Full Employment

The Meanings of Full Employment

Today—as thirty and forty years ago—economists debate

  • how much employment is voluntary, how much involuntary;
  • how much is a phenomenon of equilibrium;
  • how much is to be blamed on monopolies, labor unions, and restrictive legislation;
  • how much unemployment characterizes “full” employment.

A concept of full employment more congenial to economic theory is labor market equilibrium, a volume of employment which is simultaneously the amount employers want to offer and the amount workers want to accept at prevailing wage rates and prices.

Forty years ago theorists with confidence in markets could believe that full employment is whatever volume of employment the economy is moving toward, and that its achievement requires of the government nothing more than neutrality, and nothing less.

After Keynes challenged the classical notion of labor market equilibrium and the complacent view of policy to which it led,

full employment came to mean maximum aggregate supply, the point at which expansion of aggregate demand could not further increase employment and output.

Full employment was also regarded as the economy’s inflation threshold. With a deflationary gap, demand less than full employment supply, prices would be declining or at worst constant. Expansion of aggregate demand short of full employment would cause at most a one-shot increase of prices.

For continuing inflation Opens in new window, the textbooks at the time told us, a necessary and sufficient condition was an inflationary gap, real aggregate demand in excess of feasible supply. The model was tailor-made for wartime inflation.

Postwar experience destroyed the identification of full employment with the economy’s inflation threshold. The profession, the press, and the public discovered the “new inflation” of the 1950s, inflation without benefit of gap, labeled but scarcely illuminated by the term “cost-push.”

Subsequently the view of the world suggested by the Philips curve Opens in new window merged demand-pull and cost-push inflation and blurred the distinction between them.

This view contained no concept of full employment. In its place came the tradeoff, along which society supposedly can choose the least undesirable feasible combination of the evils of unemployment and inflation.

Many economists deny the existence of a durable Philips tradeoff.

Their numbers and influence are increasing. Some of them contend that there is only one rate of unemployment compatible with steady inflation, a “natural rate” consistent with any steady rate of change of prices, positive, zero, or negative.

The natural rate is another full employment candidate, a policy target at least in the passive sense that monetary and fiscal policy makers are advised to eschew any numerical unemployment goal and to let the economy gravitate to this equilibrium. So we have come full circle.

Full employment is once again nothing but the equilibrium reached by labor markets unaided and undistorted by governmental fine tuning.

Unemployment Policy: Measurement of Full Employment

The idea that policy can and should be directed at the attainment of a particular, specifiable level of the measured rate of unemployment (as opposed to mitigating fluctuations in unemployment) owes its wide acceptance to John Maynard Keynes’ General Theory. Opens in new window

It is there derived from the prior hypothesis that measured unemployment can be decomposed into two distinct components: “voluntary” (or frictional) and “involuntary,” with full employment then identified as the level prevailing when involuntary unemployment equals zero. It seems appropriate, then, to begin by reviewing Keynes’ reasons for introducing this distinction in the first place.

Keynes classifies the factors affecting equilibrium employment in a real general equilibrium theory: the mechanics of matching workers to jobs, household labor-leisure preferences, technology, and the composition of product demand.

Is it the case, he asks, that spontaneous shifts in any of these four real factors can account for employment fluctuations of the magnitude we observe? Evidently, the answer is negative.

It follows that two kinds of theory must be needed to account for observed unemployment movements: granted that real general equilibrium theory may account for a relatively constant, positive component, some other theory is needed for the rest.

Accepting the necessity of a distinction between explanations for normal and cyclical unemployment does not, however, compel one to identify the first as voluntary, as Keynes goes on to do.

This terminology suggests that the key to the distinction lies in some difference in the way two different types of unemployment are perceived by workers. Now in the first place, the distinction we are after concerns sources of unemployment, not differentiated types.

One may, for example, seek very different theoretical explanations for the average price of a commodity and for its day-to-day fluctuations, without postulating two types of price for the same good. Similarly, one may classify motives for holding money without imagining that anyone can subdivide his own cash holdings into “transactions balances,” “precautionary balances,” and so forth.

The recognition that one needs to distinguish among sources of unemployment does not in any way imply that one needs to distinguish among types. Nor is there any evident reason why one would want to draw this distinction.

Certainly the more one thinks about the decision problem facing individual workers and firms the less sense this distinction makes.

The worker who loses a good job in prosperous times does not volunteer to be in this situation: he has suffered a capital loss. Similarly, the firm which loses an experienced employee in depressed times suffers an undesired capital loss.

Nevertheless the unemployed worker at any time can always find some job at once, and a firm can always fill a vacancy instantaneously. That neither typically does so by choice is not difficult to understand given the quality of the jobs and the employees which are easiest to find.

Thus there is an involuntary element in all unemployment, in the sense that no one chooses bad luck over good: there is also a voluntary element in all unemployment, in the sense that however miserable one’s current work options, one can always choose to accept them.