highlighting a particular causal sequence—going from changes in prices (for a given money wage) to a fall in real wages—he asserted that the fundamental cause of involuntary unemployment is job scarcity and the inadequacy of existing demand, not workers’ obstinacy in resisting a cut in their real wage, as maintained by neoclassical economists.

Soon after the publication of the General Theory, numerous economists began to reinterpret Keynes’s analysis. Influenced by Keynes’s own empirical recognition of the stickiness of money wages in chapter 2 of the General Theory and the assumption of the money-wage unit as a mere historical datum, beginning with Franco Modigliani (1918–2003) in 1944 writers began to postulate a labor-supply function that is perfectly elastic up to full employment at a historically given money wage. Consequently, they began to explain involuntary unemployment as the result of workers’ resistance to money wage adjustment because of irrational behavior (sometimes referred to as “money illusion”). A whole generation of Keynesian economists, such as Modigliani and James Tobin (1918–2002), from the 1940s to the 1960s built macroeconomic models to explain unemployment on the basis of this static wage rigidity assumption, despite the fact that Keynes himself had rejected wage stickiness as an explanation of involuntary unemployment. In the early post–World War II (1939–1945) years, however, there emerged a related, yet competing strand of thought, commencing in 1948 with the work of Don Patinkin (1922–1995), who reinterpreted a state of involuntary unemployment as a dynamic disequilibrium due not to exogenous wage fixity but to the sluggish adjustment of wages to labor market pressures. By the late 1960s and early 1970s this work had given rise to the so-called disequilibrium theory of involuntary unemployment, associated with such writers as Robert Clower, Robert J. Barro and Herschel I. Grossman, and Edmond Malinvaud. Whether framed in an equilibrium (static) or disequilibrium (dynamic) setting, in both strands of analysis the cause of involuntary unemployment was the lack of adequate downward adjustment of wages and prices to shortfalls in aggregate effective demand.

During the 1970s and 1980s both of these approaches quickly succumbed to the criticisms of Milton Friedman, Robert E. Lucas, and the new classical economists because of problems of logical inconsistency and insufficient microeconomic grounding. According to the monetarists and the new classical economists, one cannot develop theories of the economy that assume rational behavior for an economic agent in the product market (say, as consumer) but irrational behavior as supplier of labor services in the labor market, as the earlier Keynesian writers had surmised. Moreover, because of their assumption of continual market clearance, new classical economists easily eschewed the sluggishness argument of the disequilibrium theorists. Hence, new classical economists such as Lucas were able to conclude that it was not possible, “… even in principle, to classify individual unemployed people as either voluntary or involuntary unemployed …” (Lucas 1981, p. 243).

Despite the attempt of new classical economists to purge involuntary unemployment from the vocabulary of modern macroeconomics, the concept of involuntary unemployment has shown resilience in the hands of both New Keynesian and post-Keynesian economists over the last two decades. Numerous New Keynesian models have been developed within a choice-theoretic microeconomic framework compatible with neoclassical theory. Particularly noteworthy is the abundant literature on implicit contracts and on efficiency wages that reconcile wage rigidity and involuntary unemployment and now see the existence of the latter as a Pareto-efficient solution in the labor market (see Davidson 1990). In contrast, post-Keynesian models that follow more closely Keynes’s original insights emphasize the macroeconomic basis of their theories of involuntary unemployment in which wage rigidity plays no role, even though some are founded on microeconomic foundations of Marshallian pedigree (see Davidson 1994, chapter 11).

The notion of involuntary unemployment is at the core of Keynesian theory. Ever since the publication of Keynes’s General Theory more than seventy years ago, this concept has been plagued with controversy and has remained a wedge that separates those who believe that a capitalist economy is prone to systemic instabilities, as reflected in the existence of periodic recessions accompanied by mass unemployment, from those who believe in the strength of the self-correcting forces in market economies, in which actual unemployment is conceived as a mere short-term transitional phenomenon gravitating around some stable, long-term “natural” rate of unemployment. Although today one could find some strong Keynesian sympathizers who might even be prepared to do away with the concept of involuntary unemployment because of conceptual difficulties and refer, instead, to some less controversial notions of underemployment (see De Vroey 2004), the former concept still remains very deeply ingrained in the professional vocabulary of many contemporary economists.

SEE ALSO Employment; Keynes, John Maynard; Unemployment; Voluntary Unemployment

BIBLIOGRAPHY

Darity, William, Jr., and Warren Young. 1997. On Rewriting Chapter 2 of The General Theory. In A “Second Edition” of The General Theory, vol. 1, eds. G. Colin Harcourt and Peter Andrew Riach, 20–27. London and New York: Routledge.

Davidson, Carl. 1990. Recent Developments in the Theory of Involuntary Unemployment. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research.

Davidson, Paul. 1994. Post-Keynesian Macroeconomic Theory: A Foundation for Successful Economic Policies for the Twenty-First Century. Aldershot, U.K.: Edward Elgar.

De Vroey, Michel. 2004. Involuntary Unemployment: The Elusive Quest for a Theory. London and New York: Routledge.

Keynes, John Maynard. 1936. The General Theory of Employment, Interest, and Money. London: Macmillan.

Lucas, Robert E., Jr. 1981. Unemployment Policy. In Studies in Business Cycle Theory, ed. Robert E. Lucas, Jr., 240–247. Cambridge, MA: MIT Press.

Mario Seccareccia