Economic growth and unemployment is there a connection?

By Dr Frank Shostak

Some experts hold that the key to economic growth is a strengthening in the labour market. This way of thinking is based on the view that because of the reduction in the number of unemployed more individuals could afford to increase their expenditure. As a result, economic growth is likely to follow suit. 

The expanding pool of savings and not a declining unemployment is the key for economic growth  

We suggest that the key driver of economic growth is an expanding pool of savings and not the state of the labour market as such. Fixing unemployment without addressing the issue of savings is not going to lift the economic growth. 

It is the pool of savings that funds the enhancement and the expansion of the infrastructure. An enhanced and expanded infrastructure permits an increase in the production of the final goods and services required to maintain and promote individuals’ lives and wellbeing.

Now, if a decline in unemployment were the key driving factor of economic growth, then it would have made a lot of sense to eliminate unemployment as soon as possible by generating all sorts of employments programs. 

For instance, policy makers could have followed the advice of John Maynard Keynes and employ individuals in digging ditches, or various other government-sponsored activities. Note that the aim here is just to employ as many individuals as possible. 

Observe that since government is not a wealth generating entity, in order to fund its employment programs, it would have to divert savings from the wealth generators to various individuals that are going to be employed in these government employment programs. As a rule, this wealth diversion is done either by means of various taxes and levies or by means of monetary pumping.

A policy of wealth diversion leads to the depletion of the pool of savings. This in turn weakens the process of wealth generation and in turn undermines prospects for real economic growth.

Unhampered labor market and unemployment

Unemployment as such can be fixed relatively easy if the labor market were to be free from tampering by the government. In an unhampered labor market, any individual that wants to work will be able to find a job at a going wage for his particular skills. 

Obviously if an individual demands a non-market related salary and is not prepared to move to other locations there is no guarantee that he will find a job. For instance, if a market wage for John the baker is $80,000 per year yet he insists on a salary of $500,000, obviously he is likely to be unemployed. 

Over time, a free labour market makes sure that every individual earns in accordance with the value of the product generated by the individual. Any deviation from the value of his contribution sets in motion corrective competitive forces. 

Ultimately, what matters for the well-being of individuals is not that they are employed as such, but their purchasing power in terms of the goods and services that they earn.

Individuals’ earning power, all other things being equal, is conditioned upon the infrastructure that they operate. The better the infrastructure the more output an individual can generate. A higher output means that a worker can now command higher wages.  

Monetary pumping by the central bank that is supposedly aimed at helping workers improve their living standards achieves the exact opposite. Loose monetary policy undermines the pool of savings. 

This in turn weakens the wealth generators’ ability to enhance and improve the infrastructure. As a result, workers productivity comes under pressure and their ability to command higher wages weakens. 

Additionally, loose monetary policy after a time lag lifts the prices of goods and services thereby eroding workers earnings purchasing power. 

Is fixing unemployment cost free?

Once an economy falls into a recession and the unemployment rate starts to rise, most commentators are of the view that it is the duty of the government and the central bank to step in, in order to counter the rise in unemployment. 

Some commentators are of the view that the lowering of unemployment is going to be cost free given that the unemployed individuals are idle. According to Paul Krugman, 

If you put 100,000 Americans to work right now digging ditches, it is not as if you are taking those 100,000 workers away from other good things they might be doing.  You are putting them to work when they would have been doing nothing.

However, how is the lowering of unemployment going to be funded? Who is going to pay for this? It seems that Krugman and other commentators are of the view that funding can be easily generated by the central bank by means of printing presses. 

Again, contrary to Krugman and other commentators, funding is not about money as such but about savings, which is the amount of consumer goods produced less the consumption of these goods by the owners of these goods. 

Observe that in order to maintain their life and wellbeing what people require is final consumer goods and services and not money as such, which is just a medium of exchange. Money only helps to facilitate trade among producers— it does not generate any real stuff. 

Contrary to Krugman and other commentators, the artificial generation of employment such as digging ditches is not going to be cost free. Various individuals employed in non-wealth generating projects must be sustained i.e. funded. Since government does not produce any wealth, obviously, it cannot save and therefore it cannot fund any activity. 

Hence for the government to engage in various activities it must divert funding i.e. savings from wealth generators. This however weakens the process of wealth generation. 

The fallacy of insufficient demand

Whenever the so-called economy shows signs of weakness most experts are of the view, that what is required to prevent the economy sliding into a recession is to boost the overall demand for goods and services. If the private sector fails to increase its demand then it is the role of the government to do this.

Following the ideas of Keynes, most experts associate economic growth with increases in the demand for goods and services. There is however never such a thing as insufficient demand as such. We suggest that an individual’s demand is constrained by his ability to produce goods. The more goods that an individual can produce the more goods he can demand i.e. acquire. 

Note that the production of one individual enables him to pay for the production of the other individual. (The more goods an individual produces the more of other goods he can secure for himself. An individual’s demand therefore is constrained by his production of goods). 

Observe again that demand cannot stand by itself and be independent – it is limited by production. Hence, what drives the economy is not demand as such but the production of goods and services.  

In this sense, producers and not consumers are the engine of economic growth. Obviously, if he wants to succeed then a producer must produce goods and services in line with what other producers require.

If a population of five individuals produces ten potatoes and five tomatoes – this is all that they can demand and consume. No government and central bank tricks can make it possible to increase their effective demand. The only way to raise the ability to consume more is to raise the ability to produce more. 

The dependence of demand on the production of goods cannot be removed by means of monetary pumping and government spending. On the contrary, loose fiscal and monetary policies will only impoverish wealth generators and weaken their ability to produce goods and services – it will weaken the effective demand. 

Therefore, what is then required to revive the economy is not to boost aggregate demand but seal off all loopholes for the creation of money out of “thin air” and curbing government spending. This will enable true wealth generators to revive the economy by allowing them to move ahead with the business of wealth generation. 

We can conclude that by strengthening the economy’s ability to produce goods and services we are also strengthening the so-called aggregate demand and promoting real economic growth

Conclusion

A reduction in unemployment is not the key factor for economic growth. The heart of economic growth is the expanding pool of savings. It is savings that is instrumental in the expansion and the enhancement of the production structure. With an expanded and enhanced production structure, a stronger economic growth can be secured. 

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